If you’re looking at forming a partnership with another advisor, think long and hard before you make the leap. Advisors take on significant risk when they form business partnerships: there are notable liability issues.

“A partnership is a marriage. If one partner gets into hot water, both partners are in hot water,” says Rick Johnson, director of practice advisory services at Advocis in Toronto. “If you go into a partnership, you might as well understand that you’re sleeping with that advisor.

“I don’t think the bulk of people going into partnerships fully comprehend the responsibilities they’re undertaking,” he adds.

In the honeymoon stage of a partnership, people tend to focus on the strengths that create a good synergy. The last thing on an advi-sor’s mind is how it could affect his or her business and future career if the potential partner does something unethical or illegal.

“Because advisors share the assets as well as the liabilities of a partnership, you have to make sure the other advisor’s book is compliant,” says Ellen Bessner, a lawyer with Gowling Lafleur Henderson LLP in Toronto. “Liabilities are the risks associated with reputational damage, challenges to licence, and the costliness of litigation and regulatory matters. You can’t just look at the size of the advisor’s book and the revenue it generates. You have to look at the risk and the expenses.”

Reviewing the potential partner’s book has its own challenges. If two advisors are not yet partners, they are not entitled to see the names or identities of each other’s clients. “They can’t share that information,” says Bessner. “So they have to block out all client names and information such as addresses — anything that might identify the client — because that’s private.”

Bessner suggests advisors make a list of questions to ask themselves when reviewing the other side’s book of business and then sign a confidentiality agreement before doing due diligence.

James Schofield, an advisor at Assante Capital Management Ltd. in Ottawa, recommends advisors also examine the other person’s track record, looking for honesty, integrity and a strong work ethic. He suggests first “renting” a partner. Invite the person you’re considering as a potential partner to sit in on a few meetings and see how it goes. “Try it out for a while,” he says. “See if you can do it.”

After weighing the pros and cons and deciding to forge a partnership — but before signing a binding agreement — each advisor should seek a lawyer’s advice. “You need to make sure you’re onside, regulatory-wise and legal-wise,” says Simon Romano, a lawyer with Stikeman Elliott LLP in Toronto. A legal partnership agreement will not only help to create the parameters of the partnership but also help in case things don’t work out.

An advisor should contact his or her provincial law society to get a reference to a lawyer who deals with partnership agreements and contract law. Many advisors simply consult a lawyer with whom they already have a relationship, such as a real estate lawyer, which can be a big mistake because the skill set is different.

“A partnership is a very dangerous legal relationship because of this liability for all your partner’s acts,” says Romano. “It sounds nice to shake hands and say, ‘We’re partners.’ It sounds like we’re working on the same page and we understand what it means. But, in law, it has quite a specific meaning and a lot of liability associated with it.”

There are two kinds of partnerships. In a general partnership, partners are liable for everything everyone does. Then there’s a limited partnership, which is much more complex to structure. “It’s more like a company,” Romano says of the latter. “An investor in a limited partnership doesn’t have to be liable. If I just shake hands with you and say, ‘Now we’re partners,’ and we sign a letter that says we’re partners, I’m probably liable for things you do wrong.”

There are several things to look at when forming a partnership, Romano says, including implications around regulation, clients, risk, and structuring and planning issues — “Both while things are good and if things aren’t good,” he says. “Those are the real issues in any grouping together for business purposes.”

Experts recommend advisors considering partnerships brainstorm before putting an agreement together. Examine the major issues, including disagreement, death, disability and disaster. Consider termination issues, insurance coverage, arbitration mechanisms, valuation issues, each partner’s duties and roles, succession or sale issues, and compensation. Finally, don’t forget to look at issues such as taking time off or resolving disputes, and agree on an arbitrator who can deal with issues that may arise.

@page_break@Despite your best efforts to investigate a potential partner and put together an agreement that outlines all the possible pitfalls and their solutions, are you liable if your partner defrauds clients? Probably, says Bessner. “Defrauding clients is a criminal offence, so it depends on the structure of the partnership, what the allegation is, the relationship and how it’s configured, and whether or not both partners advised the client,” she says. “Going into a partnership, assume that if your partner doesn’t have a clean book of business, that will come back to haunt you.”

A partnership isn’t the only way to work with other advisors. “A partnership in the financial services industry today seems to me a very poor way to structure a business,” says John Page of Page and Associates in Richmond Hill, Ont. Given the drawbacks of partnerships, he suggests considering alternatives, such as forming a corporation.

“Advisors can incorporate the insurance aspect of their business,” he says. “While the Investment Dealers Association of Canada has been pretty slow to allow the incorporation of its people, right now there are a lot of advisors in the Mutual Fund Dealers Association of Canada channel that are incorporated, and they are basically waiting to see whether or not the MFDA will continue allowing them to be incorporated.”

A strategic alliance is another option. Page describes it as “an agreement to work with another individual or another company for a common purpose, which is generally serving a broader market.” For advisors who aren’t sure how things will work out, that is a good way to test the waters.

If entering a partnership is the option advisors decide to take, they should approach it with caution. “Keep kicking the tires,” says Bessner, and continue asking questions.

“Once you get in knee-deep and start spending money,” she says, “you won’t want to pull out of the deal because you’re in too far. It is very important not to buy if there are red flags waving.”

An excellent way for advisors to protect themselves against liability is to build strong relationships with clients. “If you have a great client relationship, it can withstand almost anything,” says Page. “And you get a great relationship by serving people and listening to what they have to say. That’s your best defence.” IE