THE BLOG
08/05/2013 10:38 am ET Updated Oct 05, 2013

In Business With Your Partner's Spouse?

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Many business partnerships start out with two or more individuals having a great idea and creating an actual business to support that idea. The partners then create infrastructure, hire personnel and begin operating the business. What the partners fail to realize is that there's a never a problem... until there's a problem.

A major problem most overlooked by business partners is what happens to the business upon the death or disability of one of the partners? You love your partner, you love your spouse (think positive!), but do you love your partner's spouse?

Without a written business agreement, with the appropriate disability and buy/sell provisions, a business owner is taking some very serious chances. In this case, if one partner becomes disabled or passes away, the surviving partner has to deal with the deceased partner's spouse or Estate. This may entail explaining certain expenditures or business practices and include audits and/ or appraisals of the business. Audits or appraisals can put the surviving partner and the disabled/deceased partner's spouse in an adversarial situation. Not to mention the expense of audits and/or appraisals- and attorney's fees.

I once represented a partner of a manufacturing business. The two partners had an unwritten agreement that the business would be split 75%/25% due to one partner's contribution to the business. The 75% partner being the one who came up with the business idea and garnered the clients. And the 25% partner ran the day-to-day business operations. And the tax returns were filed accordingly.

One day the 25% partner had a stroke, rendering him incapacitated. Along came the 25% partner's wife. She did not have an understanding of the business being a 75%/25% split and began inquiring into the books and records of the company. These inquiries lead to her hiring an attorney and then litigation.

By-the-way, this is the point when the 75% partner retained my firm. Over $150,000 in legal fees later, the business litigation was resolved and the 75% partner ended up having to give up money and some of his 75% ownership of the business in order to settle the lawsuit. This does not make for a happy business owner. However, at some point in the litigation process, the partner has to make a choice--more legal fees with no guarantee of a positive result or settle the case and end the stress! Not fun decisions to have to make.

How could this have been avoided??? With a well-written operating agreement or shareholder's agreement drafted by a competent attorney. The agreement would lay out the percentages of ownership and management of the business in the event of disability or death. If drafted properly, it would leave no room for interpretation.

When you are starting a business, the tendency is to want to skimp on things like lawyer's fees. I have often heard: "We're friends and we can work anything out" or my personal favorite-- "I trust my spouse/kids to do the right thing". I have found that when money is involved, sometimes the "right thing" is conveniently forgotten...

I cannot emphasize enough that a competent attorney should draft the initial documents. My firm was once brought in on a matter between two doctors. They were each 50/50 partners of a medical practice. One doctor became addicted to prescription pills (which were conveniently stored at the medical practice). The "healthy" partner wanted to dissolve the partnership, split everything 50/50 and get on with his life.

However, the operating agreement only allowed for dissolution of the partnership by a majority of the partners. Of course the "unhealthy" partner did not agree to end the partnership because the healthy partner was making the business a lot of money. And you guessed it... we ended up in Court. This was also a very expensive way to get to the correct result- i.e., ending the partnership.

What is the take-away here for business owners? Factor attorney's fees into the startup costs of your business. Just like you would for accountants, computers, rent, etc. Take the time to outline percentages of ownership and management of the business at the onset. You can always change agreements later on if facts and circumstances change. And if the business is not successful, you can factor the attorney's fees into your carry-forward loss.

Not having a written agreement is never a problem when things are going well and the partners are making money. Until there's a problem...