The elements of good partnership agreements with Drew McLellan

Speaker 1:

If you’re going to take the risk of running an agency, shouldn’t you get the benefits too? Welcome to Agency Management Institute’s Build a Better Agency Podcast, presented by White Label IQ. Tune in every week for insights on how small to mid-sized agencies are surviving and thriving in today’s market. We’ll show you how to make more money and keep more of what you make. We want to help you build an agency that is sustainable, scalable, and if you want, down the road, sellable. With 25+ years of experience as both an agency owner and agency consultant, please welcome your host, Drew McLellan.

Drew McLellan:

Hey, everybody. Drew McLellan here from Agency Management Institute. Welcome back to the Build a Better Agency Podcast. Hopefully, you are a regular listener and you’re just coming back like you always do every week. But if you’re new, welcome. Every week, we have a new episode, usually a new guest, and a new topic. So, I hope you’ll go back and listen to some of the other 300 episodes that we’ve already done as well as follow along with us as we move into the future.

This week’s episode is one of my solocasts. So, again, for those of you that are familiar with the show, this means no guest this week. It’s just you and me talking about something that I think needs to be on your radar screen. I’ll be back next week with another guest. Before I talk about what we’re going to talk about, a couple of quick housekeeping things. Number one, as you know, on every solocast, we give away a free seat at one of our workshops. The way that you get in the drawing for the free seat is you just leave a rating and review for the podcast. So, go to wherever you download your podcast, whether that’s Apple Podcasts or Google or wherever you may get it. I know we’re in a lot of different places. All I need you to do is leave a rating and review.

But when you do that, make sure you take a screenshot of it and email it to me at [email protected], because a lot of you have different usernames tied to your podcast subscription. Sometimes you’re using something that I’m not going to recognize or I’m not going to be able to associate with your agency. So, if you have Dodgers or the best baseball team in the world 62 as your username, which, by the way, would be a really good username if somebody hasn’t already used it, I don’t know that that’s you.

So, take a screenshot, send it to me, and I will make sure that you stay in the drawing and you stay in the drawing till you win. So, odds are good for you that sooner or later, you’re going to win a seat at either one of our live workshops or one of our on-demand workshops. That’s about a $2,000 value. So, pretty good odds for a pretty good price for very little time and effort. So, hopefully, you think that’s worth it. So, all you have to do is again, leave the rating and review, send it to me, and we will put you in the drawing.

I want to tell you a little bit more about a workshop that we have coming up as well. It is February 17th and 18th, which seems far away but actually is not. It’s only a few months away. It’s a brand new workshop that we have never offered before called Rethink Innovation. I’m super excited about this workshop, because if you’re watching the video of the podcast and you’re seeing this alligator over my shoulder, this alligator painting, I’m in New Orleans for a peer group meeting. The hotel is quite New Orleans themed. So, gators everywhere in my room. Anyway, I just looked over my own shoulder on the video inside. So, I thought I probably need to explain it to you.

Anyway, as I was saying, we have this great workshop called Rethink Innovation. The person that I am co-teaching it with and she’s going to be doing most of the teaching, I’m really more of the color man. But anyway, the person who’s going to be teaching this workshop is a woman named Carla Johnson. Carla is an innovation specialist, I guess you might call her. She studied innovation for much of her professional career. She helps reinvigorate the ability to think and think big time and demand. She talks about in her book, and she was a podcast guest about a year ago, I think. She talks about the idea that when we’re kids, all of us are innovative. We can turn a couple boxes in a pan and a wooden spoon into a circus or whatever we want it to be.

But as we get older, that drive and that natural ability to be innovative somehow gets squelched in us, especially in our line of work. This is a skill that we have to be able to tap into on a regular basis. Many agency owners tell me that they’re the only ones in their shop that can really think big or come up with the big idea. So, one of the great things about this workshop is that Carla has built a framework to reinvigorate our ability to be innovative thinkers. The framework is something you can learn at the workshop and then take back to your shop and teach everyone in your shop, because her premise is that everyone in the agency can and should be innovative and have big ideas. There’s no reason why they can’t come from the CFO or the intern or anybody in between.

