Entering a business partnership needs careful consideration and planning from the beginning. Setting out rules in advance can save considerable time and costs for the respective parties when the relationship dissolves.
In this article, we take a look at some of the challenges of setting up and exiting a business partnership, and speak to local experts who can help you mitigate the tough times by ensuring you’re prepared for what lies ahead.
Thank to our Chamber Member contributors:
- Business banking team at ASB
- Natalie Milne, Director of YRW Limited Chartered Accountants (pictured)
- Lauren Te Pairi, Co-owner of MTF Finance Fraser Street
- Marcus Wilkins, Partner at Mackenzie Elvin Law (pictured).
When entering a business partnership, what are some key considerations at the setup stage?
Bank (B): Seek independent legal advice and have a plan formalised for any future event, an in-depth discussion with an accountant and a solicitor in relation to the same, a partnership agreement with clear details outlining the businesses exit plans should the partnership dissolve. As bankers we are not in a position where we can provide any advice and, in these situations, we can only refer them to their professional advisers.
Accountant (A): Do your due diligence on your business partner before you establish a partnership. You will be spending a significant amount of time with them during the lifetime of the business, so you need to be confident that your values are sufficiently aligned and that you are clear on what your roles in the business will be and what your goals are.
You will need to consider what operating and ownership structure is best suited to your business and the needs of each partner.
It is important to set the rules down in advance. A partnership agreement, or shareholders agreement (should you choose to operate via a company structure), is a key document that should be put in place when you enter a business partnership. You should engage a solicitor to assist with the preparation of your agreement and each partner may wish to take their own independent legal advice to consider how the provisions of the agreement may affect them personally.
Lawyer (L): The success or failure of a business venture between two or more people depends largely on the relationship established between the participants, and any decision to go into business with another person should be established on a culture of fairness, good faith and observance of some agreed fundamental principles and philosophies.
Getting personality profiling on each of you, such as Myers Briggs or any of the other tests that are available, can be invaluable to obtaining an understanding of what makes the other person ’ tick’ and what their ‘hot buttons’ might be. Doing this and sharing the results with each other and discussing them openly can be good fun and help to establish how you can work together and relate to each other on a day-to-day basis.
Ascertain what is the appropriate legal structure: Should it be a standard partnership or limited liability company or limited partnership? Generally, a limited company structure with equal shareholding and directorships will be the best structure. Limited partnerships have advantages where the two partners have different financing and tax considerations to consider. Whatever the structure clear documentation setting out the ‘rules’ about funding, salaries and drawings, responsibilities and roles, resolving disputes and getting in and out of the relationship are critical. Going into business with a friend can work very well or end up with your friend becoming your foe. Open discussions at the outset with clear documentation is essential so that the ‘what ifs’ have been thought about, discussed and documented.
Financial provider (F): Be clear about your timeframes for investment, job roles and the non-negotiables for you. These are the things that can really cause issues in a relationship.
A plain English shareholders agreement is vital to documenting intentions at the beginning.
What are some important aspects to consider when working with your accountant / bank / financial advisor / lawyer to set up the business with someone else?
A: Your accountant will be able to recommend an operating structure (i.e., commonly a Company, a general partnership, or a limited liability partnership), which is best suited to your business and the needs of the owners, as well as advising on the tax implications of the chosen structure.
If the initial funding of the business isn’t equal between partners (or shareholders), your accountant will be able to assist in considering options for funding structures within the business to ensure arrangements are equitable and to protect the capital invested to the maximum extent possible.
If external funding is required in the business, your accountant will be able to assist with the preparation of financial forecasts and can liaise with your banking advisor to assist you in securing the required funding.
Your accountant will also be an integral in advising on clauses of the partnership (or shareholders) agreement and the financial provisions included within the agreement. A partnership (or shareholders) agreement is prepared by your solicitor based on the requirements communicated by the respective parties.
L: The legal structure is important to decide on at the outset because that determines the documentation, tax treatment and banking arrangements.
Going into business with other people can be to establish or purchase a business with no fixed end date. Generally, that would be using a limited liability company incorporated under the Companies Act or a Partnership under the Partnerships Act.
Going into business with someone else can also be for a specific project, such as to buy and build a home to sell. This will have a limited term rather than being open ended and is commonly called a ‘joint venture’ and could be incorporated (e.g. a limited company) or unincorporated (the latter being more in the nature of a partnership).
In an unincorporated business (e.g. partnership / joint venture agreement), the profits or losses go directly back to the participants and are taxed accordingly. A limited company is a separate legal entity and trades in its own right and is liable to tax as a separate entity. There is also a limited partnership structure which can be useful in certain circumstances.
Other considerations to decide and document include capital structure (how each party’s capital contribution to the venture is to be structured); pre-emptive rights (when a party wishes to sell its interest in the joint venture, that interest must be first offered to the other party). There should be a mechanism in the pre-emptive rights provisions to determine the ‘fair value’ of the interest if the price is disputed); technology and intellectual property, confidentiality, structure of Board and control and so on.
