A couple of weeks ago, I posted an article about the importance of “partnership agreements”, and why you and your business partner(s) absolutely need one. And I recently posted an article about the difference between a joint venture agreement (“JVA”) vs. a shareholder agreement (“SHA”). Today I’ll go one level deeper to discuss some of the provisions you should consider including in your partnership agreement.
Dispute Resolution Provisions
This clause that sets out how the parties would resolve any legal disputes. It usually consists of boilerplate language that your lawyer will insert into the contract. But the content may actually turn out to be pretty important.
For example, you could say that the partners must go through a mediation process before eventually going to the courts. Or you could prescribe arbitration, which is usually way faster but also more expensive. And in any case, you may want to identify which court system (the “jurisdiction”) makes the most sense. This may be based on the location of the business venture or the convenience of the parties. So, this may be especially important if not everyone lives in the same area.
Finally, this clause will specify which laws should be applied to resolve any disputes. Imagine that Partner A and Partner B live in different countries, and the business venture is in a third country. The legal systems in those 3 jurisdictions might approach a potential lawsuit from very different angles.
There is one more thing I want to add here. The partnership agreement itself makes it much less likely that you will end up in a legal dispute where this clause ever becomes relevant. So good job!
Business Plan Parameters
Your agreement can define the purpose of the partnership and the initial strategy to execute the business plan.
For example, it could put a cap on the debt the business venture can take on until achieving certain milestones. Or we can include references to certain expense budgets, and require a shareholder vote to exceed those budgets.
These kinds of parameters may be especially important to partners who will be less involved in the day-to-day management of the venture. And the partners will need to give clear instructions to the attorney who is drafting these provisions.
Initial Shareholder Cap Table
If the partnership is incorporating, how will the shares of the company initially be issued to the partners? And what rights will be associated with the shares?
This could be very straightforward. For example, let’s say that Partner A and Partner B might each hold 50% of the shares. And those shares entitle each to 50% voting rights, 50% profit distributions and 50% funding to maintain their positions:
| PARTNERS | Funding | Voting | Profits |
| Partner A | 50% | 50% | 50% |
| Partner B | 50% | 50% | 50% |
But sometimes it may be more complicated than that. One of the partners may be the one that brought the deal, created the business plan and will be managing the business on the ground (the project “Sponsor”). In that case, the partners could agree that the project Sponsor will have more voting rights than funding responsibility. The Sponsor may also be entitled to some type of disproportionate share of the profit distributions (often referred to as a “Promote”).
There are a many ways to approach this. But as an example, the resulting cap table could end up looking something like this (where Partner B is the project Sponsor):
| PARTNERS | Funding | Voting | Profits |
| Partner A | 70% | 40% | 50% |
| Partner B | 30% | 60% | 50% |
Funding Commitments of the Partners
There may be an initial funding commitment at the beginning of the partnership. And any subsequent funding is probably tied to the cap table (“Funding %”).
But here we can also establish the procedures for when the venture needs to request more funding from the partners (a “Capital Call”). For example, how much time should the partners have to respond to a Capital Call?
And what happens if a partner declines to fund or is unable to fund? Generally, there will be some type of a dilution mechanism – especially if one partner funds a disproportionate amount.
The agreement can also set out HOW the partners will fund the partnership. The standard is for the partners to “capitalize” the company with an equity contribution. But the partners could also fund “investor loans” or “shareholder loans” to the company, which would appear on the balance sheet as liabilities and would take priority over profit distributions in the distribution waterfall. A partner who funds this way will often even put an interest rate on the loans. And a non-funding partner could even allow the funding partner to put a lien on his shares until the “investor loans” or “shareholder loans” are repaid.
These are just some examples of the range of provisions that may appear in this section, which is often one of the most important parts of the partnership agreement.
Distribution Waterfall
When the venture is ready to send money back home to the partners, how does it get distributed? Depending on the complexity of the cap table, this may also be one of the most important provisions to include in your partnership agreement.