So, I think it’s going to be a spectacular workshop. It’s going to be super active, lots of small group activities, and all kinds of, I think, really fun ways to learn our framework. So, again, if you’re interested, head over to the Agency Management Institute website. Under the How We Help, you’ll find a Workshops tab and look for Rethink Innovation. Again, February 17th and 18th on Disney property. So, that doesn’t suck. So, we would love to have you there.

So, I started to tell you how to win the free workshops, but I didn’t tell you who won this month. So, Jen Brilliant, which is really a great name for an agency owner. Jen Brilliant from CND Advertising, you are this month’s lucky winner. I’ll also shoot you an email, so you know, but thank you for your review. I look forward to meeting you at a workshop soon, maybe the Rethink Innovation workshop. So, all right, enough housekeeping. Let’s get to the content at hand.

So, as some of you know, we do a lot of work at AMI, helping agency owners think through succession planning. In particular, we come alongside them if they are working on an internal sale. In other words, an employee or group of employees are buying out the current owner. Sometimes that process, we can get that done in six to nine months. Sometimes the agency owner or the buyers or circumstances means that we’re hands in it for a couple of years.

But one of the things that always ends up coming up is the need for partnership agreement, because typically, in many cases and most of the cases actually, the agency is owned by a single person and they are selling to either another single person or a group of people. But oftentimes, that sale takes place over time. So, the buying partner, if you will, might buy 5% or 10% or 20%, and then over the course of a few years, buys out the rest of the agency. So, for a period of time, the selling owner and the buying owner are business partners. The selling owner never had a partnership agreement because they used to own it all by themselves. Now, that’s not the case anymore.

So, if you were at the Builder a Better Agency Summit this past August and you heard my keynote, you heard a horrible story of how I as a young agency owner had a business partner and we did not have a partnership agreement. That ended badly. That is the understatement of the planet. It ended very badly because we weren’t smart enough to have the documentation that we needed to easily dissolve our partnership. So, it got problematic, let’s say.

So, what I wanted to talk about today was the elements that should be in a partnership agreement. So, if you have a partnership agreement already, if you already have a business partner, I want you to listen carefully to all of the elements that should be in your partnership agreement. Maybe it’s time for you to update or augment your partnership agreement. If you are a solo owner and you’re thinking about bringing on a partner, this is a document you’re going to want to talk through and work through and build together with that person. Prior to selling them any piece of your business, you want to have this in place.

If you are solo owner and you have no intention of having a partner, then this is probably an episode that is interesting to you, but perhaps not something you’re going to put into play right away. So, I’m hoping that this has some insight and value for all of you. By the way, some of these things are also good things just to have on employment agreements, but as you’re going to hear, some of them are specific to ownership. So, all right, let’s dig in.

Obviously, the very first thing that’s going to be in your partnership agreement is the name of the organization and the legal designation as an S corp, an LLC, a C corp, whatever that may be. So, just again, nuts and bolts, here’s who we are and here’s what we are. And then you need to outline how the ownership is divided. So, that’s probably a percentage. If you own shares of stock, it can be that. It can be if you’re an LLC, it might just be membership entities, pieces.

But however ownership is handled, so it may be you’re 50/50 partners, it may be that one of you own 75% and the other owns 25%. But you need to define how the business is owned by the one, two, three, four, seven partners, whoever is a partner, and also how that ownership percentage can change. So, are people allowed to buy each other’s parts and pieces of the agency? Is there a schedule to that? Is it a formal plan that’s already in place, or is it just something that you can deal with as you want it to moving forward?

The next one is one that a lot of partnership agreements, when people asked me to look at their partnership agreements, the next one is one that’s often missing. It’s actually one of the most important pieces of the partnership agreement, which is really clear definitions of each partner’s contributions and responsibilities. So, think of them as smart goals, only they’re smart roles. So, they should be something that all the other partners can look at and say, “Yup, Drew did that. Yup, Drew did that,” or “Oh, Drew is dropping the ball on that. That’s not happening.”

