A leading business law firm in Denver, Colorado
Contact Us

Category: All

Six Areas to Consider in Partnership Agreements

Posted on by PLinden

Are you considering a business Partnership Agreements? When structured properly, a partnership can benefit your business in ways supported by the timeless adage that “two heads are better than one.” Practical benefits of partnership might include access to a level of capital, labor, know-how, customers, or expertise not available absent partnership. However, just like personal relationships, business partnerships have their ups and downs.

What might seem to be an enthusiastic partnership arrangement at the beginning often will hit bumps in the road. The odds of failure in partnerships (or worse, failure coupled with lawsuits) increase substantially when structured hastily or without a proper written partnership agreement.

The potential for success and the ability of the partners to work through issues increase significantly with a partnership agreement that has been specifically crafted with the objectives and desires of the partners in mind and which provides for a dispute resolution mechanism.

Types of Partnership Agreements

For purposes of this blog, we refer to a “partnership agreement” generally as meaning a written agreement between the owners of a business. The legal type and form of the written agreement is determined by the legal entity of the underlying business. For example, “operating agreements” or “limited liability company agreements” are used to document the agreements of the parties in limited liability companies.

“Shareholders’ agreements” or “stockholders’ agreements” are utilized for interests in corporations. True “partnership agreements” are used for entities legally formed as partnerships, such as limited partnerships (LPs), limited liability partnerships (LLPs) or limited liability limited partnerships (LLLPs).

Your legal and tax advisors can advise you on the best entity to use based on the business and the objectives of the partners. While we refer to “partnerships” or “partnership agreements” generically below in this blog, the principles would also largely apply to written agreements among owners in a corporation or limited liability company context.

What to Include to Consider in Partnership Agreements:

1) Purposes; Roles and Responsibilities. Include a description of the principal business and activities to be conducted by the partnership. In addition, whether in the partnership agreement or another written agreement, the partners should consider and memorialize their respective roles and responsibilities involved in any day-to-day or even periodic activities, as well as the rights of more passive owners (when applicable).

2) Capital (and other) Contributions. Disputes over money often occur in partnerships when the financial commitments of the parties are not appropriately spelled out. A clear statement providing for the amount(s) of required initial capital contributions of each partner is critical. The partnership agreement should also provide whether additional capital contributions are required, permitted or prohibited.

Consider ownership vesting over a period of time for partners receiving “sweat equity” in exchange for expected provision of services or expertise. With vesting, if partners receiving equity in exchange for services or expertise do not perform as expected, they will typically lose the portion of their ownership interest that has not become earned (i.e., the unvested portion).

This can happen for any number of unanticipated changes in life circumstances, discontinuation of service before becoming fully vested, and/or a failure to provide the services required in the manner or at the level required in the written agreement of the parties. Without a vesting provision, non-performing partners are typically able to retain their entire equity stake (and the voting power that goes with it), and in turn often leading to messy disputes with the other partners.

3) Management and Decision-Making Authority. It is paramount to determine the management of the partnership and provide detailed terms regarding the decision-making authority of the partners. While it is inadvisable to require unanimity or consensus of the partners for literally every routine activity or decision (this is simply counter-productive), it may be advisable for some partnerships to require super-majority or unanimous consent of the partners on key “major decisions”.

Major decisions tend to be those that could intuitively be expected to have a material impact on the equity or ownership value of a partner or class of partners. In practice, the provisions of a partnership agreement covering these major decision categories are often referred to as “protective provisions”. Examples of protective provisions in the partnership agreement might include provisions (among others) concerning:

  • Incurring debt above an established threshold amount;
  • Increasing or decreasing the size of a board of directors or board of managers;
  • Hiring or firing executive personnel;
  • Admitting new partners or issuing equity to third parties;
  • Acquiring or starting a new line of business;
  • Approving a change in control over the business (and/or permitting or prohibiting the sale or transfer of the equity interests of any partner or class of partners); and
  • Dissolving the partnership.

4) Distributions and Allocations. Limited liability companies, legal partnerships and s-corporations are often referred to as “pass-through entities” because the profits and losses get allocated for accounting and tax-paying purposes to the owners, rather than staying at the entity level.

This avoids “double taxation,” where the entity pays taxes on its profits and then the owners pay taxes on funds distributed to them. Allocations are accounting entries, and are different from actual cash distributed, which is frequently what matters most to the partners. A good partnership agreement will have clear and detailed provisions regarding distributions of cash, as well as the allocation of profits and losses.

