Co-Founder Feuds Highlights Importance of A Written Partnership Agreement

A recent article in the Los Angeles Times highlights that handshake agreements and napkin contracts can lead to nasty legal disputes among business co-founders. Most importantly, it underscores the need for a formal written partnership agreement or shareholder agreement.

Citing ongoing disputes involving Snapchat, Yik Yak and Tinder, the article suggests that the booming tech industry is particularly prone to feuding founders. Several years ago, Facebook’s woes played out in the courtroom and on the big screen.

In many cases, the young entrepreneurs are so excited to bring their idea to market that they shun the typical formalities of forming a new business. As the article highlights, money is usually at the center of the dispute, whether it involves hitting it big or going bust.

Unfortunately, hoping for the best and failing to plan for the worst can have significant legal and financial consequences. In many cases, start-ups waste valuable time and money hashing out disagreements over each business co-founder’s responsibilities and financial rewards.

To avoid a similar fate, all start-ups should take the time to reduce their partnership agreement to writing. Below are some of the key provisions that should be included in any partnership or shareholder agreement:

• Roles and responsibilities of co-founders. Most importantly, the agreement should set forth the obligations of each partner, including time, labor, and financial contributions. The agreement should also detail how the ownership percentages will be allocated and who will be designated a “co-founder.”
• Financial allocations to co-founders. The agreement should establish how profits, losses, and draws will be allocated, as well as the timing of such transactions (i.e. quarterly vs. year end).
• Legal authority to bind the business. This is one of the reasons to form the business as a corporation instead of a partnership from the get-go. Absent an agreement that states otherwise, any partner can create legal obligations on behalf of the start-up. In order to require partners to obtain the others’ consent before acting to bind the partnership, a provision should be included in the partnership agreement. However, third parties who have no knowledge of any limitations placed by an agreement between the partners regarding contracting for the business are allowed to rely on the apparent authority of the partner to bind the partnership.
• Management decision-making. To deter disagreements, the agreement should detail the management duties of each partner, and what business decisions will require a majority vote or unanimous consent. But as soon as additional partners are brought into the business, this type of set-up almost inevitably creates conflict. That is one of the reasons most businesses look to a corporate framework.       Investors should a will demand it, and not just as part of an exit strategy..
• Dispute resolution. The parties should outline how deadlocks or conflicts will be resolved. These agreements frequently call for alternative dispute resolution, including mediation or arbitration.

While it may seem tedious to address all of the above issues at the outset, having a written agreement in place can avoid a lot of legal headaches down the road. These initial discussions and negotiations also can prove of value for providing insight to the parties as to their ability to get along and grow the business cooperatively.