Partnerships: How To Avoid A Nasty Breakup

31-Aug-2017

In the early stages of starting a business, you and your business partner work tirelessly to set-up the business to hit the ground running – brainstorming the business' name, setting up social media accounts and finalising the fit out. It's an exciting time. Neither you nor your business partner are considering any issues that could arise. But no relationship is immune to a breakup.

A shareholders agreement is a contract that sets out the business partners' rights and obligations towards each other and the company. The first step when an issue arises is to revisit the shareholders' agreement (if there is one) that sets out the dispute resolution procedure. It's easier to negotiate terms at the beginning of the business relationship than in the middle of a dispute when parties are entrenched in their positions and less likely to compromise.

Are We Business Partners or in a Partnership?

We’ve all likely heard the word ‘partner’ tossed around in various contexts. In the small business space, a business partner refers to a person who is either:

  • committed with you to a business venture; or
  • operating a business with you as a partnership.

The difference is important. Individuals who are committed to a business venture can be business partners and choose from a number of different structures to establish the business, such as a partnership, company or trust structure.

On the other hand, a business partnership means that you have established a legal relationship with your partner(s) with a partnership structure. As a result, you will have fiduciary duties towards each other. There are three types of partnership business structures: a partnership, a limited partnership and an incorporated limited partnership. Each structure differs in complexity, liability of the partners and tax treatment. If you are entering into a partnership business structure, it is recommended to have a well-drafted partnership agreement. However, if you are looking to set up a business with your business partners in a company structure (which has benefits of limited liability for directors and more advantageous tax planning rates), you will likely need to enter into a shareholders agreement.

Important Clauses in a Shareholders Agreement

Clause
What it means
What it does
Roles and obligations  A description of the roles and responsibilities of each partner.  Depicts the expectations of each partner to avoid any disputes about roles and responsibilities.
Confidentiality  Sets out what constitutes confidential information (e.g. financial records, client lists, trade secrets etc.) and limits its disclosure to third parties.  Protects confidential information and the interests of the business even after a partner leaves the company.
Intellectual Property Ensures all intellectual property (such as trade marks) created by a partner is assigned to the company. Ensures that the company owns all intellectual property created for and required to operate the business.
Dispute Resolution Provides the process to be used to reach an agreement in the event of a dispute. Ensures that disputes are dealt with both efficiently and effectively in a way both parties have agreed upon.
Restraint of trade Prevents a partner from competing with the business, poaching clients and benefiting from confidential information. Protects the goodwill and reputation of the company and prevents your partner exploiting the business
Termination Details the way in which a partner can remove himself/herself from the business if things become difficult. Provides a mutually agreed upon way for a partner to exit the business with minimal negative impact.

Practical Considerations When Resolving Disputes

Identify mutual interests

Both you and your partner will have your own interests in the business and reasons for wanting to "break up" (i.e. exit the business). Identifying shared interests makes it easier to achieve a fair outcome in the event of a dispute. Cooperation goes a long way, as does mutual respect.

Negotiate

Try to stay calm and level-headed when negotiating with your partner. Identify what is working, what isn't and why. Remember that the more open and honest your communications, the easier it is to reach a reasonable solution. This involves acknowledging your partner's interests and shared interests when negotiating.

Keep a paper trail

Document all correspondence and interactions in relation to anything concerning the business. It’s much easier to rely on a documented paper trail as opposed to word of mouth and memory when in the middle of a disagreement.

Plan ahead

Before your business relationship even officially begins, consider what you would want to happen if the relationship was to break down. A good starting point is to ask questions like:

- Would one partner buy the other one out? If so, at what price? 

- Would the departing partner be entitled to take any assets or intellectual property with him/her or would everything remain with the company?

It’s important to come to a mutual written agreement regarding these questions before a dispute, to ensure that there is a clear procedure to follow if necessary. A well-drafted shareholders agreement containing clear, previously agreed-upon dispute resolution provisions can help you avoid the messiness of a breakup with a business partner. Following simple and practical considerations when dealing with the fallout can also soften the blow and ensure the breakup is as amicable as possible.

Authors: Jill McKnight and Casey D’Souza, of Legal Vision. If you have any questions or need assistance with small business legal questions, including partnerships, get in touch on 1300 544 755 or legalvision.com.au