It is common in instances where a particular partner (or class of partners) makes disproportionate cash investments (such as venture capital investors) relative to other partners (such as founders or sweat equity partners) for the cash investors to receive their money and a return (referred to as a “preferred return”) before the non-cash partners begin to participate in distributions. Partnership agreements will also often permit cash investors to take a higher percentage of losses given they have taken a greater financial risk (from a pure investment standpoint anyway).

5) Dissolution. The partnership agreement should provide for the circumstances under which the partnership can be terminated through a wind-down or dissolution mechanism. The agreement should also document the understanding of the partners on the disposition of partnership property and the distributions to the partners upon liquidation (such as on a sale of the business).

6) Other Key Considerations. While the specifics of each partnership differ, other terms that should at least be considered in any partnership agreement include:

  • A buy-sell provision;
  • General restrictions on transfers by partners of their partnership interests;
  • Right of first refusal on possible transfer of partnership interests (in instances where a transfer is even permitted);
  • Co-sale and drag-along rights;
  • Deadlock and dispute resolution procedures;
  • Meetings of partners and the persons managing the partnership;
  • Financial, reporting and other information rights of the partners;
  • Buy-out or disposition of partnership interest in the event of a partner death, disability or other exit from the business;
  • Non-competition and non-solicitation obligations (or not) of the partners; and
  • Key-man insurance policies benefiting the partnership or other partner(s).

Linden Law Partner’s Experience with Partnership Agreements

The preparation and execution of a partnership agreement is critically important whenever there is more than one owner in a business. Linden Law Partners has extensive specialized experience developing, drafting and negotiating partnership agreements for a broad variety of participants across many industries. Please contact us here if we can be of assistance to your business partnership.

Selling Your Business? 3 Steps to Help Prepare

Posted on by PLinden

Merger and acquisition (M&A) activity is expected to remain robust in 2019. Qualified buyers are still able to access capital for acquisitions at relatively low cost. This, in turn, provides qualified sellers with leverage to command higher sale prices. Sellers who most successfully capitalize on these opportunities tend to be those who are most prepared.  

The complete process for a business sale transaction typically ranges from a few months to a year or more. It is never too early for a seller to begin preparing to capitalize on the right opportunity – whether through a deliberate sales process or responding to an unsolicited inquiry from a potential buyer. Below are three steps for potential sellers to position themselves for optimal business sale outcomes.   

1) Get Organized

The first step is to get your “business house” in order. A buyer will conduct a comprehensive due diligence investigation on your business and its records to evaluate the strengths and weaknesses. Be proactive in trying to assess your business through the lens of a potential buyer with a reverse due diligence process. Then take steps to position the business in the best light possible and to minimize issues that might negatively affect valuation. Transparency and a clean business will provide a buyer with more confidence about paying a higher purchase price than for a business that has clean-up issues.

A few examples include:

  • Ensuring that books and records – especially accounting and financial records – are up to date, accurate, complete and use sound accounting principles. There is no faster way to scare off a buyer than to have sloppy, incomplete or questionable accounting and financial records or practices.
  • Making sure your arrangements with key customers and vendors are memorialized in signed written contracts.    
  • Documenting and clarifying ownership and licensing of intellectual property that is important to the business.
  • Buttoning up your capitalization table and owner or founder agreements, such as operating agreements, shareholder agreements, voting agreements, buy-sell or similar agreements among owners and investors.
  • Reviewing your contracts and applicable regulations to identify approvals that might be required from customers, vendors, regulators or other third parties in connection with a sale of the business.

2) Get Educated on the Value of Your Company.

Understanding customary factors that drive enterprise values and sale prices based on your specific business or industry is critical in reasonably assessing potential fair market value. EBITDA or other earnings-based multiples are used for some industries and technologies whereas others may be driven more by top-line revenue figures with less emphasis on profitability, or by other intangible assets, including goodwill. Goodwill assets include brand recognition and reputation, a strong customer base, good relations with employees, customers and vendors, or patents or other proprietary intellectual property. An independent third-party valuation can provide a realistic estimate of what qualified buyers may be willing to pay for the business.

It is best to evaluate opportunities to increase the value of the business before going to market. In order to enhance value, management may want to identify and implement opportunities for revenue and profitability growth, cost reductions and improved operational efficiencies. A seller should also identify and support key employees for retention to help demonstrate to potential buyers that the business will continue to thrive post-sale.

