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Entrepreneurs who start up in business alone have a tough challenge ahead. To help share the load, it can be advantageous to establish a business with someone else. The benefits include the chance to share decision-making and responsibilities, to benefit from each other’s strengths and learn from one another, to reduce the level of financial commitment and, in the long term, to collectively enjoy the rewards.
Although it sounds wonderful on paper, circumstances, aspirations and people change and at times, things can become bitter and acrimonious. This is why when you start a business with other people, having a formal document – for example, a partnership agreement or shareholders’ agreement – outlining the terms of your business arrangement is essential. It can make a significant difference, both financially and emotionally, if you do end up separating.
When putting an agreement together, be clear about what it is you want and expect from the business and your partners. Discuss these issues openly and agree what you are seeking from the business in both the short term and long term. Then set goals that are related to a specific action and the achieved outcomes within a set timeframe.
What are the tell-tale signs of partnerships in trouble?
Clearly document job roles
If you are in a situation where circumstances have changed in these ways, it’s important to take control. Your fellow partner(s) may be unaware you have identified problems, or there may be an opportunity to take action collectively.
One reason why many business partners end up disagreeing is due to the absence of clearly defined job roles. If this sounds familiar, it’s time to review what each of you is doing for the business on a daily basis and document it as an official job specification. This will highlight if one person is doing more than the other(s). It will also bring any misunderstandings to light and highlight in a non-confrontational way where additional help is needed.
Know when it’s time to move on
If, after trying to resolve the problems, things are not better within an agreed timeframe, it may be time to make the hard decision over whether to continue.
The most common way for a partner to leave is for them to be bought out after formally valuing the business. This option requires further investigation because, if the business is trading as a company and one shareholder sells their shares early to exit, their entitlement to entrepreneurs’ relief may be affected.
Practical aspects to consider
If your business partner is not interested in an offer to be bought out and the business is able to continue in different directions, it may be possible to divide the firm’s interests. This could result in two new entities being formed, with each former partner owning 100% of their own new entity. Whilst this can create a number of practical distractions which can detract from the business in the short term, it can be achieved tax efficiently, although it is more complex where a limited company is involved than a partnership. In addition, unless the new businesses can have two distinct elements – a restaurant and separate café, a web development and graphic design agency, or a cleaning and ironing business for example– it can be difficult to agree on the dividing lines and customer share.
Where separation involves agreeing the rights to intellectual property – graphic artwork or a technology platform for instance – it will be necessary to account for this in the financial settlement. Either the rights are assigned to one business as a separate entity, or you may agree to pay your former business partner a royalty based on future earnings from their share of ownership of the intellectual property. So, in the case of the software example, they may be paid 5% of all revenues generated from using that tool.
What happens if you can’t agree?
If, after lots of negotiating, it is impossible to come to an amicable agreement, the final option is a cessation of trade for a partnership or members’ voluntary liquidation for a company, although reference should be had to the recently introduced 'phoenixism' legislation.
For anyone who might have been through an experience like this before, you will appreciate the value of having a formal business agreement in place from the outset. Once things start to fall apart, it’s a bit late to think retrospectively about the importance of a document prepared when things are amicable.
This article was originally published on BusinessZone.co.uk by Lesley Stalker, who heads up the tax team at RJP LLP.