STARTING A PARTNERSHIP? AVOID THESE 7 LEGAL MISTAKES!
Partnerships have always been compared to marriages. Just as there are some guidelines to make a marriage work, there are some rules to make a partnership succeed. Here are seven pitfalls which we advise clients to avoid when considering a partnership venture:
- NOT HAVING A WRITTEN AGREEMENT
“We have a very clear picture of the venture. We don’t need a written contract.”
It is very important to have a written agreement among the partners. When two people come together to start a business, they are optimists. They see each other as friends with the most complementing skills. This is indeed the best time to record their commitments to and their mutual expectations from each other. If things go well, chances are that the partnership agreement will never be referred to ever again. However, if things go wrong, the agreement can provide a pre-agreed tactical plan of action, avoiding bruised egos, sleepless nights and heartburns.
- NO REGISTRATION
“If it's not needed to start the business, why bother?”
Under the Indian laws, registration of a partnership firm with the government is optional. However, an unregistered firm and its partners lose various legal benefits available to a registered firm. Summarily: (a) partners of an unregistered firm cannot file a civil case against a counterparty in a court of law (however, a counterparty may file such a case against the firm), (b) a partner of an unregistered firm cannot file a civil case against the firm any of the other partners, and (c) an unregistered firm cannot claim a set-off of an amount payable to a person against any amount receivable from such person.
- UNDEFINED SCOPE OF WORK
“We’ll distribute work as and when it comes up.”
Most of the times, each partner has his or her competencies and needs make a contribution to make the partnership work. If that partner fails to perform, the business fails. It is therefore essential that the partners have a clear understanding of the specific responsibilities on each of themselves. This fixation of scope of work also helps avoid misunderstandings and silent grudges.
- UNCLEAR DECISION MAKING STRUCTURE
“We’ll probably have unanimous consensus on all matters anyway.”
While every partner may wish to have an equal say in the running of the business, each partner may have his or her own competencies and shortcoming. A well-thought partnership structure details the management powers of each partner and the overall decision making mechanism. Clarity about the manner in which the business would be run helps to avoid confusion, arguments and deadlocks.
- LACK OF AN EXIT STRATEGY
“But we’re just starting! Let’s talk about it when one of us wants to leave.”
It is important to trace out an exit strategy for the partners. What happens if a partner is uninterested to continue with the business or is unable to contribute to the venture? Do the partners envisage any circumstances in which a partner must be retired from the partnership involuntarily? An exit strategy helps in a smooth transition and can avoid triggering off the dissolution of the partnership business.
- FAILURE TO FACTOR IN MORTALITY
As implausible as it may sound, building a scenario for death of a partner is important. Upon death of any one of the partners, the partnership firm will be considered dissolved by law - unless all the partners have agreed in writing that the business will continue despite the death of one of them. Many partnerships agree that in case any of the partners die, the remaining partners will support the heirs of a deceased partner - by making the next-of-kin a sleeping partner in the business or by requiring the remaining partners to buy out the share of the deceased partner by remunerating the legal heirs.
- IGNORING DISPUTE RESOLUTION MECHANISMS
“This one’s simple – we’ll never fight, right?”
In a perfect world, people who start a venture with a common goal never disagree with each other. Unfortunately, however, that’s not how things work in this world. We suggest that our clients maintain – in that order – discussions, mediation, negotiations, arbitration and litigation as the means of resolving disagreements. Why? Well, because it saves everyone a lot of time, money, effort - and embarrassment. Also, a structured means of resolving differences avoids acrimony and spite among the partners, helping them to continue working together once the contentious issues are settled.
It’s a lot easier to talk dispassionately about these issues when you are starting out rather than when you are in the aisle heading for the door. As I said earlier, partnerships are like marriages – not informal relationships. Just as a marriage needs a social framework to protect its sanctity, a partnership requires a legal framework to maintain its integrity. To construct this framework, I recommend that the partners engage a legal professional to put a well-constructed partnership contract in place. In addition to the issues listed in this article, a well-drafted customized agreement will contain provisions regarding capital infusion, sharing of profits and losses, induction of partners, loans to partners by the firm and vice-versa, etcetera.
Many partnerships are formed because of friendships, and both get ruined when things go wrong. A smart contract saves you money - and friends - by laying down rules to simplify potential complications in the future.
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