Partnership and Operating Agreement Retirement Provisions: Transition Plans, Vesting and Payout Periods, Clawbacks

Small businesses often give little thought to what happens when one of the owners decides to retire, but addressing these concerns at the inception of the business allows all parties to consider what may be important in the future.

Any partnership agreement or operating agreement should include a transition plan--it is critical to ensure the business retains the clients, skills, and abilities of the retiring partner. The transition plan itself is something that will be developed by the retiring partner in consultation with, and with the ultimate approval of, the managing partner or owner. It is quite common to have penalties built into the agreement for failure to give the requisite notice or failure to adhere to a transition plan.

Retirement benefits typically have a defined vesting period--20 years is not uncommon. Each company can decide to give partial or full credit for any years a partner or owner spent as an income partner. Likewise, the retirement payout period is typically 10 years, with the total aggregate amount payable to retired partners each year usually capped at some portion of the annual revenue or net income of the business.

There has been a recent revival in retirement "clawback" provisions. These provisions essentially reduce otherwise expected retirement payments if the retired partner's book of business or prior clients do not remain with the company after the partner's retirement. Clawback provisions are intended to encourage a well-executed retirement transition that accounts for the company's best interests.

Listen as our expert panel provides best practices on the considerations every startup should address in its organizational documents regarding retirement provisions. The panel will adiscuss these and other key provisions that owners must include to avoid future conflict.