A partnership has many important provisions that will guide the business through the good times and the tough times. Transitioning periods can fall into either or both of these categories. For instance, if one partner wants to leave the partnership, it can be an opportunity for them to leave an endeavor to which they are not fully committed. Allowing them to exit the partnership successfully and smoothly can be in everyone’s best interest, the partnership included. Depending on the value standard included in the partnership agreement, however, a partner may be hesitant to leave the partnership as their share of the company could end up being significantly devalued.
Partnership Agreement Value Standard
You may have guessed, and would have done rightly so, that the value standard in a partnership agreement is the standard by which the partnership is valued. This can have big implications for the partnership and for any partner that wishes to ever leave the partnership and have his partnership shares bought out. If the value standard inadequately values a partner’s shares, the partner may be dissuaded from leaving the partnership altogether. This is usually not the best scenario for anyone involved as a partner with one foot out the door is not likely to be committed to the continued success and growth of the partnership.
Many partnership agreements make the mistake of setting the value standard in the partnership agreement at the partnership’s book value. “Book value” is an accounting term and, in order to calculate the partnership’s book value, you look to its tangible assets. Tangible assets will include things like the business’s equipment and inventory. Once the value of the tangible assets has been totaled up, you have the partnership’s book value.
When you look at the definition of “book value,” however, you may notice some glaring omissions to what actually brings value to a business. After all, the intangible assets of a business can make a big different in its value. The goodwill, for instance, a business has built up with its network, customers, clients, and community can solidify critical business relationships and help ensure the long-term success of the company. The cash flow and revenue stream of a business is also a big part of its value. While tangible assets and cash on hand may be in relatively short supply, The continued flow of business opportunities and revenue generation should not be discounted. Additionally, the future revenue opportunities for the partnership can also bring a great deal of value to the business. All of this, however, is not included in the book value of the partnership.
That is why partners should take great care in establishing the value standard in their partnership agreement. It may be easy to agree to a standard, boilerplate provisions, but it can be important to take a moment to reflect on the implications of such provisions. Take the time to evaluate your value standard options and determine which valuation method will best serve your purposes.