3) Assemble a First-Rate Deal Team.

Sellers sometimes unknowingly hinder optimal sale outcomes by failing to engage qualified advisors or by trying to do too much themselves to save on transaction expenses. For example, a long-time family attorney or CPA whose practice is not focused on sale transactions is much less likely to identify key value drivers for sellers than advisors that specialize in M&A deals.  Costs and expenses are important considerations. However, engaging the right experts to assist with your deal typically pays for itself in spades. Having a high-quality team aligned with you can best help you navigate through the complex and time-consuming M&A process to a successful completion and maximized transaction outcome.

Key advisors to consider engaging for advice and assistance before you begin a sale process may include:

  • Experienced legal counsel with specialization in business sale transactions.
  • Investment banker or business broker to help value and market the business.
  • Qualified tax or audit professional(s).
  • Financial planner to develop a seller’s post-sale wealth management plan.
  • Human resource professional(s).
  • Industry expert(s) versed and experienced in the opportunities and challenges of the business.

Conclusion

Selling a business is a specialized and process-driven endeavor. The most successful sellers are prepared from the outset. Some advance planning, refinements and building the right deal team goes a long way in helping sellers achieve their goals. The attorneys at Linden Law Partners have extensive specialized experience helping sellers prepare for, execute and successfully close business sale transactions across a broad spectrum of industries. If you would like to learn more, please contact us here.

Joint Ventures 101

Posted on by PLinden

A joint ventures (JV) is a business arrangement where two or more parties pool resources for a focused task, project or investment. Each participant is normally independently responsible for contributing toward the costs and labor based on the strategic value each participant brings to the venture, and they also have an agreed upon sharing percentage in any resulting profits of the venture. JVs can be documented in a contract, but generally the venture is its own entity and separate from the other business operations conducted by the participants.

The Joint Ventures Agreement  

The legal entity for the joint venture can be a corporation, partnership or LLC, and the choice of entity decision is normally tax driven based on the specific venture activities. Whatever legal form the JV takes, the JV agreement provides the written agreement of the parties regarding division of costs, sharing of profits, and it also sets out the specific services, roles and responsibilities of the participants. The JV agreement should also cover capital contributions, tax matters, competition (where applicable), accounting and financial reporting rights.

We often advise that the participants negotiate the key elements of the JV through the negotiation of an initial term sheet or letter of intent to assure the participants are aligned. See more on letters of intent in our LOI blog  here. While our LOI blog discusses LOIs in an M&A context, many of its principles would also apply to an LOI or term sheet for a joint venture.

Winding Up a Joint Venture

The JV agreement will generally cover winding up considerations for when the venture goal is achieved, or the venture ceases, fails or otherwise liquidates or dissolves. For example, one of the participants might buy out the interest of the other venture participant(s) or the venture entity could be sold to a third-party buyer. In either instance, the participants would normally have agreed upon liquidation or similar rights, such as whether there are payout preferences or other differences between the interests of the participants in the venture.

Other Joint Venture Considerations

  • Non-disclosure and confidentiality
  • Intellectual property of the participants
  • Budget and budget determination processes
  • Staffing and resources
  • Operational considerations and processes

Linden Law Partner’s Experience with Joint Ventures

A joint venture is an important business and legal undertaking, each being unique based on the parties, endeavors and industries involved. Linden Law Partners has specialized experience with joint ventures across a wide spectrum of structures, industries and participants. Feel free to contact us here.

Letter of Intent Considerations

Posted on by PLinden

Introduction To Letters of Intent

A key component to any successful merger and acquisition (M&A) transaction is the letter of intent (LOI). A thoughtfully negotiated and comprehensive LOI establishes specific and critical deal terms prior to drafting the definitive purchase or merger agreement, rather than engaging in the more arduous process of negotiating deal terms through extensive (and expensive) drafts of those definitive agreements.

An effective LOI establishes whether there really is a “meeting of the minds” between the parties that can survive the rigors of the transaction process. Negotiating a comprehensive LOI at the beginning of an M&A deal substantially improves the likelihood of successfully closing the transaction, is more cost effective for both parties, and makes the drafting process more efficient and better coordinated.

Although most of its provisions are non-binding, the LOI is often considered to be the good faith understanding of the parties and a roadmap for the definitive agreement.

