A Look at Partnership Dissolution
While the decision to operate a business as a partnership can be an excellent one for many reasons, let’s face it, partnerships are not for everyone. One of the best reasons is the ease of having a partnership dissolve. You can simply have a provision in the partnership agreement that states how and when the partnership will be dissolved.
Partnerships can be dissolved at will, unless otherwise specified in the agreement. But there must be cause to dissolve the partnership. For most private business owners this means that they simply lack the "appetite" to continue managing the business on a day to day or strategic level. For example, if you have grown the business and the market has opened up to sell your business, that opportunity may be the right time to dissolve the partnership . If one partner wants to retire from the partnership or focus on other investments, continuing the partnership can often no longer be attractive to that partner.
There are other reasons why a partnership may be dissolved. Someone may want to "cash out" their interest in the partnership. A partner may move out of the geography, or disagree with the direction of the company. The key point is to make sure you have a clear mechanism in the partnership agreement to resolve tension between the partners so that it assists in allowing a dissolution and assists the partner looking to cash out. It is also important to acknowledge when things do not work as hoped that you have a clear way to end the partnership.
Terms of a Dissolution Agreement
When business partners decide to end their relationship, the dissolution must be formalized in a document that clearly identifies how the partnership will be dissolved. The elements of that document vary based upon the nature of the business and the personal preferences of the partners. However, there are several key components that should always be addressed in a dissolution agreement, including:
Agree on the Division of Assets
The division of assets is often one of the most contentious issues resolved in a business dissolution. Parties need to outline what constitutes a business asset, as well as how it will be divided between them. In certain instances, assets may have appreciated over the term of the business. This also needs to be addressed in the dissolution agreement.
Identify Liability Settlements
Similar to the division of assets, partners need to agree on how liabilities will be handled in the dissolution process. Depending on the nature of the business, certain debts may also need to be paid before the business can be dissolved.
Complete Tax Due Diligence
Because the business has been operating under the legal structure of a partnership, partners will have identified tax strategies for their business. Those strategies may need to be updated as the business is dissolved, so partners may want to consult with an accountant at this time.
Agree on the Timeline of the Dissolution
Partnerships that will be dissolved over time (called a winding up) might need a different template than those that will be dissolved immediately.
Determine the Future of the Entity
Once a partnership is dissolved, the entity still technically exists. It is often necessary to outline the future of the entity, such as when fees for licensing, taxes, and other regulatory requirements must be paid.
Finalize the Termination Process
Finally, partners will need to agree on the process for terminating the business itself. If it is a limited liability company (LLC) or corporation, there are likely different processes that have to occur in order to legally terminate the business.
How to Dissolve a Partnership
The process of dissolving a partnership requires agreement from all partners who see the need or desire to terminate the business relationship. Sometimes, the dissolution is completely by mutual consent, but often, one partner wishes to dissolve while others want to remain. A partnership agreement may contain a dissolution procedure stating what steps are required of the partners to dissolve the business.
1. The first step in dissolving a partnership is for the partners to agree by consent to dissolve the relationship. The partnership should create an operating document that outlines the dissolution procedure to ensure that all procedures for terminating the relationship are fair and legally binding.
2. If the partners cannot come to an agreement about the dissolution, the partners may petition for judicial dissolution of the business. A judge may grant dissolution in the following conditions:
• The illegal activity of one or more partners
• Failure of partners to perform a partnership obligation
• Dissolution of the business under a partnership that has a specific end date
• Dissolution of the business under a partnership at-will (no partnership end date) where it is no longer economically feasible to continue the partnership
• Transfer of ownership interest to a new partner without agreement of all partners in the partnership agreement
• Physical incapacity or death of one or more partners
• Impossibility of the business to continue in its current form
• If it is not reasonably practicable to carry out the partnership because of a partner’s conduct
3. Formally file the dissolution with the secretary of state office for your state (if required).
4. Notify the IRS of the dissolution. If the IRS does not require a formal dissolution filing, it does, however, require the partnership that is disbanding to file a final return. This is a tax-reporting requirement, if unable to file a final return, the partnership remains open. Form 1065 is filed for partnerships that do not have employees and do not own property as part of its business. Form 1065 is a federal tax return, so if you are registered in a state that has a state-level tax, such as California, you are also required to file a final state tax return.
If the transition of closing the business is too complex to handle without a lawyer, contacting a business attorney about your dissolution is a good way to step through the process.
Legal Aspects of Dissolution
The dissolution of a partnership is a legal matter with potentially wide-ranging implications for the parties involved. This means that you need to take the matter seriously and ensure that your interests are fully protected. A completely-drafted Dissolution Partnership Agreement will go a long way to making sure that is the case, but there are still a number of legal concerns you may need to deal with.