F: Businesses can cost a lot to set up and often fail due to poor cash flow in the early days. First time business owners can be cash strapped and inexperienced when forecasting income and expenses.
Ideally each party puts in equal capital, but if this isn’t possible, document the terms of the repayment so everyone is clear.
Personal guarantees are a non-negotiable for suppliers to a new business so be prepared for those and make sure comprehensive terms of trade are attached to any creditor account application.
What protection do you have over the financials, in terms of who has access to the money and for what purposes during the term of the business partnership?
A: Your partnership (or shareholders) agreement will set specific limits on items of expenditure that require unanimous approval by all parties to the agreement.
You should also consider how you structure banking mandates for signing authorities and/or authorisation limits to control how funds are processed (i.e., each transaction requires authorisation from a minimum of two partners, or directors).
L: People in business together should ensure that there are controls over bank accounts and decision making. This can be covered in documentation, such as a company constitution, shareholders agreement, joint venture agreement or partnership agreement depending on the legal structure. At a practical level, however, controls on operation of bank accounts and the right to enter into binding contracts needs to be considered and restricted.
B: In experiences we have encountered, a two-to-sign account could be an option to avoid a depletion of funds with no recourse.
During the business operations, what key documentation should be retained for future purposes?
A: It is always a good idea to document all meetings in a written form. Having the written record of meetings approved/signed by the partners, or directors, will assist in ensuring key decisions are implemented. The record of the meetings should be retained for future reference.
In addition to minutes of meetings, the following key documentation should be retained for future reference:
- business formation documents.
- tax returns and supporting documents.
- employment records.
- sales receipts.
- business asset records.
- ledgers and registers.
- leases or mortgage documents.
L: All company records need to be kept for IRD purposes for seven years. In terms of relationships between the parties, key documents will be a company constitution and shareholders agreement or partnership deed or joint venture agreement (depending on the legal structure) and minutes of meetings and resolutions recording decisions reached.
When a business partnership breaks down, how can an accountant / financing company / lawyer / bank help during the process? This could be if the business is being dissolved, ownership is being transferred, or the business sold.
L: The lawyers’ role when there is a dispute between business partners start with a consideration of who the lawyer is acting for. If it is a company structure or a partnership structure, then the lawyer who has been advising either the company or the partnership needs to consider whether they continue to act.
It is possible for that lawyer to continue acting for the company or the partnership if the business owners who are in dispute with each other agree that the ‘company lawyer’ can continue acting for the company /partnership as a separate legal entity because there will be an ongoing need for advice for the trading entity regardless of the dispute between the owners.
Each of the business owners needs to get their own lawyers to advise them. The respective lawyers’ roles in that situation would be to try to get their clients to come to an amicable agreement without recourse to the Court. Of course, if agreement cannot be reached then each party’s lawyer will be representing them in litigation in Court. Being able to pull a well-worded shareholders or partnership agreement out to deal with issues is infinitely preferable to leaving it to a Judge to decide what each party intended at the time of going into business together. Your lawyer will be able to tell you what your rights and responsibilities are under this documentation if you have taken the time to sort this out at the start of your business relationship. It is too late to sort this out when a dispute has arisen.
A: Your accountant will be able to assist you in determining your rights and obligations based on clauses in your partnership (or shareholders) agreement assuming you had one in place. If you don’t have an agreement, your accountant in conjunction with your solicitor will be able to advise you of your rights based on the relevant legislation (i.e., Partnership Law Act 2019 or the Companies Act 1993).
An accountant will be involved in calculating the valuation of your partnership interest, or shares in a Company, in accordance with the agreed fair value clause in the agreement. Most fair value clauses record that the fair value is to be calculated by a member of Chartered Accountants Australia & New Zealand, so usually this can be completed by the accountant engaged by the business. Although in complex situations it is a good idea to have an independent accountant assess the fair value of your interest.
Your solicitor will also play a key role in the process, so your accountant will always recommend obtaining legal advice.
F: If the business is viable, a combination of bank, finance company and private investment can be used to buy the exiting shareholder out. The more the shareholders can work together during this time, the easier it will be.
What other advice and support can you provide for either party when a business breaks down?
F: Stand back and take a big picture view, this time will pass and eventually it will be a distant memory in a long career. Negotiate hard, but be fair. If you opt to do the right thing in business, you’ll always sleep well and hold your head high.
Circumstances change all the time, your intentions when you entered a partnership might be totally different after a couple of years. Address it early and communicate with your partners.
B: Don’t wait for the business to ‘go bad’, see the warning signs and be proactive in getting the business. Advise the bank at the earliest possible indication that there might be issues so we can put some preventatives in place. Find a great business mentor with proven local references to help you through any challenging times.
Disclaimer: This article is general advice only. It should not be relied on or used as the basis for any decision or legal action. Detailed professional advice should always be sought specific to your circumstances.