What is a Silent Partner Agreement?
A silent partner agreement allows one individual, the "silent" partner, to have a financial stake in a business without having any say over company operations. Whereas there are many different types of written partnership agreements, such as limited liability company (LLC) agreements and dissolution agreements, there is no universal "silent partnership agreement." The term "silent partnership agreement" generally refers to any written contract that grants a financial stakeholder a non-voting ownership interest in a company.
While a silent partner agreement may not be precisely the same type of contract as , for example, an operating agreement, it serves a very similar function. Both agreements establish the business interests of particular individuals and limit or restrict the rights and responsibilities of those interests. Other partnership agreements may allocate the roles and/or responsibilities of stakeholders in order to operate a joint enterprise. Silent partners, however, have no role in the management of the business at all.
Advantages of a Silent Partner
The greatest benefit of having a silent partner is that they do not need to have daily involvement in your business. You can be hands-on with the company’s day-to-day actions while knowing that the silent partner will maintain their side of the agreement. Some people start a company with the intention of bringing on a silent partner. In this scenario, the owner, Joe, has been running a plumbing and heating service. Joe knows the trade and wants to sell the company in the next 10 years, hopefully to one of his managers. To do so, he needs to grow the organization, leaving it in good hands.
Joe meets Matthew at a city council meeting. Matt happens to work in construction – plumbing and HVAC too. They talk business over drinks and realize that they think very much alike. In non-pandemic conditions, they could probably meet once a week for lunch and start to get ideas from each other about how to expand the operation. Matt isn’t ready to quit his job yet. He still makes a good salary. Joe asks him if he’d be willing to come on a part-time basis to help add some more commercial accounts. Joe’s solicitation of a part-time position was a smart move. He didn’t ask Matt to quit his job. That doesn’t build trust or reliability like offering the part-time position.
Matt comes on board and Joe starts mentoring him more about how the business works. They work together for a few years, expanding the company. Soon, a couple of local grocery stores are coming on as accounts. Joe is paid more for the work because more people are hired to run things and keep them running without as much interaction from Joe. Matt agrees to buy 60% of the business for $200,000. They sign a Silent Partner Agreement that lays out the controls. Joe can continue with day-to-day tasks and build up equity while slowly passing the reins. On the other hand, Matt has been learning the ropes and has money to invest.
With the Silent Partner Agreement in place, they’ve set a percentage for Matt to receive each year. As Joe makes money, his shares increase while Matt’s stay at the agreed amount. His shares climb with profit, removing the risk of letting go of 60% of the business now. On the other hand, Matt makes more money now too. He didn’t lay out the majority of the cost to buy. He’s making more money in relation to his investment. Like Joe, he also has a good salary. In his free time, like Joe, he spends time with the company as it continues to grow. He’s quick-minded and sees how to make the company better in a short time.
At the end of Joe’s ride "in the captain’s chair," his partner’s bought out the rest of the business for a majority share. Matt hired new people, mentored them like he had learned from Joe, and planned for the next decade of growth. The company more than doubles its value, allowing both men a comfortable retirement. The passive and active investments each made life good for themselves and others.
Essential Elements in a Silent Partner Agreement
When engaging a silent partner, it is imperative that your agreement covers the following essential components: Capital Contributions: This should include all information regarding the capital contributions each partner is expected to bring to the business. Profit-Sharing: It should be clear in the agreement how profits will be divided. While this percentage can fluctuate as the business changes and grows, it should outline a standard to avoid complications and contention down the road. Decision-Making Restrictions: This should state clearly where the silent partner has authority for company decisions, and where their ability to affect company policy and direction is limited. This area must be carefully crafted to avoid missed opportunities to make investment decisions, or to ensure that the silent partner does not have undue influence on the company. Exit Strategy: When engaging a silent partner, you want to ensure that you have the ability to buy them out in the future. Likewise, the silent investor needs to know that if they invest in your business, they will be able to exit when they desire to do so. The exit strategy should outline terms for buyouts that are favorable to both partners.
How to Create a Silent Partner Agreement
A silent partner agreement can be drafted in several steps. A general outline of an appropriate agreement is as follows:
1. TITLE
The title may include the names of the partners and the business name.
2. INTRODUCTION
State the location of the Silent Partner, name of the Silent Partner, the Parties and control of the business. "The Principal partner, with a principal place of business at Street Address City, County and State, and the Silent Partner, a resident of Street Address City, County and State, wish to enter into a Silent Partnership Agreement."
3. APPOINTMENT OF THE SILENT PARTNER
"By this Agreement, the Principal partner appoints the Silent Partner as its Silent Partner, who in turn accepts such appointment."
4. DUTIES AND RIGHTS OF THE SILENT PARTNER
"In exchange for investment by the Silent Partner, the Principal partner agrees to look to the Silent Partner for advice on matters relating to the Partnership."
5. DEFINED TERMS
Defined terminology may be listed in this section. Defined terms are usually capitalized throughout the agreement.
6. CONSIDERATION
"A total consideration of ($ Amount) dollars is paid to the Principal and shall be used to (describe how funds are to be used)."
7. TERM OF THE SILENT PARTNERSHIP
"This Agreement shall be effective from the date of execution to the date of termination of the silent partnership, to be determined as follows:"
8. TERMINATION
"This agreement shall terminate on the occurrence of any of the following events:"
9. LOYALTY
"The Silent Partner shall work towards the best interest of the Principal partner by not using confidential or proprietary information for his own benefit or the benefit of a third party. Violation of this section 9 shall cause the termination of this agreement at the option of the Principal."
10. ARBITRATION
"A dispute regarding this Agreement shall be settled by arbitration. The arbitrator shall be retired from the top court".
