Why You Should Get a Small Business Prenup

Some say running a business with a partner is like being married to them. That’s why a growing number of small business owners are incorporating “prenuptial” agreements into the startup stage of their businesses.

Just like marriages, many business partnerships end in a flurry of legal paperwork and bad feelings. So before jumping into a partnership, ask a lawyer to create a prenuptial for your venture. After all, business partnerships end for any number of reasons, including illness, divorce, loss of interest in the business, and most commonly, strife between the partners. A business prenup protects your investment; in many cases it can also save a friendship.

Business prenuptial agreements -- or business partnership agreements -- vary by the type of partnership and the goals of the business. They also vary by state. Most states operate under a rule called the “Uniform Partnership Act” or similar. Those rules govern the partnership unless different rules are set out in a legal partnership agreement. The UPAs are baselines -- the bare minimum that partnerships must do to be legally binding. Even with those rules, it is necessary to craft your own agreement that covers many different scenarios, from the unexpected death of a partner to who writes the checks and the shares of the expenses each partner is expected to pay.

Business prenuptial agreements should include the following:

• Management agreement: Who runs the business? Who deals with employees? How do you accomplish the business’s goals? Who writes the checks and has daily financial responsibility? Who makes the equipment purchasing decisions? At what price point must all partners sign off on a substantial purchase? If there is more than one partner involved in day-to-day operations, clearly spelling out who does what before the business launches can help you avoid headaches later. Although it may not seem necessary to lay out all the minute details, it’s important to have a clear picture of how the business will operate.
• Buyout agreement: If one of the partners should want to leave the business, what is the process required and how will that partner be compensated for their shares in the business? This is particularly important for early stage businesses in which the shares might not be worth very much.
• Buy-sell provision: This specifies how the transfer of equity in the business can take place. Most business partnerships are formed out of a friendship or business connection. As a small business owner, you most likely don’t want to find yourself in a business partnership with someone you don’t know. Specifying how ownership shares can be transferred and to whom protects you from having to work with someone you may not like.
• Distribution agreement: This details how profits, losses, and owner draws are handled among the partners. Clearly spelling out how partners are paid -- or not -- and when those payments take place will prevent one partner from accusing the other of skimming. Sketching out a good distribution agreement is one of the most important parts of the pre-partnership process.
• Expansion agreement: At what point does the business add new partners? What process do potential new partners follow to join the business? How much buy-in of shares is expected from new partners? A standardized procedure for admitting new partners allows the business to add partners to fund expansion without alienating current members.

No matter what form your business takes -- two friends creating a new venture together or a more formal investor-owner relationship -- having a legal agreement in place before joining hands in the venture is key to success. Seek out an experienced business attorney (not your Uncle Joe who is a criminal attorney) and spend the money to make the best agreement you can. It will protect your business, as well as your friendship, in the long run.