In my experience, business partnerships are like marriages without sex. Even if you love your partner when you start the relationship, things can sometimes change after you saw your vows. In some cases, the business relationship becomes too dysfunctional to continue and the relationship ends in the equivalent of a business divorce—which can come in many forms including a buyout or dissolution.
For purposes of this blog, I am using the term “partners” loosely to refer to co-owners of a business. Co-owners can own a business as partners, members of an LLC or shareholders in a corporation, among other business entities. These distinctions matter when we talk about remedies for disputes between co-owners in litigation, but the issues that plague business relationships are the same regardless of the form of entity used to operate the business.
For today's video, I want to discuss with you my Top 5 Reasons why Business Partnerships fail:
1. You Picked the Wrong Partners
Business partners are like wives and husbands. You can fall in love with the at first for the wrong reasons. He or she is beautiful, well built, funny, charming and has great career. Everything looks good on paper. You date for a while. The chemistry is good and you think, "Wow!!! This person is just fantastic. I am going to ask her or him to marry me. Your partner feels the same way so you get married. After you say “I do”, you start to see another side of that person. People can lie and hide their less desirable qualities for while—but not forever. Eventually, they let down their guard and you get to see the real person you are sleeping with. You may have different expectations for life and what you want from each other. You want a big family and he or she doesn't want kids at all or maybe only one or two. He or she wants to give up their career and stay home and you were counting on having a two income household. She wants to raise the kids one religion and you want another. I think you get the point—these issues that should be, but aren't always considered at the start of a relationship. If they are considered, you might rationalize them away and say, it's not a today problem---we'll work it out down the road. Well, that might be a lot harder than you think.
What applies for good partners in a relationship also applies for good partners in business. You can meet a potential partner, they wow you with charisma and charm. They seem to have their act together. They have some great ideas and hopefully a good track record of prior success. You think this person will be a great partner in a new business--until you start the business and realize he or she is not a good partner at all!. That charming guy who seemed great, might have oversold himself. Maybe he doesn't have the connections he promised. Maybe he failed to disclose some issues he had in his past. Unfortunately, the papers are signed and this person is now your partner and getting rid of him will not be easy.
In another case, maybe you got a business off the ground on your own, but you need more staff and support.. You don't have enough cash to hire a top notch employee, but you happen to meet someone you think will be a great addition to the company. Instead of hiring this person as an employee, you offer them a piece of business instead. This makes sense, but it can end up being a really lousy deal, particularly for you if you don't plan ahead and give yourself a way to buy back this new partner's interest in the company. If this person turns out to be a lousy "employee", you cannot fire a partner like you would an employee. You're stuck having to work out a deal with with this person.
It's hard to find good partners and, like marriages, many partnerships end up in a business divorce. That's not to say you should not have business partners. We need partners in many instances or we would not have business at all. Don't just start a business with the first person that looks good and is willing to get into bed with you. Make sure you take all the steps you can at the beginning to mitigate the risks of committing yourself to the wrong partner.
2. You Don't Have a Negotiated Partnership Agreement
A good partnership agreement is like a good prenuptial. The process of negotiating the agreement is a wonderful opportunity for you and your prospective partners to discuss the types of disputes that could arise during the course of operating the business and negotiate a means for resolving those disputes—all before you start the business and these disputes actually occur. For example, what happens when one partner wants to make a distribution of profits and the others don't. What happens when one partner wants to sell her business interest to someone you don't like? Do you get stuck with a new partner you never agreed to and didn't want? Do you have a right of first refusal? Can you simply veto the sale?
Here's one that is often (and surprisingly) overlooked: what happens if one partner dies? Are you suddenly partners with the surviving spouse—you know, the crazy one your partner wanted to divorce, but never could bring herself to leave that guy.. I can't tell you how many clients I have had that start businesses with people and don't: (a) have a written agreement defining their respective roles in the company; (b) do not have an agreement on how deadlocked decisions would be broken (if at all); or (c) do not address how buyouts would work or how would their respective business interests be valued in a buyout. I can go on and on with the foreseeable possibilities that some clients should, but did not discuss with their partners before starting the business—let alone come to an agreement on how those issues would be handled.
A well drafted, negotiated agreement that covers reasonably foreseeable issues reduces the risks that comes with starting a business with other people. When I say well drafted and negotiated, I mean prepared by an experienced attorney or attorneys representing each owner that will help you iron out areas of contention specific to your expectations and those of other co-owners and drafted to take account issues unique to your business and industry. Please don't use a form partnership, shareholder or operating agreement that you bought for $75 from Legal Zoom or some other online vendor. Using generic forms and skipping over the negotiation of terms can actually put you in a worse position that if you had no agreement at all. In fact, going through exercise of negotiating the agreement itself will give you a much better idea of who these people are that you are starting a business with and whether you can work with them long term. Think about negotiating your partnership agreement as being part of the vetting process.
3. Changing Expectations
When people get together to start or join a company as partners, they generally share an understanding of what they each expect from the venture and each other. As time goes on, however, those expectations can change and priorities can change. You may both be committed to building business at first, but things can change with time. Personal lives get in the way or perhaps your partner starts another business and can no longer commit 100% of their time and attention to your business. These can be difficult issues to overcome. For example, let us imagine a situation where you start a small business with a good friend as your partner. You each own 50% of the business and there is no written agreement is in place--after all you have been close personal friends for years. Unfortunately, two years after you start the business, it turns you are doing 75% of the work and maybe even putting in your own money into the business to cover operating shortfalls. You partner appears to be missing in action. She shows up a couple of times a week (maybe??), but she appears to have lost interest in the business or has other distractions in their life. Nevertheless, you each own half the business. Your lazy partner is entitled to an equal share of the profits and you cannot even give yourself a raise without her approval--which you will not get unless you agree to give her the same raises. This situation is not fair for you. You can try to negotiate a new deal with your partner. Maybe your partner can be convinced to sell their interest to you or agree to a more equitable arrangement, but don't count on that happening—at least not without you giving up a lot more than you want or should give up.
4. Bad Habits and Behavior
Again, just like with marriage, you don't always realize who you are partnering with until after you say your vows. Your spouse might have an alcohol or drug problem that you did not know about--or perhaps you should have known about the problem, but you ignored the signs. At the same time, you might not have known that that charming and charismatic man or women had anger management issues. I have had clients that are partners in successful businesses, but they need to get out or get rid of their partners because the didn't realize their partners had drug or alcohol problems, anger management issues or could be taking risks that put the business in jeopardy and could actually damage my client's good reputation by association. Bad habits and behavior can ruin what could have been a great business relationship just as quickly as they ruin marriages.
5. Loss of Trust
Finally, relationships usually end when there is a loss of trust. Business partners can enjoy very successful business and they don't need to like one another. They do, however, need to be able to do is trust each other. Partners need to be able to make informed decisions about the company and they need to be able to rely on the information they are given by their partners when making those decisions. If that information is not reliable, problems will arise. If a partner promised to do something, and they don't—and this becomes a pattern---problems will arise. In worst case scenarios, a partner may steal from the business, start a competing business on the side or engage other conduct that results in breaches of a fiduciary duties and duties of loyalty to other partners. This is the business equivalent of one spouse cheating on the other. Once trust is lost, it is going to be very difficult to save the relationship.