Five Tips for Avoiding Partnership Disputes

I represent clients involved in highly contentious disputes with their business partners. Partnership disputes are personal, expensive, and terrible for business. They are to be avoided if at all possible. In the hope of helping entrepreneurs avoid partnership disputes, I offer these five tips.

1. Choose your partners wisely.

The worst mistake an entrepreneur can make is choosing a bad business partner. Having a dishonest, disloyal, or unreliable business partner is sheer misery. Getting rid of a bad partner is expensive and often requires litigation.  The best advice: don't partner with someone you don't know.

The best way to avoid partnership disputes is to avoid doing business with a bad partner.

Many clients profess to have an innate ability to size up a person's character. I am skeptical. In my experience, people who make judgments on "gut instinct" often see what they want to see. The decision of who to partner with is far too important to wing it.

I recommend that clients engage counsel to conduct an investigation of a potential business partner before signing the partnership agreement. Does your prospective partner have a criminal record? Has he been sued? What is his background? What do his former business associates say about him?

You can avoid a great deal of heartburn by avoiding the wrong partner.

2. Get your partnership agreement right.

Business partners should enter into a written agreement governing their venture. Depending on the structure, this might be an LLC operating agreement, a partnership agreement, a joint venture agreement or a shareholder's agreement.  

Sit down with your prospective partner and make sure your partnership agreement fully states the terms of your agreement.

Too often, entrepreneurs approach partnership agreements as a mere formality. "Just give me a standard partnership agreement," I am sometimes asked. There is no such thing as a "standard" agreement. Poorly drafted partnership agreements frequently lead to disputes among business partners. Before signing a partnership agreement, it is wise to have a frank discussion with your partner about the terms of your agreement. Make sure you and your partner are truly on the same page. This can be an uncomfortable conversation. However, if you and your prospective partner are not truly in agreement, far better to know before you go into business.  

3. Observe business formalities.

Business partners who are working well together will often adopt a relaxed, informal way of dealing with one another. While natural, this is a dangerous way to do business. 

Partnership disputes often result from partners failing to adhere to standard business formalities.

Partners sometimes conduct business according to informal, ad hoc "understandings" that are not reflected in the partnership agreement. Business partners might get away with this for a while. However, when things become contentious, informal arrangements lead to litigation.

Similarly, managing partners often become somewhat casual about providing minority partners with financial information. The perception that management is withholding information often sows the seeds of future conflict. Many partnership disputes can be avoided by scrupulously observing business formalities.

4. Share the credit.

Partnerships can be ruined when one partner refuses to acknowledge the contributions of the other partner.

Sharing credit with your partners will help to avoid resentments that often lead to bigger problems.

Few things strain a partnership more than when one partner insists on hogging the credit for the company's accomplishments. I have seen successful companies go through destructive litigation all because one partner insisted on diminishing the other partner's role in the company.

As a company grows, a majority owner can avoid many problems by making a habit of saying "we did this" instead of "I did this." On the other hand, if a partner feels slighted, the rift can quickly turn into open hostility. Always remember, partnership litigation is very expensive; a few generous words are free, and they can go a long way toward maintaining good partnership relations.

5. Beware success.

Ironically, it is success - not failure - that leads to many partnership disputes.

Partners can avoid the perils of success by anticipating and openly addressing the anxieties that come with prosperity.

As a company becomes larger and more successful, the need to establish clear lines of authority can bring to the surface disagreements regarding ultimate decision-making authority. Likewise, if the venture is making a lot of money, there are incentives for a majority owner to squeeze out the minority owners.

When a venture achieves a degree of success, the stakes go up. Minority partners become anxious that the majority is plotting to squeeze them out. There may be accusations of self-dealing. The majority owner may then react by withholding information or firing employees who are not "his" people. These conditions frequently lead to litigation.

Partners can avoid many problems by recognizing the anxieties that come with success and taking proactive steps to avoid creating suspicion and misunderstandings.

We Can Help.

If every entrepreneur were to follow these five tips, there would be a lot fewer partnership disputes. If you need a lawyer to help you follow this advice, Thomas C. Sima should be your lawyer. If you're reading this and you're already in a dispute, give me a call and we can figure out a strategy.