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Business is a lot like marriage. Not all partnerships work out—and some even end in what feels like a fiery divorce. That’s why it’s essential to sign a business agreement, the business world’s equivalent of a prenuptial. While discussing sensitive topics might be uncomfortable at first, trust me when I tell you this little document will benefit both parties tremendously in the end. Like a prenuptial agreement, a business agreement isn’t betting on a failed partnership; it’s simply a precaution incase the worst case scenario becomes your reality.
While business agreements greatly vary and can cover hundreds of issues, there are a few essentials that every business agreement should address.
This is perhaps the biggest question of all. Who owns what percentage of the company’s equity? Are you equal partners, or is one partner taking on a larger role? The longer you wait to have this conversation, the more difficult it becomes. As soon as you begin forming your business, clarify each of your ownership roles.
You and your partner should also transparently discuss your financial commitments to the business. Will you both contribute the same amount of money? If more capital is needed, what is expected of each of you? Is the company financially responsible for contracts and accounts, or are you responsible as individuals? Make sure that each of you understands how much money you are expected to give, and under what circumstances.
A young business requires a lot of money—but it also needs time. How much time and effort will each side give to the company? If each partner isn’t expected to give even amounts of time and effort, then account for this by making adjustments to ownership and compensation.
How much do you get and when will you get it? Is it based on hitting certain milestones or on hours spent on the business? Will compensation be in the form of salary or distributions? Do you have to take cash, or could you exchange it for more shares instead?
What’s your policy on expenses? How much entertaining can you do? Who writes the reimbursement checks? These are important questions to discuss, as you don’t want one partner spending more than the other believes is necessary on wining and dining investors.
If one person has more shares, does he make all the rules? If you’re 50-50 and don’t agree, what are the next steps? Do all big decisions need to be unanimous? The last thing you want is to find yourselves incapable of making a decision because you don’t know who ultimately holds the power.
Make sure you have a vesting schedule in place that outlines how and when equity is distributed. This protects you if one partner decides to leave the business.
Under what circumstances can you sell your interest in the company? To whom can you sell, and if you do so, what are the terms and how will the value be calculated? This is an important issue that needs to be discussed up front.
The moral of the story is this: If you’re thinking about entering into a partnership, get all these issues down on paper now. The sooner you reach an agreement, the sooner this little document can save the day should the relationship go awry.