Why Oral Partnerships Are a Bad Idea

In this writer’s experience, the most common cause of business failure is the lack of a written agreement between partners. No one ever enters into business with a friend or trusted associate thinking that the deal will collapse around them. Yet, business relationships routinely run into difficulties, and without a written contract defining the contours of the relationship, the difficulties are often destructive. Even minor disputes result in financial ruin for unwary partners who had vastly different expectations regarding the minutia of the business relationship. Moreover, partners expose themselves to substantial liability for the debts incurred by their partners on behalf of the partnership and for the conduct of their partners.

807851_friends_in_business.jpgPartnerships are complex and demand serious commitment much like any business relationship, whether a corporation, limited liability company or other formal business entity. Along with the financial resources necessary to start up the partnership, partners invest their time and energy. In most cases, they make a personal and emotional commitment to the venture hoping for significant financial reward. This personal investment makes it all the more difficult to deal with the inevitable conflicts. The key to success is planning and this starts with a well drafted partnership agreement.

People often start out in business together with nothing more than a hand shake, but they rarely anticipate the number and variety of decisions they will have to make moving forward. It is common for young partners to exhibit flexibility in the beginning but as businesses grow or struggle, the decisions become more complex and more important and partner flexibility starts to wane. If the partners cannot agree on key decisions, the partnership falls apart. See “Ending Bad Partnerships“. Without a well drafted written agreement, the partners have no mechanism for operational continuity or for winding up the company’s affairs. Will one partner be bought out? If so, for how much? How should the business be valued? If both partners wish to continue, who will retain the company’s assets, including the company’s name, website, location and customer lists? If both partners have personally guaranteed a lease, how will the exiting partner be relieved of his obligations? What other continuing debt obligations will the exiting partner retain? If the partners decide to dissolve the partnership, how will the company’s debt be paid? How will the remaining assets be divided? Who will be responsible for winding up the company’s affairs? What if one partner abandons a failing business entirely and disappears? What recourse does the remaining partner have to recover losses? A well drafted partnership agreement will set forth mechanisms to deal with such contingencies.

In addition, the partnership agreement will define procedures for taking out loans, making capital improvements, securing investment, bringing on new partners, determining partner income and agreeing to contractual commitments.  In most cases, lenders are reluctant to lend money to partnerships that do not have a formal written partnership agreement.  One partner may be forced to provide a personal guarantee with limited recourse against the other.  Even worse, one partner may expose the other to significant civil liability for negligent and/or criminal acts.  It is common for the more responsible partner to be left holding the bag.
To prepare for all of these contingencies, prospective partners should consult a San Diego Partnership Attorney regarding all available options.  Forming a corporation, a limited liability company or other business entity offers additional partner insulation from liabilities.  If the ultimate choice remains a Partnership, it is not wise to move forward without a well drafted agreement.

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