The role of a business lawyer and the cost of legal services during the formation process and early stages of a new multi-owner business are perennial concerns for business partners. The owners often don’t see the benefits of paying a couple thousand dollars to draft a partnership agreement that doesn’t appear to bring them any commercial value.
I agree that it’s certainly important to manage startup costs effectively. Your cash supply is limited, and you can’t be cavalier in your spending. Unfortunately, certain expenses are perceived as “better” because the benefits to the business are more obvious. Partners might quibble less about spending on marketing materials, office improvements, or advertising because the effects are more immediately apparent in the form of new leads, better working spaces, or increased revenue.
However, this shortsightedness has led many companies to a ruinous end. Legal preparations are about long-term risk management and asset protection. Your partnership agreement, in particular, is an investment in the future of your company. Yet, calculating the return on that investment is difficult.
On the one hand, humans have a psychological tendency to discount the future and prefer rewards in the here-and-now. On the other hand, a partnership agreement doesn’t make you money; it helps you avoid losing money through disputes, arbitration, and litigation.
So, to help you see the value in loss avoidance and risk management, let’s take a look at the costs, fees, and harms from which a well-written, comprehensive partnership agreement protects your business. By comparing these costs side by side, it will be clear that arbitration or litigation will cost you much more in the long run than a partnership agreement.
The Role of a Comprehensive Partnership Agreement
A partnership agreement is a foundational document for your new multi-owner business. Whether you’re going to operate as an LLC or corporation, a comprehensive partnership agreement is the best way to set the new business up for success.
The agreement will address many of day-to-day operational aspects of the business such as partner employment, compensation, management responsibilities. More importantly, though, it will include vital directions for how to deal with less common situations:
- New partner admissions and valuation procedures
- Partner disputes and resolution mechanisms
- Voluntary and involuntary partner exits
- Partner death, disability, or incapacitation
You should have an experienced business attorney prepare your partnership agreement to ensure it’s tailored to your business and its needs.
Why Doesn’t Everyone Have a Partnership Agreement?
Obviously, hiring a lawyer to prepare a comprehensive agreement like this costs money—money that some business owners are unwilling to pay. If we’re getting along just fine, so the flawed reasoning goes, why should we pay another couple thousand dollars for a partnership agreement on top of all the other startup costs?
Well, the partners may be all smiles in April but at each other’s throats by July. Then, there’s always the specter of an unexpected accident or death. That’s the point—you just don’t know.
Business partnerships must proactively protect themselves against these situations. As I said above, a partnership agreement is all about mitigating future risk and protecting the value of your business. Much like a seatbelt, you won’t realize the agreement is there until it has to do its job and save your company’s life.
Just the Tip of the Iceberg
Without a partnership agreement in place, even a relatively small partner dispute could be an enormous disaster for the business. If partners cannot settle a dispute, a court could summarily dissolve the business. The two paths available to resolve the dispute are arbitration and litigation, both of which can be very expensive.
Arbitration: $70k-$90k
Since the 1990s arbitration has become an increasingly popular way to resolve a business dispute in lieu of litigation. In fact, many business contracts now contain “arbitration” provisions. The popularity of arbitration as a means of resolving a partner dispute is due in no small part to the belief that arbitration is cheaper than litigation.
This may have been the case originally, but today arbitration for a complex business dispute could easily run you $50,000–$70,000. Why are these costs so high?
- Filing Fees. National groups like the American Arbitration Association (AAA) have been steadily raising the rates to file for commercial arbitration. Depending on the claim size and the number of arbitrators, your filing fees could range from $3k to $12k.
- Arbitrator’s and Attorneys’ Fees. Unlike judges, arbitrators charge you by the hour. For more complex claims, it’s also a smart choice to have independent legal counsel. Both your arbitrator and attorney could have fees anywhere from $300–$600 an hour. Assuming a multi-day arbitration, you could easily be looking at an additional $12k–$15k in fees.
- Court Reporter. You’ll need to have written versions of all depositions as well as the arbitration proceedings themselves. For this you’ll have to hire a court reporter, whose hourly rates could be $50 or more. Also note that this rate probably will not include the final transcription process or hard copies of the transcriptions.
- “Administrative” et al. There are a slew of additional fees and costs to consider. The AAA tacks on an administrative fee of $75 per hour. You may also have to rent room space (e.g. one room available through the AAA currently rents for $250 a day).