So, the purpose of these definitions of the contributions of the partners is so that the business partners, it’s tough when your business partners to hold each other accountable. So, the roles clearly defined as smart roles, either specific or measurable, all those things. It gives me a mechanism as a business partner to have a conversation with one of my business partners if they aren’t meeting our expectations. It’s also a way for me as a partner to know what I’m responsible for and for me to stay in my own lane. A lot of times business partners, how they work is fluid. So, you want to make sure that everybody is doing their portion of the work and staying focused on their job. So, these clear definitions and contributions for each partner is a way to do that.

As you might imagine, it’s really important to define in writing. So, think of partnership agreements as prenuptial agreements in a marriage. You write those when you are madly in love with each other and you don’t think you’re ever going to have a fight, let alone a conflict or let alone thinking about dissolving the marriage. Partnership agreements are exactly the same thing. You want to write these when there is no conflict or when the conflict is super manageable. You’re going to want to write these in a way that you’re writing them in a moment in time when everything is going well. You can’t imagine actually having to trigger any of these things, but you are smart enough to know that sometimes even in the best partnerships, things go sideways, maybe even temporarily.

None of these are about breaking up or the deal ending. Well, some of them are, but it really is more about the idea of you being able to use this document as talking points and for clarity. So, it’s really important to do this together. It’s important to do this at a time when you can really have good candid conversations, and everybody can be really honest about what they want under the partnership. So, anyway, back to the next topic.

As you might imagine, one of the most important things to have in your partnership agreement is, “How do you divvy up the money?” So how do we handle profits? How do we handle losses if everybody has to put money back in the business? How much loss are we willing to tolerate before we take action? How are draws or distributions handled amongst all the partners? So, this is all about basically, “How are we handling the proceeds of the agency and how are we dividing that up?” Again, it might be by ownership percentages. It’s also about how often, for example, you’re going to take draws. Can a partner trigger a draw that’s out of the sequence?

All of a sudden, I want to buy a car. Can I take a draw? So, it just outlines the rules around money. When you’re talking about money, one of the currencies I don’t want you to forget about is points. So, for many of you, you played the points game with credit cards and you’ve accumulated a lot of points. So, understanding how those are going to be used and how somebody can tap into those for whatever reason is also an important currency to cover in the profits, losses, draws section of your partnership agreement.

One of the most important things that business partners do in agencies is they are responsible for making commitments on behalf of the agency. So, in the partnership agreement, you need to be really clear about the partnership authority. So, who has the power to bind the agency in a contract? Think about all the ways that you commit the agency to things as an agency owner. You sign media contracts, you sign loan documents, you rent the copier for five years, you sign a telephone contract, you sign a lease. I mean, big and small, as agency owners, we bind the agency to lots of different financial commitments. So, you want in this document who can do that and at what level.

So, is that each of the partners can commit the agency without talking to the other partners for up to 25 grand? You require two signatures for something that is in duration longer than a year. Lots of different ways to think about this, but you want to be really thoughtful about it and really, really clear in your language about who can do what.

As we’re doing succession work with buying and selling partners, one of the places that is really fascinating where we have a lot of conversation as we’re thinking through the partnership agreement is, “How are we as partners going to make decisions?” So, in a lot of cases, you have a solo owner selling to either one more person or multiple people. Remember, the solo owner is used to making all these decisions by themselves. They don’t have to get anybody else’s vote. Oftentimes, they’ll talk about it with their leadership team or maybe the person who actually is not buying into the agency. That’s usually a right hand person that they confide in. But everybody in the agency knows that the buck stops with the agency owner and they make decisions.

So, all of a sudden, when you take out a partner and all of a sudden, you have to actually run things by someone else and they get to vote on your vote, that’s a very different shift for agency owners. So, in this part of the partnership agreement, you need to decide who owns what decisions. So, sometimes it’s divided up by areas of responsibility, like Partner A takes care of finance decisions ups to X dollars, Partner B handles most operating day-to-day decisions.