The partners could agree that one partner is entitled to certain priority distributions before money is sent to the other partner.
Or, as I mentioned in the previous section, sometimes the partners will fund loans to the partnership or company. Generally speaking, a company’s creditors are prioritized before the distribution of profits or dividends. So, funding “investor loans” or “shareholder loans” to the company can be a way of ensuring that the repayment of that funding takes priority over other distributions to the partners.
Operational Responsibilities of Any of the Partners
Some of the best partnerships consist of a marriage of talents, experience and expertise. One partner may bring technical know-how to produce a product, while the other knows how to market and build a buzz around the product. Or one partner may have boots on the ground, while the other has access to capital markets and a rolodex of fundraising sources.
Also, it is common for some of the partners to be active in the business while others are simply passive investors. And those passive investors may want to include certain commitments from the active partners to continue being active in the business.
If there is the partners are aligned in their expectations, then it should be easy to draft these provisions.
Notifications to the Partners
How and where the partners can receive any important notifications about the JV?
This sometimes sounds silly at the beginning of the business venture. “If I need to tell my partner something, I’ll just call her or send her an email.” But this become really important when it comes to corporate governance, such as ensuring quorum for a formal meeting of the shareholders.
And it could also become important if there were ever any legal dispute between the partners, where one partner may have an incentive to deny having received a particular notification or correspondence.
Decision-Making Procedures
In the absence of specific provisions in a partnership agreement, the general rule is that a simple majority of the shareholders takes decisions on behalf of the company.
But this may not always be sufficient and fair. For example, should a shareholder holding 51% of the shares be able to change the cap table so that that his shares entitle him to 100% of the profits? Should he be able to sell all of the company’s assets at any price he wants? Or unilaterally change the company’s scope of business activity? Or how about having the company issue new shares to dilute the 49% shareholder?
In most partnerships, the answer to these questions is a resounding “NO”. This is why most partnership agreements will have a section dedicated to “Special Decisions”. These provisions set out certain decisions that require a “super-majority” vote (70%… 80%… or even 90%). There may even be certain decisions that should require all of the shareholders to agree by “unanimous” vote.
These sections may also designate certain authority to a board of directors, and it will provide for how that the partners wil appoint the board of directors. And it will also set the rules for calling a shareholder meeting to vote regarding decisions of the partnership.
Share Transfer Limitations
This is one other important component in a partnership agreement. There are a few reasons to limit how one partner scan sell or transfer their shares to a third party. We call these types of provisions “Preemptive Rights”).
For one thing, your business partner may bring some special skill or experience to the partnership. What if that partner was to sell his shares to someone you don’t want as a partner? Or even to someone notorious. Imagine waking up one morning to learn that you are now business partners with Pablo Escobar?
So, your partnership agreement could provide for some specified amount of time during which the partners cannot sell their shares. We call this a “Lock-up Provision“.
Or the agreement could grant the partners a first option on the other partners’ shares. So if Partner A wants to sell to a third party, Partner B has an option to acquire the shares at the same price and under the same terms. We refer to this as a “Right of First Refusal”.
Or the partnership agreement might provide that if a majority shareholder sells his shares to a third party, the minority shareholders can condition the transaction on the buyer’s willingness to acquire their shares as well. We call these “tag along rights”. This type of provision allows the minority shareholders the right to “tag along” in a sale of shares.
Some partnership agreements also contain a provisions called “drag along rights”. This type of provision allows one partner to force the other partner(s) to sell under defined conditions. This usually serves to protect the majority shareholders, because itlimits the minority shareholders’ ability to hinder a potential sale of the company.
Bottom Line?
Partnership agreements don’t have to be complicated. But a solid agreement should generally touch on the considerations referenced here. I’d recommend using this as a checklist to review the provisions in your partnership agreement.
If you work with The Independent Lawyer to draft your joint venture or shareholder agreement, we will think through these types of scenario with you and incorporate them into your agreement.
Do you have questison? You can write to me at info@theindependentlawyer.com.
