This article is one in a series dealing with partnerships. It covers issues that can come up in a family business and provides important guidance as to why you need a formal partnership agreement in place in a family or husband and wife business.
Plenty of people advise (based on their personal experience), that you should not start a business with a family member. The reason so many family businesses end sourly is because the owners never bothered to establish a clear business structure. Being unclear leads to costly mistakes and strained relationships.
So if you are thinking of starting a business with your spouse, or if are already running one, without having given any consideration to the structure under which the business will or should be operating, this is where you should start.
What is a business partnership?
A partnership is a type of business structure where two or more parties enter into formal arrangement to manage and operate a business and to share the profits that will be made.
Further, in law, unlike companies or individuals, partnerships are not legalistic persons. Partnerships do not have their own legal personality. They are simply a framework of rules that govern how partners in a business will work together so that they can reap the benefits of shared support.
There are a number of types of partnership arrangement that you can adopt: general or ordinary partnership, limited partnership, and limited liability partnership.
In a partnership, you’ll want to establish and set out the key nature and details of the business including the capital investment made by each of the partners, the roles of the partners such as their rights and responsibilities, and a procedure to adopt in case the business relationship breaks down.
While you may not have started a business with your spouse thinking or planning to have problems or disagreements, it is a very real possibility, and one for which you should prepare and plan.
Why you need a formal business partnership arrangement with your spouse?
Regardless of with whom you are starting or running a business, you should always enter into a formal arrangement that governs the structure of the business. This is not any less true just because you are in business with a member of your family or even your spouse. In such cases, there really is no problem until there is one. Yet still, many husband and wife businesses start without any formal arrangement in place.
Having disagreements or problems relating to how the business will be operated and decisions will be made is a real possibility - one which you need to think about and plan ahead.
You do not want issues arising from running of the business to get in the way of your personal relationship with your spouse. This is where documenting the partnership arrangement comes in. It not only helps avoid miscommunication, it can also prevent legal disputes and keep the business running and afloat should there be an issue between the two of you.
In cases of informal partnerships, the law dictates that the relationship between business partners is governed by a set of default rules set out in the Partnership Act 1890 which dates back over a hundred years.
The default position does not reflect how modern day partnerships operate.
For instance, in absence of a formal partnership arrangement, assets of a partnership will vest equally in all its partners. In cases where one partner invests more or works more than the other, equal ownership of all assets may not reflect the true intentions of the parties. This may lead to legal problems.
Therefore, a partnership agreement is required to not only improve the default provisions but also to set out in greater detail how the business will work. This is even more true where the business is going to be the primary source of income for a household.
Consequently, you need a formal partnership arrangement that lays out the roles and responsibilities of you and your spouse in the business, limiting the issues which may come up and providing an effective method to deal with any disagreements.
Some important factors and areas that you should consider are as follows.
Ownership of the business
You need to discuss and decide early on what percentage of the business is owned by each of you.
A fifty-fifty split may be simplest, but there may be other reasons why a different split is more attractive.
Equal partnership in a family business may sound reasonable and natural since the partners may have assumed that they will always be able to work out whatever issues they have. Nevertheless, a 50-50 partnership means that if there is any disagreement, it will be awfully tough to resolve it since both partners have equal say. This can often lead to disharmony amongst the wife and husband and to erosion of trust and goodwill.
Income tax may be another reason to avoid equal shares.
A solution is to decide beforehand a process to use when you and your spouse cannot come to an agreement on an issue. You might also put in place a process for dismantling the partnership business if the conflict is irresolvable.
Another option is to set up an advisory process that allows for an independent person to be able to decide the conflict. This will rid the business of the instabilities that can be caused by an equal partnership.
However, you might also want to consider what happens if the neutral third party is unable to mediate the conflict. Perhaps you develop another clear mediation process to enact should the need arise.
There are several other things that can be done to resolve a conflict. The most common is to define a process that allows one partner to be bought out following a process for valuation and a decision about which partner gets to keep the business.
Control of the Business
Aside from ownership of the business, you and your spouse should be on the same page regarding control of the business and how major decisions concerning the business can be made. You need to agree on the types of decisions that may be made by a partner without consent of the others. You can also place limitations on decisions that can be made without consent. For instance, a limit can be placed on the amount of money that be spent by any one partner and for the purposes it can be used.
Other issues that relate to control of the business are things such as location of the business, the services the business provides or the products it sells, procedure regarding bringing on a new partner, and closure of the business without consent of all the partners.
Liability of the partners
Matters concerning liability of the partners are of significant importance. The liability of each partner depends how you structure your business. There are several types of partnership structure.
In a general partnership all liability and responsibility is shared. In a limited partnership, some partners’ liability can be limited, especially if they are only initial investors.
Therefore, you need to decide which partner will be liable in case of legal issues.
Please check out our article of the different types of business partnership arrangements for further information.
Dissolving the business
While you never think of such extremes when you start the business, relationships do break. It is wise to decide beforehand the procedure in case the relationship breaks down and either partner wants out.
Unless the deed of partnership states otherwise, a partnership business can be dissolved simply by one partner giving notice to the others of his or her intention to leave, or automatically, by death or bankruptcy of one of the partners.
If the relationship between you and your spouse becomes strained, either of you may decide to break free and insist that all assets of the business are sold off. This can be disastrous for most businesses. Therefore, there needs to be a process in place which establishes the fair value of the leaving partner’s share.
Summary
Having a formal partnership arrangement in place is a must, regardless of whom you are going into a business with. If you don’t have one, you’ll be at significant disadvantage because the default legal position is so archaic.