5 key reasons to have a partner agreement

plus what can happen if you don’t.

by marc rosenberg
partner agreement essentials

what is a partner agreement?

according to nolo.com, “a partner agreement spells out the rights and responsibilities of the firm’s owners.  without one, firms will be ill equipped to settle or avoid conflicts because if certain key passages are missing or written improperly, the courts will intervene in ways that the partners may not like. a partner agreement allows the firm’s partners to structure their business relationships with each other in ways that suit their desires, needs and preferences.”

more on partnership: protect your business with a solid partner agreement | how business entity type affects partner income | equity vs. non-equity partners | partner pay in retirement transition period | buyout: the flip side of buying in
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but most readers probably knew this definition, so it might not be very illuminating. let’s try this one.

a partner agreement is a legally binding document that stipulates how the firm will be governed. by signing this agreement, all the partners agree to abide by the document’s terms. this helps the firm minimize problems and disputes such as these:

1. in the absence of a signed agreement, state laws, which vary by state, will be used to settle partner disputes. by necessity these state laws are one-size-fits-all rules. it’s much better to have an agreement in which the firm’s partners state the rules for their firm on their own terms. examples:

• a cpa firm decides not to provide for payment of goodwill-based retirement benefits. without a partner agreement, state law could require the firm to pay these benefits if the departed partner sues the firm for them.
• if the founder or power partner dies or becomes permanently disabled, the other partners may be legally entitled to a much larger share of the firm than they deserve.

2. voting. great example: a four-partner firm asked me to help them with their first-ever partner agreement. the firm was dominated by its founder. he brought in most of the firm’s clients, managed the firm and was the primary driver of virtually everything in the firm, including its success and profits. without a written agreement, the founder was susceptible to the three other partners essentially throwing him out of the firm, with or without valid cause.
3. other critical issues partner agreements need to address:

• admitting new partners
• expelling partners
• duties of partners
• management duties

4. allocating firm income. most firms allocate partner income based on partner performance, as opposed to non-performance methods such as ownership percentage, pay equal or seniority. although many firms may factor this into the allocation system, in the absence of a written agreement, in the case of a dispute, it’s possible a court could force the income to be allocated on ownership percentage rather than performance.
5. specify circumstances that allow the firm to expel a partner. without this, firms may be greatly limited in terminating partners, even for egregious acts.
6. when duties and rules of conduct are documented in a partner agreement and signed by all partners, they are more likely to adhere to these rules than if there is nothing in writing.

the partner agreement’s role in overall firm management

a partner agreement is essentially a contract among the partners, setting out their duties, obligations and entitlements. here is how the partner agreement serves as a starting point for firm governance:

1. it establishes rules for how decisions are made, whether by managing partner, executive committee or votes of the partner group as a whole.
2. it prescribes how the firm expects its partners to conduct themselves and to what extent violations of these guidelines are grounds for expulsion. this enables a firm to terminate a partner who impairs the firm.
3. it prevents a departing partner from taking the firm’s clients and staff. at a minimum, if this occurs the agreement specifies the liquidated damages for doing so. without this clause, it is likely that a court will set the damages considerably below what the firm would otherwise have been entitled to.
4. it provides rules for how long partners may work at the firm and in what capacity. this is critically important for the firm’s succession planning. when partners have the right to work “forever” and perpetually work on their terms instead of the firm’s, the firm’s general management and efforts to bring in new partners are greatly hindered.
5. not having a partner agreement becomes a huge problem when new partners are admitted or when the firm merges with another firm. in both cases, the prospective new owners will want to see and sign a partner agreement. failure to have an agreement could prevent these potential partners from joining your firm.

there are hundreds of provisions that should be in a cpa firm partner agreement, not because some lawyer says you need them but because the partners sit down and decide exactly how they want their firm managed and how decisions will be made. without a binding agreement, the owners may be denied the opportunity to manage their firm the way they want to.

posted on march 21, 2018