Napolitano says every January might be the right time to look at and revise partnership agreements.
Most partnerships are forged because people want to work together. There may be a little more than that in some cases, as in one has the capital and the other has the knowledge or business acumen. But generally, unless you inherited something with someone else, partnerships should be based on an amicable relationship with a prosperous goal.
All partnerships share similar risks and issues whether you deem it a good partnership or one that isn’t working. The common issues include capital obligations, splitting of net income, division of duties and responsibilities and terms for what happens if someone becomes disabled or passes prematurely.
Regardless of how big or small your partnership is, you need a written agreement among the partners. This agreement should be updated often, even annually.
A yearly update may be the best way to update the value of the partnership interest in the event of death or disability. You may have legal documents where a valuation is required upon the triggering event – change it. This is extremely dysfunctional.
Perhaps a better solution may be to have the value agreed upon by all of the partners on an annual basis. If your agreement has language that calls for a valuation after something occurs, ask your professional accountants and lawyers for the language that is more specific with respect to value. If you don’t fix it, you’ll remember this comment when the ugliness of death or disability causes a valuation confrontation among the partners.
The division of responsibilities and net profits may cause an issue if the efforts are not somewhat equal or agreed upon in advance. For example, when there’s rental property with multiple owners, it’s common for one to manage the property. In most partnerships that I’ve seen, there is rarely any compensation to the managing partner and that may cause some ill will. Be clear in your agreement about who does what and whether there should be compensation to anyone for their efforts.
Similar problems can arise when the partnership needs additional capital. Absent an agreement, your partnership may be stuck in the mud if lacking clear language regarding the inability to make timely capital contributions. A good partnership agreement will stipulate how that is handled, whether interest is paid to the contributing partners for their support, a dilution of the ownership interest of the noncontributing partner, or a preferred distribution upon dissolution of the partnership.
Last is the language regarding a partner’s death or disability. There are a few things that really matter here.
First – what happens to your partner’s interest? Does it go to their heirs or is their interest bought out? If your partner has a sloppy estate plan (which many do!), your partnership may get dragged into a prolonged estate settlement or disputes that arise along the way.
Make sure that both the valuation and the terms of the buyout are affordable. Too often I see terms that are unreasonable and that the surviving partner cannot easily afford.