REtipster does not provide legal advice. The information in this article can be impacted by many unique variables. Always consult with a qualified legal professional before taking action.
There are plenty of reasons to be uneasy about starting a business partnership.
I've heard Dave Ramsey say,
“The only ship that doesn't float is a partnership.”
To that point, I know many entrepreneurs who simply won't get into a partnership with another person, period.
It's usually because of a desire for control and autonomy in their business.
Sometimes it stems from a bad experience, where they didn't see eye-to-eye with their partner and felt stuck in a “bad marriage” of sorts (I've also experienced this first-hand and know how miserable it is).
But here's the million-dollar question:
Should we really write off partnerships for good?
There's a lot to gain from teaming up with the right person!
What if Bill Gates and Paul Allen had decided to go solo rather than starting Microsoft together?
And what about Larry Page and Sergey Brin? If they hadn't joined forces, Google would just be a misspelling of a huge number!
So, think about it. By saying “No” to ALL partnership offers, you might just be walking away from your next big break!
Solving the Partnership Dilemma
In the fall of 2022, when I was halfway through building my first self-storage facility, I was approached by a local competitor in my market who proposed the idea of partnering with me on my facility.
Originally, I started developing this facility with the plan of owning and operating it by myself. I wanted 100% control and autonomy, and I had no plans to take on a partner.
The first time he reached out to me, my initial reaction was to say, “Absolutely not,” and go on my way, but after meeting with him and hearing his case for why we should partner together, I had to admit that it made a lot of sense.
This guy had two established and well-respected storage facilities in the same town and knew what he was doing; he was a good communicator and already had a good management team and marketing channels in place.
He also seemed like a nice enough guy who meshed well with my personality. He had a good track record, and I could tell he would hold up his end of the business without making my life difficult.
He proposed buying into my company at 25%, and then he would act as the property manager while giving me access to all of his software and records, so I could oversee what he was doing without having to do any hands-on property management myself.
Since he had two other storage facilities nearby, it only made sense for my property manager to have his skin in the game at my facility, too, so he wouldn't intentionally run my business into the ground while driving traffic to his other locations instead of mine.
Property management was one thing I never wanted to do in the first place. If he became my partner and ran this side of the business, I would be free to spend my time on other things!
On paper, it seemed perfect. I couldn't think of many reasons not to work with this guy.
Even so, I was old and wise enough to know that the devil is in the details. Things are rarely as simple as they seem.
My biggest apprehension was that if we ever decided we didn't want to work together, I'd be trapped in a messy situation that would be difficult to get out of.
What Is the ‘Freedom Clause?'
After communicating this concern to our attorneys, they put their heads together and devised a clever way to address this problem.
They wrote a few clauses in our Operating Agreement that would act as a mechanism to ensure neither of us would ever be “stuck” in our partnership. Here's how it works…
If I ever wanted out at any time, I could offer to buy out my partner's shares in the company. This offer would be based on the current market value of the property, verified by an updated, third-party appraisal at the time of the offer.
Now here's the kicker… if my partner says “No,” to my offer to buy him out, he has to turn around and buy me out within 90 days.
Either way, we aren't stuck! One of us can stay, and the other can get cashed out based on the property's current market value.
How Does This Work?
For example, let's say that three years into the future, I want to buy back my partner's 25% of the company. I would have to notify him in writing that I want to trigger the buyout clause; when this happens, we would order an updated appraisal, and this 25% buyout price would be based on whatever value is stated in this new valuation.
Even if the original cost of the facility was $2 million, and at the time, the original investment from this partner was $500,000 (25% of $2 million), the buyout price would be based on the updated appraisal. So, if the new appraisal says the property is now worth $3 million, I would have to buy him out at $750,000 (25% of $3 million).
If, when receiving the offer, my partner doesn't want to sell, he would have to turn around and buy me out instead. And if he can't do this within 90 days of his offer, we would have to revert to my original buyout offer.
It's a bit like a game of poker, but everyone walks away as a winner, and neither of us is stuck in a bad situation.
My ‘Freedom Clause' In Writing
For obvious privacy reasons, I'm not going to paste the exact language from my Operating Agreement here.
However, I did ask Chat GPT to come up with some similar language to show you what this could look like.
Please understand that I am not an attorney; this is not legal advice. Partnerships often involve some complex legal considerations, and the actual legal language should be drafted by a qualified attorney based on the specific circumstances and laws of your jurisdiction after thoroughly reviewing your needs and situation.
With all that said, here is an illustrative example of how it might look:
7. Buyout Provisions
7.1. Voluntary Offer to Buy Out: Any member (the “Offering Member”) may at any time present a voluntary offer (the “Offer”) to the other member (the “Offeree”) to buy out the Offeree's interest in the Company based on the current fair market value of the Property. The fair market value will be determined by an independent appraisal of the Property by a mutually agreed-upon, licensed appraiser. The Offering Member must agree to pay the cost of such appraisal.
7.2. Acceptance or Rejection of Offer: Upon receipt of the Offer, the Offeree will have thirty (30) days to either accept the Offer or reject the Offer. If the Offeree accepts the Offer, the transaction shall be completed within ninety (90) days from the date of acceptance. If the Offeree rejects the Offer, the Offeree shall then be obligated to buy out the Offering Member's interest in the Company at the appraised value.
7.3. Completion of Transaction: If the Offering Member fails to complete the transaction within the ninety (90) day period specified in Section 7.2, the Offeree may then exercise their right to buy out the Offering Member's interest in the Company at the appraised value. Such transaction must be completed within ninety (90) days from the date the Offeree exercises this right.
7.4. Financing: If either Member exercises their right to buy out the other Member's interest and requires financing to do so, they shall have the right to obtain such financing. If the Member is unable to secure financing within the ninety (90) day period, then the other Member shall have the right to buy out the interest of the initial offering Member, as outlined in Section 7.3.
Again, this is just an example and should not be used as is. This is a complex matter and should be handled by a licensed attorney in your jurisdiction who can make sure all the terms are legal, fair, and enforceable based on your specific situation.
The Beauty of the Buyout
The real beauty of this clause is that it sets a clear timeline, with a clear, one-way-or-another path that both parties have to adhere to.
Whoever initiates the buyout must complete the transaction within 90 days. If they fail to do so, the other party gets the chance to buy them out.
It's a fair, balanced way to ensure that each partner has an exit strategy and that the transaction will occur within a reasonable timeframe.
Why is this so important, you ask? Because real estate partnerships and made up of people, and like any relationship, people can change over time. The person I am today won't necessarily be the person I am five years from now.
Business goals, personal circumstances, market dynamics – all these factors can change, and sometimes, they can leave one partner wanting to exit the deal.
The ‘Freedom Clause', as I call it, provides an equitable and efficient way to handle these situations without either partner feeling trapped.
In my opinion, having a clause like this is a game-changer for any partnership. It's like a built-in safety net that ensures our interests are protected while also allowing for the flexibility and freedom to adapt to changing circumstances.
Remember, the key to a successful partnership isn't just about joining forces; it's also about having the foresight to make provisions for potential changes. So, if you're about to enter a real estate partnership, I encourage you to consider a ‘Freedom Clause' like this. It's a small step in the beginning, but it can make a world of difference in the long run.