- Opportunity Costs. Lastly, you’ll lose out on the ability to produce, sell, or manufacture while the dispute is going on. The dispute can taint employees’ impressions of the owners and turn customers’ feelings against the business.
Litigation: $100K+
Litigation is the worst-case scenario for a business dispute because it is the most time-consuming and the most expensive. Seeing a business, contract, or partnership dispute all the way through a full jury or judge trial could takes months and easily cost you over $100,000 in attorneys’ fees alone.
Estimating the total costs of complex business litigation is difficult because, well, it’s complex. Many factors determine the number of hours that will be spent on legal tasks including case complexity, your expectations, and your attorneys’ relationships with opposing counsel. And given the increase in electronic records, the requirements for pretrial preparations, electronic discovery, and depositions are becoming more extensive.
At the end of the day, the most significant cost to you and your business will come from the following:
- Attorneys’ Fees. Substantial costs will come from the fees paid to attorneys. Depending on what firm you hire, how complex the case is, the number and sophistication of the documents, the number of witnesses, etc., you could be on the hook for a $75–$100k bill from your attorneys. Furthermore, should you lose the case, you might be on the hook for the opposing party’s attorneys’ fees as well!
- Expert Witnesses. Field experts may be called to give evidence or testimony on complex issues of a case, such as a business valuation. These expert witnesses do not work for free. Typically, they charge hourly rates of $200–$400. Your costs can quickly stack up if more expert witnesses are needed.
- Depositions. Your attorneys will conduct depositions of witnesses. They charge for the preparation time as well as the time spent in the deposition. A court reporter will be present too and will charge by the hour for the deposition and for copies of the transcripts. With three or four hours of prep time for your attorney, the court reporter fees, and other incidentals, a five-hour deposition can easily cost $3,500 or more. Multiply that by the number of witnesses and you have a sizeable sum of money.
- Opportunity Costs. Like with arbitration, litigating a business dispute exacts massive opportunity costs on you and the business. Litigation is a slow process, and production will likely take a hit while the business partners are feuding. This internal conflict is sure to infect employees and maybe even customers or clients, which could further harm your business. Moreover, if the case goes to appeal, it could stretch on even further.
Cold, Hard Facts
Specifics are generally hard to come by, but a 2013 report from the Court Statistics Project found that attorneys spent an average of 367 hours to complete a “typical” contract dispute case. Those hours are divided among the senior attorney, associate or junior attorney, and paralegals, with corresponding hourly rates.
There are two main takeaways from the CSP report to keep in mind as you contemplate whether risk mitigation strategies are worthwhile for your business:
- The numbers in the graphs above are from the study’s 50th percentile. The hours spent increases significantly when we look at the 75th percentile: 70% for paralegals, 57% for senior attorneys, and 75% for junior attorneys. Hourly rates rise as well, meaning you will be paying more money for more hours.
- Of the six case types included in the study, contract disputes ranked third in average hours spent and second in average overall cost. The majority of the time and cost was devoted to the discovery and trial stages. Again, because electronic records are becoming ubiquitous, discovery will likely continue to increase in scope.
The Better Path
No sane business owner would look at the cost of arbitration or litigation and think that would be money well spent. There is no return on investment—it is an entirely sunk cost. Moreover, regardless of the actual outcome of the case, litigating a business dispute will still cause harm to the business both financially and reputationally.
Instead, business partners should take a long-term approach to risk-management. Compared to months of gut-wrenching stress and $90,000 down the road, smooth sailing and $4000 now is just a drop in the bucket. Have a comprehensive partnership agreement prepared, complete with dispute and deadlock resolution mechanisms and buy-sell provisions to protect the value you create in your business partnership. A template or form agreement purchased from a “LegalZoom”-type site won’t cut it—you need a customized agreement that contours to your partnership like a tailor-made suit.
You’ll be glad you did!
Your Path to a Successful Business Partnership
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Building Better Business Partnerships
Here at Alexander Abramson, we focus exclusively on business-related legal matters. We have advised business owners and entrepreneurs for over 25 years on partnerships and partnership agreements, and we have distilled that knowledge into our Partnership Design System.
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- Guide a discussion of the 21 key partnership parameters,
- Build a strong foundation for your new business partnership,
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- Increase the chance of success for your business partnership!
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