Sometimes, one partner just wants out. Here’s why it’s smart to have a partnership agreement sooner than later.
Starting a business is probably easier today than it has ever been before. Entrepreneurs have access to a broad array of free or inexpensive tools, templates and advice from websites, incubators, unemployed or retired corporate executives, students looking to get some experience, non-profits such as SCORE and many, many others. If you want to start a business, you have options galore.
Most of these sources provide endless encouragement. They minimize the risks, downplay the difficulties, exaggerate the opportunities, and discount the competition. They don’t just wear rose colored glasses, they hand them out like cupcakes.
The problem is that while it is fairly easy to start a business, it isn’t easy to STAY in business. It’s even harder to grow the business into something valuable over a period of 5, 10 or 15 years. I’ll outline a number of ways businesses can fail in another post, but here I’ll focus on just one — partner disputes.
On August 16, 1858, Abraham Lincoln famously said, “A house divided against itself cannot stand. I believe this government cannot endure, permanently, half slave and half free. I do not expect the Union to be dissolved — I do not expect the house to fall — but I do expect it will cease to be divided. It will become all one thing or all the other.”
Lincoln was thinking on a grander scale than small business, but his conclusion holds just the same: no business will survive intact if the partners are constantly at odds with each other. Hopefully you won’t need to go through a civil war to get your house in order, but you may need to make some tough decisions if you want your company to survive.
How most small business partners break-up.
Two friends come together on what they see as a brilliant business idea, form a company, and work together well for several years. Then some sort of life changing event occurs — maybe one of them gets married (or divorced), or one of them has kids, or one of them develops an addiction and runs into money problems, or (fill in the blank). The specifics really don’t matter; what does matter is that the easy relationship they had when they started now becomes strained. One partner is happy with the way things are; the other isn’t. One partner wants more money, or less responsibility, or a different role, or … just wants out.
First the partners sit down and discuss things.
But more often than not cannot find a mutually satisfactory resolution. So they keep going on as if everything is OK. But eventually things get worse again. Resentments build; and employees, vendors and customers all start to notice that something isn’t right.
The business begins to suffer.
Revenues start to falter. Profits turn into losses. Cash reserves melt away. One or two key employees leave, and morale among the remaining employees takes a nosedive.
The partners try to come to an agreement.
But quickly realize they are just too far apart. They go back and review the buy-sell agreement they wrote up when they formed the company, but discover it is out of date and was too simple to begin with. The contract specifies that either partner can leave at any time, but his or her compensation upon leaving is much too high (or much too low). So one partner gets the gold, and the other gets the shaft.
Over time, the situation gets worse.
Until one or both partners call in their attorneys. Sometimes the attorneys can broker a resolution where the partners stay on and the company stays intact, but often one partner leaves and the other ends up paying through the nose. Or all parties agree the only thing to do is shut the company down and sell the assets. In any case, when the dust has settled, at least one partner is worse off than before, and the company is less valuable — if it still exists. But the attorneys have done very well.
Here are a few things you can do to help prevent this kind of breakup.
Know who you’re partnering with.
First and foremost, be careful who you partner with. Do you trust them? Are you compatible in terms of style? Do they have the skills and experience needed to make this business a success?
Have common ground.
Sit down with your potential partner(s) and have several in-depth discussions about the business. Do you agree on the business model? Your roles? Do you have similar aspirations in life and business? Do you agree on how you will each be compensated, in good times and bad?
Prepare a buy-sell agreement.
If you both agree to move forward with the partnership, you should prepare a buy-sell agreement to specify what happens if one of you decides to leave the company, or dies, or wants to sell shares, or buy shares, etc. It is very tempting to “save money” by hiring one attorney to draw up the contract, but this is dangerous. Instead, you should each hire your own attorney to edit the agreement in your favor. This will take time and may require some tough negotiations, but the end result will often be very different from a “standard” buy-sell agreement: a customized document that protects both partners.
Review your agreement annually (at least).
Once you have formed the company and started operations, be sure to sit down with your partner(s) at least once a year. Have a frank discussion about the business. Try to identify any incipient or recurring problems and resolve them before they grow out of hand. Carefully review your buy-sell agreement and update it based on your current situation and future plans. Once again, this may require two attorneys and some back and forth.
Make it a priority.
If you already have a company with two or more partners, and don’t have an updated buy-sell agreement, then now is the time to fix this. If you already have an agreement, but you are not communicating with your partner(s), then you need to start now, before it is too late.
Avoid litigation if possible.
If by some twist of fate you find your buy-sell agreement doesn’t resolve your situation, then try to come up with an alternative resolution through negotiations yourselves, before resorting to litigation. A great book on this subject is “Getting to Yes” by Roger Fisher and William Ury. You may still have significant legal fees, but they will likely be far less than what you would have to pay to litigate (or arbitrate).
Partner disputes are very common, and even more painful. And all of the above can happen with a family owned business too. Only there, it is usually even more complicated since several generations can be involved, and often young family members have decisions made for them by others long before they understand what is happening. The damage can be widespread and long lasting.
If you keep your eyes open, address problems before they fester, negotiate in good faith while still looking out for your own interest, and work with a good attorney, you should be OK.