When business partners fall out

Many businesses are conducted through partnerships, but the impact on a business when partners fall out can be immense. As a general rule the smaller the partnership, the greater the impact of a dispute on the business and the more embittered it becomes. This is probably because larger partnerships are more likely to have agreed procedures to deal circumstances likely to cause disputes.

The Importance Of A Partnership Agreement

A well-structured partnership agreement is the best way to prepare for any issues that might arise between partners. The agreement will state clearly the measures to take to resolve a dispute. It will include voting requirements for different partnership decisions and will usually specify how any grievances should be dealt with. There is, however, no requirement for partners to have a formal written agreement and if there isn’t one and a dispute arises then it would be dealt with in accordance to the Partnership Act 1890 which rules:

• an equal sharing of profits; and
• that any difference arising regarding ordinary matters may be decided by a majority of the partners, but no change can be made to the nature of the partnership business, or another partner admitted without the agreement of all partners.

Profit Sharing

Equality is still the most common form of profit sharing in smaller partnerships. It can work very successfully when all the partners trust each other and value their respective inputs into the business. However, partners should consider how differing inputs might be dealt with in the event of a fall-out. There is no easy way to define how profits should be shared between partners. In most cases the solution will be a combination of reward based on financial contribution and recognition of management and business development input. The problem for smaller partnerships is that non-financial input is difficult to measure. A common solution is for the first instalment of profit to be shared on an equal basis, with a second instalment shared according to financial contribution. Establishing an agreement from the beginning of the partnership has a number of benefits when it comes to sharing profit.

• It encourages partners to accept that, during the life of any partnership, it is quite usual for partners to contribute to the business in different ways and with differing levels of input.
• It forces prospective partners to discuss a difficult issue. If they cannot agree how varying input should be rewarded, it may be that they need to reconsider whether a partnership is the correct route for them.
• If a profit share method is agreed by all at the outset, it minimises the likelihood of future disputes.
• An initial outline framework for sharing profits can, if necessary, be revised in the future.

Overdrawn Partners

Another common cause of partnership disputes is if one or more of the partners takes out more from the business their profit share permits or more than the other partners. There are a number of steps that can be taken to reduce the likelihood of such disputes. 1. Set conservative drawing levels for partners that are linked to profitability. These can be based on anticipated profit levels, less taxation and a contingency reserve just in case things go wrong. 2. Ensure partners have regular financial management information so any likely excess drawings can be identified and corrected at the earliest opportunity. 3. Ensure the partnership has enough funds to meet partners’ business taxation liabilities and that they can be paid from actual profits and not anticipated future profits. 4. Incorporate interest on partnership capital within the profit-sharing arrangements so that partners with the greater financial interest in the business are rewarded appropriately and overdrawn partners penalised.

What To Do When It All Goes Wrong

However good the partnership agreement and management style, disputes can still arise. Ultimately a partnership dispute can only be resolved by a combination of:

• negotiation
• mediation
• legal action
• dissolution

If it seems inevitable that a dispute will escalate, what can be done to aid a speedy resolution?

• Seek professional help at an early stage. Alternative Dispute Resolution is the collective term for the ways parties can settle civil disputes, with the help of an independent third party and without the need for a formal court hearing. Visit www.dca.gov.uk/civil/adr
• Keep talking and negotiating and take full advantage of mediation and ADR.
• If dissolution is unavoidable ensure ypu get good accountancy advice regarding taxation issues and other complexities such as valuation and assignment of ongoing contracts.

Guy Rigby is a partner at chartered accountants, business and tax advisors, MRI Moores Rowland LLP