Whatever it is, you have to decide what decisions can be made independent of each other, where each of you has authority and responsibility, what decisions need to be unanimous, like moving the agency to a different building or taking on a large contract or maybe a big loan or maybe hiring decisions at a certain level. So, you have to decide, “What decisions have to be unanimous and what is the process of decision making?”

So, when do I inform my partners I’ve made a decision? Do I talk to them before I do it? Is it an ask or is it a tell or report again after I’ve made a decision? But where the discussion gets really interesting is what happens when the partners are stuck and you’re at a deadlock and you can’t make a decision. You are in disagreement with one another. How do you handle in essence breaking the tie?

I have seen it all over the years. Literally, I have helped partners negotiate that they’re going to do rock, paper, scissors to decide. In other cases, they’re going to take turns. So, if it’s Drew’s turn this time, then it’s Babette’s turn next time. They just alternate through the partners. I have seen coin flips. I actually am in some partnership agreements as I’m the tiebreaker, so a trusted advisor of some kind. Sometimes it’s an attorney or a CPA or like I said, in some cases, it’s me. However you determine and define your tiebreaking methodology, it doesn’t matter. As long as it works for you and all the partners, it doesn’t matter what it is, but it does matter that you have it.

This is a place where if an agency does not have a partnership agreement, sooner or later, I don’t care how aligned you and your partner are, it doesn’t matter, sooner or later, you are going to disagree. We’re human beings. You really do want a predetermined, clearly defined, no wiggle room or arguments. So, like at coin tosses, one coin toss, is it best three out of five? You need to be very specific about how ties are going to be broken. You need to have it in writing and it will save you such headache and such heartache if it’s predetermined when you do not have conflict. So, there’s that.

All right, I’m going to take a quick break. You can probably hear my voice is a little scratchy. I am battling a bit of a cough. So, I’m going to swing some cough medicine and some water and then I will be right back. I’m really sorry to interrupt the show, because I know that you are into it, but I promise we’ll get right back to it. I couldn’t miss this opportunity to tell you about a workshop that we’re teaching, the Build and Nurture Your Agency Sales Funnel. This is a workshop that I teach with Stephen Woessner. It is the next step after you read our book, Sell with Authority.

This is all about building a new business machine that works every day to attract right fit clients right to your front door. This workshop is a little different than some of our workshops. This is much more a hands-on workshop. There’s a lot of homework that you’re going to actually do in the workshop, because we want you to leave the two days with a completed marketing and sales plan. I’m talking tactics. I’m talking timetable. I’m talking who’s going to do what at your agency. You are going to leave with it built out and ready to implement the very next week.

We know that if we taught you how to do it, but we didn’t make you do it in the workshop, by the time you got back to the office and all the craziness that waits for you there, it would never get done. So, that’s why we built this workshop this way. It’s been very well received. In fact, it’s backed by popular demand. This workshop is January 20th and 21st in Orlando, Florida, on beautiful Disney property. If you are ready to kick off the new year, being serious about bizdev, and really separating out prospects who aren’t that good for you or aren’t going to be profitable for the ones that are going to love you, stay with you, and help you make money, come to the workshop. Let us show you how. All right. Let’s get back to the show.

Okay, welcome back. Again, Drew McLellan here from Agency Management Institute. I can’t imagine you jumped in the middle, but just in case. Glad you’re here and it’s one of my solocasts this week. We’re talking about the importance of a partnership agreement and the elements that need to go into that partnership agreement. So, we walked through the first five or six, and I’ve got another eight or nine to go. So, when we took a break, I was talking about having a way to break ties and how to handle decision making. Escalated to that is the next one on the list, which is conflict resolution.

So, this is not about we can’t make a decision. This is my partner and I are sideways. There’s something going on in our relationship. There’s this conflict that is getting in the way of us running the business together. So, that could be a million different things. It doesn’t matter what it is. But basically, we are not getting along, we’re not seeing eye to eye. It’s making things super difficult. Inside the agency, odds are your employees are feeling it. So, we have this conflict that we have to resolve. The conflict may be born out of a specific thing or an activity or whatever it may be, but you need to know how you’re going to resolve that conflict.

