The key question here is: “Do I need a partnership agreement if I am going into business or already in business with a partner?” The term “partnership agreement” refers generally to an agreement between owners of a dental practice. However, depending on the type of legal entity, an operating agreement or shareholders’ agreement may be the appropriate terminology. Over the years we have seen many dental business partners who form a legal entity for their practice and decide not to adopt a partnership agreement. Excited by the prospects of the business, partners believe that negotiating a partnership agreement is an unnecessary cost that will slow momentum and create unnecessary legal obstacles. Like many people they think “what could possibly go wrong by proceeding without a partnership agreement?”
To illustrate the myriad of things that could go wrong, consider the following hypothetical: A deeply shared interest in providing high quality dental care along with compassionate service was the catalyst for a dental practice partnership between Matthew and Alex. The business weathered a rocky start but appeared to be making progress toward sustainable growth. Unfortunately, by that time, the partners’ relationship had deteriorated. They were clashing often, especially over questions of contribution and control. Matthew felt he was doing the real work, while Alex criticized Matthew for mismanaging finances and employees. A friend and fellow dentist weighed in and helped Matthew see his mistakes which cost the business money and good employees. Matthew acknowledged his errors and decided he wanted out of the practice. He contacted a dental school colleague and started negotiating a purchase price for his equity in the practice. When Alex learned this, he felt angry and betrayed, and the hostility between the partners festered. Unfortunately, the situation depicted here is far from rare. These disputes arose primarily because Matthew and Alex did not have a clear partnership agreement that addressed the issues they confronted. By adopting a well-drafted and custom-tailored partnership agreement, partners can set and manage each other’s expectations and avoid future disputes or at least have a mechanism to resolve them when they arise. For example, in the hypothetical, a partnership agreement would have served to define terms such as who would manage the company on a day-to-day basis, and what responsibilities each person would be accountable for.
A partnership agreement would have allowed Matthew and Alex to agree in advance about how to manage company finances, plan distributions of profits, and whether they would make additional capital contributions or loans to the practice when necessary. Alex could have negotiated to maintain responsibility for managing practice employees. A partnership agreement could also have identified a person(s) that would resolve disputes if the partners encountered a deadlock or could not agree on an important decision. Further, addressing important issues such as restrictions on sale or transfer of ownership may have prevented Matthew from starting sale negotiations. Similarly, incorporation of a notice of partner withdrawal requirement, and a right of first refusal would have given Alex priority to purchase Matthew’s interest in the practice before any third parties. These partners could also have pre-established how equity purchase price and deal terms would be determined in the event of a future sale or other triggering events such as death, disability, retirement, or early withdrawal.
There are many key topics and questions that should be addressed in a partnership agreement. When deciding whether to prepare a partnership agreement, dental professionals should also understand that absent a written and binding agreement, a company is governed by the default statutes and regulations of the state where the company was formed. Although many state’s rules are comprehensive, they may not adequately address the rights and obligations of the partners under many different scenarios, or they may create a dead lock between the partners.
By way of example, state rules may not discuss what happens when the company needs more capital, or whether an owner is prohibited from competing with his/her other dental business. Similarly, statutes and regulations will not address how to share profits when one partner produces significantly more dentistry and revenue than another partner. Because each dental business is unique, and relationships between partners vary greatly, accepting the one-size-fits-all approach of state laws or even a generic form of partnership agreement can be dangerous. For this and many more reasons, a well-structured partnership agreement prepared by counsel, which sets forth the parties’ intentions and provides for agreed upon rights and protections in advance is the only logical option.