Things to Consider When Dissolving A Partnership

E19_dissolving partnerships

All of you entrepreneurs out there who are eternal optimists, please stand up. As you start your business do you find yourself believing all the sales guys, trusting every supplier and having a partner with whom you would place your life in his hands? Phew – Be Careful!

It’s funny because most partnerships don’t have written agreements in the event things go to hell in a hand basket. Whether it is a limited partnership or a corporation with equal shareholders, your life is in each other’s hands as long as you are part of the business, and maybe longer.

Longer? Yes, if you dissolve your company, many people forget to deactivate things that they have become liable for, including leases on office space and assets. The good thing about corporations is that they provide you with limited liability meaning if the company goes broke creditors can’t come after you personally but these days, many suppliers including leasing companies require you to be personally liable too.

Thinking Ahead
I’m going through partnership planning with two partners at the moment. What do I mean by this? Before we even incorporate our new nanotech business, we have spent months putting together a Shareholders’ Agreement. This document is all about the rights and obligations of the owners, as well as how the company will be operated. It’s also the document that will guide us through problems we may run into with each other if they arise.

To some, it may sound like a lot of work for something that may never be needed, but that’s the beauty of having a solid shareholder agreement. It’s a rock solid plan in the eventuality that a partner dies, wants to leave or disagreements need arbitration. To me, it’s a plan that answers the questions that none of us really want to address at the moment because, as they say, we are in the ‘honeymoon’ of our startup –everyone is honest, happy and forthright.

I failed to follow my own advice a couple of years ago and didn’t put together a shareholders’ agreement. It was disastrous. When things started to go sideways, there were recriminations and hurt feelings, resulting in a good business losing its way and failing.

I mentioned briefly the reasons why you need a shareholders’ agreement. It can be put together very simply, or it can be a very complex agreement. Each partner needs to agree to all the terms, have his or her own legal advice and go into it carefully thinking about the ‘worst case’ scenario.

I’ve seen ‘shotgun clauses’ put into an agreement. I think it is a bit scary, but it works for some people. It essentially says that if a partner wants to take over the company, he can offer to buy his partner’s shares at a certain price. The tricky part comes when this clause is activated. The shotgun clause allows the second partner the option of taking all the other partner’s shares at the price the aggressor is offering. It keeps the price of shares at a fair market value, but it is a tricky maneuver that can certainly go the wrong way for the partner who wants to take over the company.

In my case, we have sought legal advice on what clauses should be in the agreement, just so we won’t miss something. My partners didn’t know about ‘vesting’ until they spoke to their lawyers. Vesting allows partners to receive their total share structure over a period of time so that they stay involved and committed. If the shares are vested over three years, for instance, they may receive 33% each year until they have received the full amount of shares. If they leave or can’t fulfill their duties, there is a clear understanding from the beginning what share amount they will receive.

My partners are a lot younger than me and have young families, so they plan to be in the business for the long haul, whereas my plans really don’t go past a comfortable five years in the future. This is written into the agreement, as well as situational plans in the event one of us goes crazy trying to run the zoo or is hit by a driver-less Google car.

It may seem logical that a spouse would automatically take over the partner’s share of the company in the event of a catastrophe, but with that brings a lot of responsibility and control they may not wish to accept. The partnership may need to have strategies in place so that competent management is maintained in the event of an emergency.

A dissolution plan in the agreement allows for the disposition of assets whether they are leased or purchased and allows for a clean break in the partnership. If the company is still operating when a partner leaves, a third party evaluation needs to be a part of the agreement.

The Guidelines
If you close your partnership/equal shareholder business, you must follow certain guidelines in Canada (check the variations in your country).

    • Close all your accounts including tax, sales tax, business number, payroll accounts

    • Have the directors agree to dissolve the corporation in the minutes of an AGM

    • Have a third party evaluate the worth of the business

    • File the Articles of Dissolution with the government (it’s a government form and is mandatory)

    • File a current year tax return

    • Liquidate all assets

    • Notify creditors and settle any claims

    • Distribute any remaining assets to directors according to their share of the corporation.

I had a client who was aware the 3-person equal share corporation was closing, but missed the compulsory board meeting to dissolve the corporation. The remaining partners provided him with an agenda, resolutions, a previous tax return, all supposedly copied to a lawyer. The problem is they kept operating the business. They didn’t dissolve the company at all, but told my client they closed the business. Shady to say the least! They could have, more easily, asked my client to resign and settle his share.

The problem in this worst-case scenario is that it doesn’t end there. As the corporation really stayed in business at the same location, so did the lease to the office and the POS equipment. Even though my client was not involved in the company, he was the only signee on the lease and was still liable for the lease. If these two swindlers decided to just walk away, he would have been left with a lease worth thousands of dollars. The bottom line is my client rightly approached me for advice and I gave him several options, beginning with hiring a lawyer.

The dissolution of a partnership can be relatively easy or extremely complex. Just as a business plan is necessary when setting up your business, taking care of each other in a startup with a shareholders’ agreement is a priority. Don’t allow anyone to be blindsided in the event the worst happens. You need legal help to navigate your way to a harmonious end of your business.

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