One of the most commonly-occurring legal issues is the division of partnership assets. In an ideal world, everyone would be amicable and reach an agreement over how assets should be divided, but not every partnership dissolution will go that smoothly. In those cases, it is possible that a legal mediator must be involved to help divide the partnership’s assets.
It is also common for disputes to arise over other assets. While in many partnerships assets are owned by the business, other assets—such as real estate—might be owned by one or more members of the partnership. During a midsize or large partnership dissolution, it is entirely possible that someone will seek damages through the courts. A Dissolution Partnership Agreement should address how assets that are not owned by the business should be allocated.
Given all the potential legal issues that can be involved in a partnership dissolution, it is often advisable to seek some level of legal advice during the process. At a minimum, it is often best to work with a professional when drafting a Dissolution Partnership Agreement.
Formulating a Tailor-made Template
The key to developing a versatile dissolution partnership agreement template is creating a document that can be easily amended according to specific circumstances. It can be difficult for a business owner to know about all the common issues they may face during a company exit. For this reason, it is best to incorporate options into the template that allow for different strategies and alternative remedies for resolution. For example, if one partner is agreeable to selling their stake in the business to the remaining partner or to a third party, then the process for agreeing to a sell-out of one partner will be useful. Including an option for determining the business’s value based on an agreed-upon valuation method is ideal. This way, if two partners see eye-to-eye, they can agree to each step in the exit strategy as they go along. The template should include amendments that allow for the discussion of whether a new investor will be acceptable. Options in the template can even build in a period of time to allow strategic analysis of whether an entity may be viable as a lone owner without a partner.
Even when the opportunity to amend or terminate a current partnership agreement exists , it can be hard to develop a dissolution strategy. Alternatively, if the event has already occurred – such as through the insolvency of a partner, a new document must be drafted or the old one must be amended to reflect the latest information. Again, the flexibility in a dissolution partnership agreement template can give a business owner the applicable resources they need to evaluate their next steps. One way to ensure flexibility is to include provisions for deciding whether the other partners have adequate notice as to the issue – given the timeline requirements under the governing laws. This gives the parties the opportunity to determine whether the other party has received notice in a timely fashion and can appropriately respond to the dissolution process in accordance with the law.
Ultimately, the purpose of a dissolution partnership agreement template should be to reflect any applicable template for resolution that may be desirable for the circumstances. Templates can be a helpful tool to assist small businesses in targeting essential issues at hand. Templates help the parties determine the best exit strategy for their business and to implement these strategies through the most beneficial methods possible.
Collaboration with An Attorney
When it comes to forming an agreement, consulting with a lawyer and a financial expert regarding your partnership dissolution can be very beneficial. To form a partnership dissolution for your own company, you should consider making a special meeting with your accountant or bookkeeper, as well as a business attorney. Meeting with these experts will assist you in determining a strategy and which forms would best suite your dissolution needs.
When you work with a lawyer on your partnership dissolution, there has to be areas where both you and your lawyer agree on. In most cases, there are two or three ways to do something, and your lawyer wants you to choose the best option. Regarding your finances, an accountant or a bookkeeper can be quite useful in assisting you with your partnership dissolution. Often, the accountant will have worked with your company in the past and may even have a little knowledge about your business. He or she will already know how your business operates, and that means they will have closer idea about what you need. You truly could not ask for more from your accountant. Then again, your accountant can help you determine if you have the cash flow required to pay your former partner correctly for his or her share of the company. Finally, with an accountant or bookkeeper, you can obtain accurate and quick information about the money or resources available at your disposal. The accountant or bookkeeper will also be able to assist you with various tax laws and the extent at which taxes might be involved when closing your company. You have to account for the tax implications, and both a lawyer and accountant or bookkeeper can help you with that process.
Common Mistakes and How to Prevent Them
In the midst of the dissolution process, the time and effort invested in the drafting of the dissolution partnership agreement template can easily become an afterthought. As a consequence, a number of costly mistakes are often made. These can include the following:
· Ambiguous language in the dissolution partnership agreement template. This is not an uncommon mistake made by partners who think they can return to their drafting days from college. There is a difference between being casual with an old friend and being clear with your former business partner. More succinctly – there is no ambiguity when it comes to the dissolution of a business.
· Failure to meet timelines. The creation of a dissolution partnership agreement template is a process. And as with any good process you should spend time developing a number of milestones. These milestones should be reviewed frequently (as in once a day) to ensure that you and all who have an interest in the process are on schedule.
· Engaging in wishful thinking. It is one thing to think your business will be valued at one amount but it is another to act upon it. Don’t fall prey to the "wishing" of the outcome. A third party should be engaged on the valuation terms of your dissolution partnership agreement template.
To avoid these mistakes , communicate clearly and document everything. Be willing to ask question in a concise manner regardless of how simplistic you think they are. Document each conversation you have in writing as part of your dissolution partnership agreement template. Not only does this assist your dissolution, it serves as proof that you have done the right thing from a fiduciary standpoint.