Accounting and Taxes | Archive

Breaking up isn't necessarily hard to do:
Ease partnership dissolutions with an exit strategy

by Kurt Taves
for Virginia Business
September 2006

Real estate investment creates many opportunities for business partnerships. Partners can contribute knowledge, cash, credit or leverage that you may not have. But in many instances, they can also bring their own agendas to the table - goals that might not mesh with yours. And though most conflicts can be resolved, it may be necessary to end the business relationship in certain scenarios.

Dissolving a partnership can be painful, but having an exit strategy in place can make the process much easier. And contrary to what you may think, it's probably not too late to modify your existing partnership agreements.

Plan for the worst
A formal exit strategy should spell out various possibilities for a rational, and sometimes profitable, separation. The more complicated your investment relationship, the greater the need for carefully planned exit scenarios, valuation options and contingency plans. But what, specifically, should you include?

For starters, state the triggers for partnership termination. There are several possible circumstances that could lead to the dissolution of a real estate investment agreement, including a termination request by a partner, the nonperformance of one or more partners, an inability to agree on key issues, failed occupancy expectations, missed investment return targets, a partner's bankruptcy, or the inability or unwillingness of a partner to contribute capital in the event of a capital call.

Dividing the interests
The fallout from a failed real estate partnership can be unpleasant and detrimental, perhaps involving bad publicity and unfavorable financial consequences. Breakups become especially difficult when partners have contributed time and financial resources unevenly or have drawn disproportionate benefits. Additional strife may arise if one partner has an advantage over the other, or considerable intellectual property is included in the venture. Intellectual property includes everything from trademarks, copyrights and patents to trade secrets and highly developed market strategies. These items are difficult, if not impossible, to divide.

An exit strategy will state, in no uncertain terms, who gets what by specifying exactly how the partnership interests will be split. There are several options to consider, including:

- complete separation of interests;

- renegotiations and restructuring (i.e., rewriting a partnership agreement);

- spinoffs (i.e., dividing a partnership's properties and placing the interests in another, separate partnership); or

- sales to a third party.

Other considerations
Other forces that can break up a partnership include a partner's death, political unrest, an act of nature, or, most commonly, divorce. Many real estate investors are partnered with their spouses, which can make for a messy partnership dissolution. Clearly, real estate partners who don't define partner responsibilities - whether parties are married or not - are headed for trouble if anything bad happens. Those who develop solid exit strategies from the beginning are the ones who avoid the most grief.

The lack of a formal, written partnership may also hinder the dissolution process. If, like some real estate investors, you have done, or are still doing, business on a handshake alone, the results can be disastrous. And oral agreements can become particularly sticky when a partnership dissolves. This, plus the lack of a written exit strategy, complicates matters considerably since each partner's understanding of the agreement may differ. If that's the case, you may wind up in court, letting a judge or jury decide whose interpretation holds sway.

Value your interests
Properly valuing each partner's interest is one of the most challenging aspects of partnership dissolution. Don't automatically assume that partners will share profits and losses equally. Duly note each partner's share during the actual partnership as well as its dissolution.

Some agreements provide for a negotiated valuation based on offers by one or more of the partners, while others provide a predetermined formula. When partners simply can't reach an agreement, arbitration - an independent, third-party assessment - is often the most cost-effective manner to determine values and dissolve the relationship.

Cut your losses
Disagreements between real estate partners are bound to arise. And the more partners involved, the greater the chances for differences of opinion. Nevertheless, spelling out ways to resolve disagreements in advance can help you avoid ugly court battles, curtail legal costs and preserve at least some element of goodwill.