Of the various variants and numerous possibilities of realizing the possibility of joint financing of the project and participation in the project’s earnings, the lawyers advised us to make a silent partnership agreement (SPA) with each investor in the project, that is, to make a SPA with each buyer of shares in the PWED project. Yes, a lot of paper, but legally legal and the simplest.
What is Silent Partner?
A silent partner is an individual whose involvement in a partnership is limited to providing capital to the business. A silent partner is seldom involved in the partnership’s daily operations and does not generally participate in management meetings. Silent partners are also known as limited partners, since their liability is typically limited to the amount invested in the partnership.
Apart from providing capital, an effective silent partner can benefit an enterprise by giving guidance when solicited, providing business contacts to develop the business, and stepping in for mediation when a dispute arises between other partners.
Regardless of such requests, it is considered a background role that cedes control to the general partner. This requires the silent partner to have full confidence in the general partner’s ability to grow the business. The silent partner also may need to ensure that their management styles or corporate visions are compatible.
Silent Partner vs. General Partner, an overview
Many small businesses and investment vehicles are structured with partners. Technically, a business partnership is created when two or more individuals come together for a specific business purpose.
Business entities can be structured as: sole proprietorships, partnerships, qualified joint ventures, corporations, limited liability companies (LLCs), trusts, or estates.
Each business designation has its own requirements, liabilities, and tax code which can vary according to local, state, and federal law. Generally, silent vs. general partners (GPs) will most commonly come into play when dealing with partnership and/or LLC structures. Both partnerships and LLCs can differ in terms of how profits, losses, and responsibilities are distributed to each participating partner. Partnerships and LLCs can also be combined and structured in a variety of ways. Typically, silent partners are known to only contribute to the business by way of capital infusion—that is, investing money in the business entity—while a general partner is an active manager in business operations.
KEY TAKEAWAYS
- Silent partners can also be referred to as limited partners.
- Silent/limited partners provide capital to a business entity with an expectation of profit, but they are not directly involved in the management of the business.
- General partners are designated as the managers of a business and can also contribute to the overall capital pool.
- General partners and limited partners are commonly found in partnerships, limited partnerships, and limited liability corporations.
Silent Partners
Silent partners are investors. A silent partner is any individual who provides funding to a business as his only contribution. Partnerships and LLCs can have silent partners. Silent partners can also be referred to as limited partners (LPs).
In a partnership designated as a LLC, the partnership agreement will provide details on the liabilities of silent partners. In some cases, silent partners may act as consultants through an advisory board or some other situational setting as designated by the business.
General Partners
A general partner is most commonly found in a limited partnership structure. Limited partnership structures include both limited partners and general partners. General partners are typically designated with control over the management, operations, and use of capital within the business entity.
As mentioned, the limited partner makes investments into the business or investment vehicle and his liabilities are limited to his investment. General partners in a limited partnership, however, have full liability for partnership debts. If the business goes under, a general partner may have his personal assets seized or liquidated to pay creditors and satisfy corporate debts. If the general partner is itself a business, then the business could be liable for debts beyond just their investment.
General partners can also be found in an LLC. LLCs have broader flexibility to structure the partnership details through a partnership agreement. Under an LLC structure, owners/investors are typically designated as members. LLC members are not personally liable for the business’s debts.
Investing Capital and Silent Partnership Agreements
Business entities need capital to manage a business. Business partnership capital can come from both silent partners and general partners. General partners are responsible for managing the business or investment portfolio. General partners usually provide some capital to the business but they also rely on capital investments from limited partners. Collectively, the investments from GPs and LPs come together to create the business’s total capital.
Partnerships with both general partners and silent partners will detail all of the business’s provisions in a partnership agreement.
Which Terms Should Be Included in a Silent Partnership Agreement?
Partnerships can be complex depending on the scope of business operations and the number of partners involved. To reduce the potential for complexities or conflicts among partners within this type of business structure, the creation of a Silent Partnership Agreement (SPA) is a necessity. A SPA is the legal document that dictates the way a business is run and details the relationship between each partner.
Although each partnership SPA differs based on business objectives, certain terms should be detailed in the document, including percentage of ownership, division of profit and loss, length of the partnership, decision making and resolving disputes, partner authority, and withdrawal or death of a partner.
KEY TAKEAWAYS
- Many small businesses are organized as partnerships, which require formal documentation before being established.
- The SPA agreement spells out who owns what portion of the firm, how profits and losses will be split, and the assignment of roles and duties.
- The SPA agreement will also typically spell how out disputes are to be adjudicated and what happens if one of the partners dies prematurely.
Percentage of Ownership
Within the SPA agreement, individuals commit to what each partner is going to contribute to the business. Partners may agree to pay capital into the company as a cash contribution to help cover startup costs or contributions of equipment, and services or property may be pledged within the SPA agreement. Typically these contributions dictate the percentage of ownership each partner has in the business, and as such as are important terms within the SPA agreement.
Division of Profit and Loss
Partners can agree to share in profits and losses in line with their percentage of ownership, or this division can be allocated to each partner equally regardless of ownership stake. It is necessary these terms are detailed clearly in the partnership agreement in an effort to avoid conflicts throughout the life of the business. The SPA agreement should also dictate when profit can be withdrawn from the business.
Length of the Partnership
It is common for partnerships to continue operations for an unspecified amount of time, but there are instances where a business is designed to dissolve or end after reaching a specific milestone or a certain number of years. A partnership agreement should include this information, even when the time frame is unspecified.
Decision Making and Resolving Disputes
The most common conflicts in a partnership arise due to challenges with decision making and disputes between partners. Within the SPA agreement, terms are laid out regarding the decision-making process that may include a voting system or another method to enforce checks and balances among partners. In addition to decision-making procedures, a SPA agreement should include instructions on how to resolve disputes among partners. This is typically achieved through a mediation clause in the agreement meant to provide a means to resolve disagreements among partners without the need for court intervention.
Authority
Partner authority, also known as binding power, should also be defined within the agreement. Binding the business to a debt or other contractual agreement can expose the company to an unmanageable level of risk. To avoid this potentially costly situation, the SPA agreement should include terms relating to which partners hold the authority to bind the company and the process taken in those cases.
Withdrawal or Death
The rules for handling the departure of a partner due to death or withdrawal from the business should also be included in the agreement. These terms could include a buy and sell agreement detailing the valuation process or may require each partner to maintain a life insurance policy designating the other partners as the beneficiaries.