Who makes a better business partner, a loyal friend or family member that you can trust or a relative stranger with a great CV but no relationship? I’ve heard horror stories and success stories from people who have made either of those choices. There are countless tales of successful, profitable businesses that failed not because the market didn’t demand their products or services, but because of internal strife. This is especially true when a company has multiple owners and operates under a partnership agreement. Much like a marriage, there’s a 50-50 chance many of these compacts will unravel, with the organization becoming a memory. There are many examples of business relationships with family members and friends that have been successful, but many more examples of those that have not.
Without using any names to preserve my legal reserve funds, I have an associate who formed a retail chain with their best friend. The two brought different skills sets to bear, one analytical and one creative and sales oriented, and things seemed to go well for the first year. After that, though, the personality differences manifested on a daily basis, eventually ending in a standoff and legal battle that devastated both sides, but somehow preserved the business, at a great personal cost.
It doesn’t have to be this way, but making partnerships work takes a great deal of effort at the front end that goes far beyond the typical marketing and product development processes. A great deal of soul searching as well as a concrete financial and operational contingency plans must be agreed upon prior to turning on the lights. So before forming the next LLC or S-Corporation with one or more partners, make sure you’ve answered these six crucial questions in detail with your business partners.
- Do I need partners? This question hits everyone sooner, or later. Many startups are initiated by one person who coordinates bringing in the other players (many of whom would never start a company on their own). The immediate questions that arise are “Who should own equity?”; “How much equity for each?”;”Who contributes what?”; etc. Most folks think that equity should be distributed equally to everyone who is there at the beginning. If everyone’s value add and participation (monetary and sweat equity) are equal, maybe this works. I have found that startups with one clear owner (51% or more of voting shares) tend to be far less likely to become mired in “owner standoffs” that can sink a company, sometimes over minor issues. One rule that I’ve used is that if someone is critical to helping me achieve the goals that I have set for the company, offer them some form of equity. If not, make them an employee (possibly a highly paid employee), if justified. Many small companies have their top sales people make more than the CEO owner). Be ready as soon as the company is up and profitable to have people suddenly willing to jump in offer their skills to “make you successful as you won’t be able to on your own” for a large chunk of equity. Although companies have increasing and different needs as they grow, many people feel that they can demand large amounts of equity (I’ve seen demands by prospective project managers for 10% equity grants in a $5M revenue business) just because they felt they were “worth it”.
- What’s our BHAG? The Big, Hairy, Audacious Goal, as Jim Collins outlined in his book “Built to Last,” is a good place to start the conversation. The differing answers may surprise you. One partner might want the goal to be nothing short of market domination. For another, it might be to develop a sustainable, lifestyle-oriented business that stays small, but generates good incomes for all involved. Yet a third partner might want to pursue aggressive growth with the intent to attract a buyer in five years. Ensuring everyone is one the same page as to where to take the company is probably the most critical question to ask at the very beginning.
- Who’s going to do what? While the partners will most likely wear multiple hats at the start, there should be a delineation of responsibilities with assigned roles that play to each individual’s strengths. This will ensure that all aspects of the business are covered while also freeing up the day-to-days tasks from being performed by committee or consensus, slowing down the process. If two or more partners completely overlap skill sets and there is not enough of that work to require two partners, maybe one partner isn’t needed. One of my MBA professors offered that $10M in revenues is required to support one business partner, so if you’re looking at a business that will steadily generate $1M/year in revenue it may not support 5 partners.
- How will we resolve conflicts? Airing differences of opinion between business partners is a very healthy exercise, but only if managed correctly. Ground rules should be established at the outset as to how to address and resolve issues so that a decision on which direction to take can be made and embraced by all parties. The time to do this is not at the first argument. Some folks like to have everything in writing to an extreme (one partner wanted a 10 page operating agreement for a single transaction in an ongoing concern – it was easier just to not invite him to be a partner in that deal), and some think that any requirement to put an agreement in writing demonstrates a lack of trust. I think that having agreements in writing lets everyone involved have a clear understanding of what is being proposed. Put signatures down and be willing to revisit the operating agreement as required.
- What happens if someone offers to buy our firm? I’ve seen companies get blindsided by an out-of-the-blue, unsolicited request to purchase the firm that pitted business partners against each other. While potentially a long-shot, it will be helpful to discuss such a scenario to find out what it would take for the partners to sell and divest themselves of the entity. A side benefit to the conversation will be to reinforce the collective BHAG.
- How will we dissolve the partnership? While no one goes into a partnership with the intent of ending it prematurely, life events or a change in strategy may mean one or more partners want out. How that will happen and under what financial terms are essential to iron out at least in principle before starting the business. If it becomes too contentious or acrimonious when it happens, the company could very well fail and everyone will lose. A buy/sell agreement should be a must have from the beginning in any concern that is expected to be worth over $100K.
The bottom line is this – never go into a business partnership lightly. There is too much financial and emotional equity at stake. Think of it in terms of a long-term, personal relationship; because that’s exactly what it is.