Typically, what is going to happen in this part of the partnership agreement is you’re going to identify a source, a mediator, or a business counselor, or a business coach, or someone who you trust who has a high emotional intelligence who can come in and help you sort this out. I mean, so think of it almost like couples therapy for business partners. Again, you don’t have to list what the conflicts are. You just need to list who is going to help you resolve those conflicts if you have them.

All right. The next one is a statement really. It’s a no compete and non-disparagement clause. So, in essence, what you’re saying is, if we break up the partnership, whoever leaves the agency won’t compete with the agency for X period of time in X geography, so no different than the no compete that you have probably for the rest of your employees. But the other part is the non-disparagement.

So, in other words, if Babette and I are business partners and we get sideways with each other and I choose to leave the agency, I am agreeing, as part of this partnership agreement, not to say bad things about Babette out in public or on a review site. Again, you want to be really specific in this language about that this isn’t going to happen online, offline, in the community, whatever it may be. So, it really is simply a statement that by signing the partnership agreement, you both or all of you are committing to.

The next thing on the partnership agreement is okay, something has happened and either a partner voluntarily wants to leave the business. Maybe they just have had enough and they want to do something different. They want to become a Tibet monk or there’s something that has gone wrong inside the partnership. For example, I want to exit Babette out of the business. I don’t want to be her business partner anymore. She’s done something that I find so egregious that I can’t or don’t want to be her business partner. There are a couple elements in this section of the partnership agreement.

Number one, you need to clearly define if Drew raises his hand and says, “I want to get out of the partnership,” what are the steps that I have to take as the exiting partner to do that? How much time do I need to give? We’ll talk later in the list of things that need to be included about, “How do the other partners buy me out? How do we decide the value of the agency or my portion of the agency?” That’ll come a little later, but it needs to be noted in this part of the section than it is later in the document. So, the remaining partners can buy out the departing partner using the valuation methodology in Section X.

On the involuntary side, typically, in this section of the partnership agreement, there would be a list of reasons why fiduciary irresponsibility, for example, an unresolved addiction problem. For each of you, it’s going to be different, but you’re going to list reasons why I as a partner could trigger booting Babette out of the business. Again, you guys are going to agree to this stuff. So, it’s not going to be a surprise to anybody if one of these gets triggered later on, because it’s in the partnership agreement. So, some people specifically list out reasons why they would break up the partnership.

Other people just say, if there is a grievance or a concern that is so great that one of the partners feels like they cannot stay in partnership with another. You might use broader language like that, but nonetheless, you need to outline what’s going to happen, how it happens, the timeline of how it’s going to happen in this section of the partnership agreement.

The next couple sections are not pleasant to talk about, but they’re important to talk about. So, the next one is incapacitation of a partner. So, let’s say Babette and I are partners. I am in a motorboat accident, and I am in a coma. I might be in that coma forever. I might be in that coma for six months. So, you need to deal with basically the incapacitation of a partner, both short term and long term. You’re going to want to talk about different timeframes and what the healthy partner, if you will, can and cannot do, while in essence the partner, me in this case in my example of the motorboat accident, Drew, what can my partners do to the business while I don’t have a say in the business?

Ultimately, if I am permanently incapacitated, then how do my partners buy out my family of my shares? So, you’re going to have the rules of engagement, like if the incapacitation is from zero to three months, this is what happens. If it is three to six months, this is what happens. If it’s longer than six months, this is what happens. But oftentimes, this section of the partnership agreement is tied together with insurance products. So, for example, again, if I’m in the motorboat accident, let’s say that God forbid, I’m paralyzed from the neck down or I have brain damage or I have something that’s going to make it so that I can’t work anymore. I can’t physically work anymore, I can’t mentally work anymore or whatever it is.

There’s an insurance policy that’s tied into the business that allows my business partners. Typically, the agency is the beneficiary or the partners of the beneficiary of this insurance policy. They’re going to be able to use the funds from that in