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The 7 deadly sins of the partnership agreement

You want to know in 2 seconds and for free the seven most relevant clauses in a partnership agreement ? We are going to make half of your dream comes true in few minutes.

Let’s remind that to incorporate a company, you need to write statutes (or bylaws) in order to organize your company life: these statutes are your internal regulations. Over the course of your company’s life, it’s important to outline the partners’ relationship in a specific agreement.

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A partnership agreement is similar to a “pre-nuptial agreement” or a “gentleman’s agreement”. It covers things that are not already in the bylaws. If it includes a confidentiality clause, this agreement can remain a secret between its signatories.

Why a partnership agreement relevant ?

When I was 6, before heading to school, my mother told me “Bring this cookie with you”. Too lazy, I refused multiple times. But, when the snack break came I have to admit that I was hungry. One day, she had this answer that changed my life forever “Take this cookie, you’ll be happy to have it when you’ll be hungry”.

My mother was absolutely right! This is what a partnership agreement is about. Not cookies and mother (!), but how to find a solution before problems arise. This example works with couples forecast as well.

In this short post, we’ll avoid going through all of the standard clauses that are always included in every agreement (duration of the agreement, copyright assignment, court jurisdiction, etc.). Instead, we’ll focus on the 7 most relevant clauses that every partner should agree on when they start a new company.

1. Clarify what happens in case of a violation of the partnership agreement or the statutes by a partner…

“Follow the rules or follow the fools” Tupac Shakur

Be honest, it often happens that the partners disagree on the direction of the company. If this arises seriously, the law provides the partners’ ability to dissolve their union due to a misunderstanding between them. To avoid drawn out and painful litigation, which will completely kill the company’s development and all of the excitement surrounding its beginnings, it’s highly recommended to agree beforehand on the end result.

If such a breach occurs in bad faith, the penalty is usually the immediate and total return of the infringing partner’s shares. The purchase price can be fixed by an expert or through another agreement between the parties.

To sum up, keep in mind that when you had a bad marriage, you should try to succeed in your divorce.

2. Partner’s departure or the revocation of their management title (out of bad faith)

“Give me your badge and your gun” —Usual line in 80’s action movies

Managers (CEO and C-levels) should be subject to a leaver clause. This clause rewards partners and tends to encourage them to stay in the company as long as possible and to be fully invested in the company’s life. Entrepreneurs favor leaver clauses to avoid useless discussions as to the reasons for departure, since no matter the reason, the end result is that one of the founding partners leaves. I don’t want to know why, you stay or you leave (poor, but free). So the only question to consider is how many shares shall be returned to the company, and at what price.

This clause states that without exception, in case of departure, the partner returns all shares if the departure takes place during the first year (cliff). As of the 13th month, they retain 25% of their shares, +2% for each month registered, finally holding 100% at the end of 4 years. In this clause, the returned shares are purchased at nominal price.

Without this kind of agreement, the solidarity of the early business is just a word. Make it a clause.

3. The return conditions for current-account operations

Your company may have a current-account fueled by the partners in order to fund the business. In other words, it is a loan granted to the firm by the partners. That is why, in case of a partner departure, don’t forget to consider the conditions (such as interest rates) for the return to the partners of their current-account amounts.

But, “mathematically”, returning these funds can damages significantly the cashflow of the company. Therefore, include in your partnership agreement the time-frame for the cash return and any other relevant conditions.

4. Tag-along clause

“Two for the price of two” — Honest marketing

This says that if a (majority shareholder) (partner) wishes to sell its shares, the others are allowed to sell theirs as well, to the same buyer and under the same conditions. This ensure good relationships and equality between partners. Above all, the cohesion of the team is protected unless the founders agree to separate.

5. Non-compete and non-solicitation clause

“Prevent a partner from being an undercover agent !”

Generally speaking, this combination of clauses ensures that, with or without the partners, the company employees and strategy are protected as much as possible.

The non-compete clause ensures that your partners will not compete against the company and will keep strategic information confidential. The non-solicitation clause guarantees that partners will not solicit any of the company’s employees.

Although everyone trusts everyone when incorporating the company, this clause is essential. Find a solution sooner the better in order to make problems later the better.

6. Non-diluting clause

“More shareholders but same powers”

If the partners decide to welcome other shareholders it is important to protect the “oldest” and ensure them equality. According to this clause, when the cake gets bigger the partners who cannot participate immediately in an increase in share capital have up to 6 months to subscribe to this increase of capital, still under the same conditions.

7. Profit-sharing clause

“Be communist in advance” (only with your employees) (so not really communist) (but in a way still)

We acknowledged that entrepreneurs tend to think global, employees benefits included. It’s recommended that you include a profit-sharing clause for employees, even if this is for the future. It is possible to add a simple commitment to reserve a percentage of your capital for your future employees, or implement a BSPCE plan along with the partnership agreement.

Why do this early, even if there is no profit? Because when investors knock at the door, these reserved shares will be secured for your employees and the investment discussions will be based on the remaining shares. It avoids a situation whereby at the end of the deal your new partners interfere in the granting of shares for employees or ask the founders to take those shares from their own percentages. By planning ahead, you 1) ensure that you have incentives for your employees and 2) keep these shares away from the negotiations.

8. And what if I’m a solo founder ?

“Whoever has the gold makes the rules”

You still may want to invite others to join in the adventure later on. Having a partnership agreement from the beginning makes new arrivals easier as it clearly communicates the rules of the game, avoids losing time in discussions prior to the collaboration beginning, and starts the countdown on your vesting clause (leaver rules). BUT, keep in mind this golden rule, keep the gold :)