11. WARRANTIES
"The Silent Partner, by signing this document, warrants that i) he is over the age of 18 years, ii) has been given full authority to contract; iii) understands and agrees to the terms of this agreement; and iv) has taken legal advice on this agreement if deemed necessary."
12. INDEMNIFICATION
"The Principal partner shall indemnify the Silent Partner in all actions arising from the performance of the business of the Partnership, unless the claim results from the wrongdoing of the Silent Partner."
13. MODIFYING THE AGREEMENT
"Nothing in this Agreement may be changed or modified except in writing and duly signed by the Parties."
14. CHOICE OF LAW
"This Agreement shall be governed by the laws of the State of (Name State)."
15. EXECUTION
"This agreement may be executed in counterparts and in (Number of copies) and each counterpart shall be deemed an original, and all taken together shall constitute one and the same agreement. The counterparts may be faxed to facsimile numbers affixed next to the signature of the Principal and the Silent Partner and shall be deemed to be original signatures."
With this information, a detailed Silent Partner Agreement can be customized for your needs.
Common Mistakes and Avoiding Them
While having a silent partner can be an asset to a business, there are pitfalls to avoid, ranging from tax-related issues to establishing a clear exit strategy. Assuming that a silent partner agreement will not be needed if the partnership is a simple arrangement may open the business up to liability if the deal sours and a legal encounter ensues. Not addressing roles and responsibilities in a silent partner agreement can lead to misunderstandings, power struggles, and in some cases, loss of business. Flaws in the wording of the agreement can also open a business up to legal action . A vague agreement that lacks the details and the difference between an active partner and a silent partner can lead to legal repercussions. Underestimating valuation of the business can also be problematic. It is important to recognize that a silent partner is not an informal agreement between two business partners. A silent partner is an official agreement, which should be legally binding in all situations. A written agreement in place that is signed by both parties is vital for the success of any silent partnership.
Utilizing a Silent Partner Agreement Template
Templates can be helpful when drafting a silent partner agreement. Good templates are generally detailed while also using relatively straightforward language. A template can also contain provisions that you may not have thought to include in an agreement, conditions, or just want to consider. If you find a template that you like, reviewing it with your lawyer will help ensure you have included the provisions and terms you want the most in the final agreement.
A template does not remove the necessity for legal advice, however. A good template will contain sections that relate to rights and obligations that may not apply to your business or partnership. When choosing an agreement template, makes sure you choose one that is appropriate to your business.
For example, a two-person partnership will not need a provision that addresses what to do in the event of one partner’s death. While the provision is useful for some businesses, in other cases it could complicate things unnecessarily. Any template you choose should be adaptable to your business. A template that contains too many provisions unrelated to your business is unlikely to be suitable. It could be a source of confusion as you attempt to determine which provisions apply and which do not.
You want a template that is easy to read, easy to adapt, and allows you to retain the level of personal control you require for your business. You need to select a template related to your specific arrangement, so it is adaptable to your particular venture.
Legalities and State Laws
While the advantages of a silent partner agreement may outweigh some disadvantages, assuming that all states will enforce such arrangements equally is unwise. Section 1-103 of the Delaware Revised Uniform Partnership Act contains a broad definition of partnership, which includes "association of two or more persons to carry on as co-owners a business for profit" and "the term ‘partnership’ is intended to be construed in its very broadest sense." As the Delaware Act makes clear, while all partners must directly contribute to the partnership, "speculative capital or leadership or a combination of both may been contributed by the limited partner." (emphasis added) (Underscore added.)
However, partnership issues are often governed by state law, and the particular language and treatment of silent partner agreements can differ from state to state. While Delaware is a common choice of law for many businesses, it may not be the only or best choice for the specific entity seeking a silent partner agreement. If an enforcement dispute arises, the inquiry into a silent partner’s role on ownership will be highly fact-intensive, and the answer turn on whether the limitations of a silent partner are properly expressed in the documents and the extent of the silent partner’s ability or authority to act for or on behalf of the partnership.
In Texas, for example, a person is a limited partner of a limited partnership if the partnership is a limited partnership under APGA, one or more persons, as specified in the certificate, become partners upon the effectiveness of the certificate and the persons have rights and powers, and are subject to restrictions, specified by the APGA and the certificate. Courts have held that "a certificate of limited partnership may limit the authority of a limited partner to act for or on behalf of the partnership and may include any limitations on that authority , " and that a limited partner "would not thereby become part of the partnership." Whether a person has become a limited partner, subject to a limited partner’s restrictions, is a question being determined on the face of a limited partnership certificate, without the need to continue into examinations of intent, actual authority and control and the like. Accordingly, in a state where the express language of a certificate of limited partnership delineates the authority of a limited partner, a silent partner agreement or participation agreement may become redundant or supererogatory.
Several other state statutory provisions dealing with silent partner agreements or limited partner arrangements are worth examining. For instance, in California, a limited partner is a person whose name does not appear in the partnership name and who does not participate in the control of the partnership business. However, CC section 152, a limitation on a limited partner’s authority and liability, requires court determination on whether a limited partner may enter into a transaction on behalf of the partnership. CC section 1560 shows the broad potential for enforcement challenges by potential claimants when the certificate of limited partners contradicts a silent partner agreement and limits the authority of a general partner. And under CC section 163, the duration of a partnership can even be determined to be not set in stone, but rather open-ended or perpetual and coterminous with the life of the silent partner.
There are several other statutory provisions that may affect the creation, enforcement and interpretation of a silent partner agreement. Be sure to check with legal counsel before making an enforceable silent partner agreement.
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