Two's a Party - Partnership and Joint Ventures
Charles Carreon
It is common for people to decide to do business together, sharing profits and losses, and this style of doing business is known as a partnership. At this point, the subject expands vastly and the issues of law begin to get rather complex, and are regulated on a state by state basis. Some general rules about partnerships can be established, however. First, you do not need to have a written partnership agreement in order to establish a partnership. If two people decide to go into business together, sharing profits and losses according to their respective contributions to the company, the law will “imply” a partnership. Frankly, you do not want to be a member of an implied partnership, because it will be quite questionable how the profits and losses are sorted out in the event of a partnership dispute.
Take this example of an implied partnership. Bill and Sally decide to go into a partnership to provide lawn service. Bill has a pickup and various lawn care tools, but very few clients. Sally has a computer, graphics arts skills, and bookkeeping software. They agree to be a 50-50 partnership with Bill handling all the onsite work and Sally handling all marketing, collections and bookkeeping. The relationship turns out profitably for both of them, and a couple of years later Bill has bought three new pickups and hired three more employees to do the work. Meanwhile, Sally, taking full advantage of advances in graphics and software technology has only hired one assistant and bought one computer. The company has been doing business under the fictitious business name “Bill's Lawncare.” Bill begins to feel that he is doing far more work than Sally, and should receive more than 50% of the compensation. Sally cannot agree with him and has control of the bank account because of her superior accounting knowledge, and refuses to issue him any more than 50% of the net revenue of the company, insisting on taking the other 50% for herself.
If Bill sues Sally to partition this business it will be as messy as if the two had been married and owned all of the trucks, computers, accounts receivable, and business goodwill as a married couple. It would be up to an overworked judge or overpaid arbitrator to sort out all of the problems, and it is possible that a court appointed receiver may even end up handling the money, doling it out to both disgruntled partners after he or she takes their cut. In their court proceedings, Sally and Bill will be trying to remember the contents of conversations they had years before, and reinterpreting them in the light of everything they have learned since then. To say that it would be a mess is a complete understatement.
Where they went wrong was in not setting out their understandings in writing, in detail, at the beginning. They could have provided for things like how they would allocate the value of capital improvements, such as the purchase of the new pickup trucks, and what would happen when Bill's job got larger and he hired more people. They could have provided for buyout provisions so that neither one would be treated unfairly in the event that one partner wanted to buy out the other.
Partnerships very commonly form between people who have different sets of resources — the idea person and the money person, or the muscle and the brain, as in our preceding scenario. Many partnerships form on a three-way basis — one person providing intellectual capital, such as a valuable program or patent, a second person providing funding or access to funding, and a third person providing marketing expertise and business contacts. If the value of these contacts is spelled out in the beginning, it can save a lot of grief down the line. For example, if someone's patent is thought to have value, perhaps it should be lessened in value if the patent is successfully attacked and defeated. If someone is supposed to provide financing, perhaps their interest will be lessened if they fail to obtain all of the promised financing. If someone is supposed to provide access to markets, perhaps their interest should be related to their ability to produce sales in their chosen market.
As a practical matter, when exposed to this kind of scrutiny, many partnerships will not form in the first place. It is much better to avoid a partnership that will not fulfill its expectations. You can spend a great deal of time unraveling a partnership that has not worked out.
Finally, when you figure out how you want to allocate the investments in a partnership, you will discover that you do not want to form a partnership at all. Once you have figured out everyone's respective capital investments, it is much wiser to from a limited liability company or corporation to accomplish your goals. We'll move on to those next.
It is common for people to decide to do business together, sharing profits and losses, and this style of doing business is known as a partnership. At this point, the subject expands vastly and the issues of law begin to get rather complex, and are regulated on a state by state basis. Some general rules about partnerships can be established, however. First, you do not need to have a written partnership agreement in order to establish a partnership. If two people decide to go into business together, sharing profits and losses according to their respective contributions to the company, the law will “imply” a partnership. Frankly, you do not want to be a member of an implied partnership, because it will be quite questionable how the profits and losses are sorted out in the event of a partnership dispute.
Take this example of an implied partnership. Bill and Sally decide to go into a partnership to provide lawn service. Bill has a pickup and various lawn care tools, but very few clients. Sally has a computer, graphics arts skills, and bookkeeping software. They agree to be a 50-50 partnership with Bill handling all the onsite work and Sally handling all marketing, collections and bookkeeping. The relationship turns out profitably for both of them, and a couple of years later Bill has bought three new pickups and hired three more employees to do the work. Meanwhile, Sally, taking full advantage of advances in graphics and software technology has only hired one assistant and bought one computer. The company has been doing business under the fictitious business name “Bill's Lawncare.” Bill begins to feel that he is doing far more work than Sally, and should receive more than 50% of the compensation. Sally cannot agree with him and has control of the bank account because of her superior accounting knowledge, and refuses to issue him any more than 50% of the net revenue of the company, insisting on taking the other 50% for herself.
If Bill sues Sally to partition this business it will be as messy as if the two had been married and owned all of the trucks, computers, accounts receivable, and business goodwill as a married couple. It would be up to an overworked judge or overpaid arbitrator to sort out all of the problems, and it is possible that a court appointed receiver may even end up handling the money, doling it out to both disgruntled partners after he or she takes their cut. In their court proceedings, Sally and Bill will be trying to remember the contents of conversations they had years before, and reinterpreting them in the light of everything they have learned since then. To say that it would be a mess is a complete understatement.
Where they went wrong was in not setting out their understandings in writing, in detail, at the beginning. They could have provided for things like how they would allocate the value of capital improvements, such as the purchase of the new pickup trucks, and what would happen when Bill's job got larger and he hired more people. They could have provided for buyout provisions so that neither one would be treated unfairly in the event that one partner wanted to buy out the other.
Partnerships very commonly form between people who have different sets of resources — the idea person and the money person, or the muscle and the brain, as in our preceding scenario. Many partnerships form on a three-way basis — one person providing intellectual capital, such as a valuable program or patent, a second person providing funding or access to funding, and a third person providing marketing expertise and business contacts. If the value of these contacts is spelled out in the beginning, it can save a lot of grief down the line. For example, if someone's patent is thought to have value, perhaps it should be lessened in value if the patent is successfully attacked and defeated. If someone is supposed to provide financing, perhaps their interest will be lessened if they fail to obtain all of the promised financing. If someone is supposed to provide access to markets, perhaps their interest should be related to their ability to produce sales in their chosen market.
As a practical matter, when exposed to this kind of scrutiny, many partnerships will not form in the first place. It is much better to avoid a partnership that will not fulfill its expectations. You can spend a great deal of time unraveling a partnership that has not worked out.
Finally, when you figure out how you want to allocate the investments in a partnership, you will discover that you do not want to form a partnership at all. Once you have figured out everyone's respective capital investments, it is much wiser to from a limited liability company or corporation to accomplish your goals. We'll move on to those next.