Key Considerations

The following are some key considerations in negotiating and drafting a comprehensive LOI out the outset of an M&A transaction:

1. Structure of Transaction.

Analyzing and considering tax consequences on both sides of the transaction are paramount before agreeing to one of the three common M&A structures:

  • Merger: a transaction where a surviving company (i.e., the buyer) merges and combines with the seller (i.e., the acquired company) with the seller ceasing to exist post-closing. The buyer also generally assumes by operation of law all the assets and liabilities of the seller, making the indemnification considerations critical for the surviving company in a merger transaction.
  • Purchase and Sale of Assets: a transaction where the buyer purchases most or all of the assets and customarily assumes limited specified liabilities of the seller. The buyer can limit its risk of inheriting unwanted and unknown liabilities of the seller through an asset transaction.
  • Purchase and Sale of Equity: a transaction where the buyer purchases the equity of the seller from its owners (i.e., stockholders, members, partners, etc.). Like in a merger, the buyer is acquiring the seller in its entirety and effectively absorbing and assuming all of the seller’s liabilities (and also similar to a merger, making the indemnification considerations critical for the buyer in an equity transaction).

Unlike a merger, the seller typically continues to exist and operate in some capacity post-closing in an equity transaction as a subsidiary of the buyer.

2. Purchase Price / Consideration.

The price can take different forms, with all cash or part cash and part of the purchase price in the form of an earnout, promissory note, equity in the buyer, and/or a combination of the foregoing. An all cash purchase price provides the most certainty and least risk.

However, a seller may be able to obtain a higher purchase price by agreeing to have some of the purchase price contingent or payable at a later time. Your M&A advisors can help you navigate through the different structures and pros and cons of each.

3. Post-Closing Management.

As part of the LOI, consider, negotiate and provide for (if applicable):

  • The continuation of the owners, key management, employees, or contractors of the seller with the buyer post-closing.
  • The material terms of post-acquisition employment or consulting arrangements anticipated.

4. Due Diligence.

Provide for the scope, period and timing of the due diligence necessary for the buyer to adequately evaluate the seller (and for the seller to evaluate the buyer, particularly in instances where a portion of the purchase price will be contingent on post-closing operations of the buyer or equity in the buyer will be issued as part of the purchase price).

5. Other Strategic Considerations.

Evaluate and consider obtaining consensus in the LOI regarding:

  • Categories of representations and warranties to be given by the seller and, if applicable, the owners of the seller.
  • Indemnification liability limitations based on prevailing market terms (which are accessible through market deal study statistics readily available to M&A professionals). These apply if a party breaches the definitive agreement.
  • All other major deal points important to either party should be considered for inclusion, such as whether:
  • Any material consents or approvals (including regulatory approvals) must be obtained by either party as a condition to closing.
  • The buyer will require any non-compete agreements or transition arrangements.
  • The buyer will assume any liabilities of the seller.

6. Binding Elements.

The LOI is generally non-binding, except for certain specific exceptions that apply prior to a definitive agreement being signed, such as:
  • Nondisclosure and confidentiality.
  • “No-shop” or exclusivity rights for the buyer that prohibit the seller from negotiating offers from other parties while the LOI is in place.
  • Costs and expenses (the expenses incurred as part of the LOI and negotiating the transaction are typically stated in the LOI that each party pays its own expenses).

Key Advisors to Consider as Part of the LOI Evaluation and Negotiation.

  • Experienced M&A legal counsel.
  • Investment banker, business broker or other experienced M&A advisory professional(s).
  • Qualified M&A tax and audit professionals.

Conclusion

The LOI is a critically important aspect in the negotiation and pre-drafting process of an M&A transaction. If evaluated, negotiated and drafted properly, an LOI can effectively establish each party’s expectations of the fundamental deal terms, provide detailed guidance for the drafting of the definitive agreements, and delineate a focused path to close the transaction consistent with each party’s intentions and expectations.

Linden Law Partners has extensive experience developing, negotiating and drafting LOIs for M&A transactions of all structures, sizes, and scopes across a variety of industries. We provide key value driven advice to our clients about LOIs.

Contact Linden Law Partners today at 303-731-0007 or [email protected].

New Attorney Announcement

Posted on by PLinden

We are excited to announce the arrival of Stephen Rotter, an employment lawyer, who has joined our firm as special counsel. Stephen brings more than 15 years of federal government and big law experience to assist our business clients with workplace and other employment-related matters. Click here to learn more about Stephen and his experience.