Protecting your interests in a group investment (Part 1)

Note: This post is part of a series of posts on the fundamentals of partnership agreements and investing as part of a group. See the introduction of the series here.

What is a Partnership Agreement and why is it so important?

In my earlier post about the pluses and minuses of incorporation I wrote a little about how different forms of business are taxed. While corporations and partnerships may be handled very differently in terms of liability and taxation, they are essentially the same when it comes to establishing the terms of the business. While the government very clearly gives you guidelines for how to pay your taxes, there are no such guidelines for the rules that establish the business. The government stays out of that completely until there is a dispute of some sort and the owners take each other to court.

So when two partners get into a dispute and are taken to court (say one of them "borrowed" money from the company) the court will ask that the owners provide evidence that supports their claims. If the owners had nothing more than a verbal agreement on how the business should be run, both are essentially put to the mercy of the judge.

So your partnership agreement (or the charter of your corporation) exists to protect you against any future problems within the ownership. But the greatest advantage that the partnership agreement provides is that it often can prevent problems from occurring. As the old saying goes, an ounce of prevention is worth a pound of cure.

So what are some very basic things you need to know about partnership agreements?

They clearly defined the terms of the partnership, explaining who owns what and who is allowed to do what. You need to try to cover every possible situation before it arises.

They are not recorded with the government. If you go to court a judge will not see your agreement until you provide it for him, so it is extremely important that every partner (or share holder or a private corporation) has their own signed and dated copy of the agreement. If possible, it can help to get your agreement notarized when it is signed, simply to strengthen the credibility of the document.

Every single partner (or share holder) has to sign one in order to be bound by it. If the document changes in any way, say you add a new investor or changes some of the responsibilities, then every single partner must sign and date a new copy of the agreement.

Every page must be signed and dated (so that new pages cannot be inserted or altered on various copies.
So now you know what a partnership agreement is and how it is used. You also know the important facts about keeping a safe and updated copy. With this knowledge in hand you are ready to begin looking at crafting a partnership agreement for your hypothetical Subway franchise.

Introduction - The basics of entering a group investment
Part 1 - What a partnership agreement is, and what you need to know about it
Part 2 - What is my interest and how do I determine it?
Part 3 - Figuring out the managment