BUSINESS WISDOM WEDNESDAYS: PARTNERSHIPS 101 SERIES – 3 REASONS YOU SHOULD TALK MONEY BEFORE YOU START A PARTNERSHIP

  1. Partners Share Losses and Profits Equally

Many of my small business clients that are operating as general partnerships usually do not have a problem with the concept of sharing profits and losses generally. There is no problem understanding this concept, except when they actually have to do it.

The default rules, meaning the law that applies when you don’t have a partnership agreement, states that each partner “is entitled to an equal share of the partnership profits and…is chargeable with a share of the partnership losses in proportion to the partner’s share of the profits.” Corp. Code, § 16401. You can always modify the default rules, but most people usually don’t. They begin operating the business and then when the problems start to roll in and the default rules actually have to be applied in reality, the problems begin.

As usual, I advise all persons wanting to operate as a general partnership to get a partnership agreement! Here is the situation many of my clients face:

One partner has put up the actual money to start the business (“capital”) and the other has put in the “sweat equity.” Sweat equity means that partner has done the actual work. In the case of our example floral shop, Irma put up the money and Bob has done all of the work. For the month of April, the floral business had some losses. Irma wants those losses to go to Bob—after all he hasn’t put in a dime. Bob of course says, “To Heck with that! I’ve been doing all of the work.” Unless, they expressly agreed to some other arrangement, the default rules come in. Their accounts are going to reflect an equal share in the losses in proportion to their share in the profits. If they have taken no further steps to change the default rules, if their share in profits is 50:50, then their share in losses will be 50:50.

      2.  Yes, I really meant it when I said, “Share Profits Equally.”

Sometimes I have clients that have no issue with sharing in losses. They seem to take the downside of owning a business well. They are gracious losers. Then comes the upside and they turn into sore winners.

It does not matter if Irma put up the money and Bob is doing the work. Absent an agreement that changes the default rules, the law will presume that Bob and Irma intended to share in the profits equally, regardless of the inequality in how much each contributed to the floral shop.

       3.   Partners Are Not Entitled to Compensation

The default rules under California Corporations Code Section 16401, subsection (h) is that, “a partner is not entitled to remuneration for services performed for the partnership, except for reasonable compensation for services rendered in winding up the business of the partnership.” Corp. Code, § 16401.

I will apply the default rule to our floral shop example. Bob is not entitled to be paid an hourly wage for doing the floral shop deliveries, unless he and Irma have an agreement to the contrary. The default rules say Bob is only entitled to share in the profits. Just like Irma will not be compensated for keeping the floral shop books. She is only entitled to share in the profits.

Bottom line:

These are common money problems I see with general partnerships.  Most of the problems between partners in general partnerships are centered on money issues. There is the rare personality conflict, but usually it comes down to the money. The default rules often take my clients by surprise. They are ready to sue and then I have to inform them about the default money rules.

If you don’t like the default rules—sharing in profits, losses, and no compensation, then speak to your partner before things get nasty and the business falls apart. Get a partnership agreement that details how you intend to deal with these issues before they become massive problems! For a partnership agreement checklist click here and for more information about general partnerships click here.

Disclaimer: The contents on this blog are informational only and not meant, intended, nor should be considered legal advice, advertisement, or solicitation for business. The material posted on this blog is not intended to create, and receipt of it does not constitute, a lawyer-client relationship, and readers should not act upon it without seeking professional counsel.

Furthermore, the information contained on this blog is not specific to any particular set of circumstances. All links to outside information are meant to provide further information on the topic addressed, I make no warranties, express or implied, as to the accuracy of the information contained herein or in the attached links.

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