One of my protégés met me a few weeks ago with a business partnership proposition. Not with me, but with a friend of his. He was very enthusiastic about the whole deal. And I was happy for him, sincerely. But just before he got carried away, I had to make him sit down and talk him through on what is really involved, and what needs to be cleared up before saying ‘I Do’ to a business partnership.
Do you co-own a business? Building a successful business venture alone is hard work as many entrepreneurs have come to appreciate. There is so much responsibility on the shoulders of the founder to make the business work.
Sometimes, however, it is a load to heavy for one person alone to bear. Partnership, though a solution to this problem however, comes with its own baggage.
Yes, I know.
A lot can go wrong in a business partnership. So a lot of care should be taken before you enter into one. It does not matter who the person is – a close friend, a family member, a colleague, even a mentor – your relationship in business has to be differently from whatever prior ties you may have with the person.
To make sure the foundation of the business partnership is firm enough to carry you to success, you must clear up a few critical issues before moving forward.
Many entrepreneurs have had terrible experiences in business partnerships because they neglected these issues or did not address them sufficiently.
Here are a few of the issues you must trash out before putting pen to paper on any form of business partnership.
1. Establish a decision making process prior to decision-making
In a one man business, it is definitely easier to make a business decision because there is only one decision maker. This invariably means that business decisions are made faster.
In partnerships, it is more complicated than that. The partners can have different opinions and ideas about how to approach certain issues within the business and this can stall decision-making, ultimately hurting the business.
All partners need to come up with a decision-making system in advance. One that finds a way to take everybody’s idea into consideration and come up with the best possible solution for the business, not any one partner.
Without such a system in place, nothing will get done. You do not want a classic case of “too many cooks spoiling the broth” on your hands now, do you?
2. Decide on the type of consent needed to obligate the business
This will go a long way to prevent your business from coming to a point of unnecessary financial distress. Let’s say, one of the partners at the business is taking a vacation and charges the cost of the trip to the business account, calling it a business trip. What will happen to the financial stability of the business which such irresponsible behavior?
Now, in general, any partner can bind the partnership without really asking the permission of the other partners. I am sure that you can see though how this is really bad for business.
To make sure your business remains in great financial health, you need to decide on what kind of permission a partner must obtain before charging anything to the business.
3. Decide on how to resolve conflicts before they arise
Perhaps there were personal ties that existed between you and your partners before the partnership. Maybe you got to a point where you and your partners could not agree on a crucial business decision.
Unless you want to spend a lot of time and resources, going to court is not the way out if you want the business to survive the feud between you and the other partners.
Develop a procedure by which you can deal with major conflicts – a mediation clause some experts call it – and include it in the partnership agreement. Make the vote for the procedure unanimous. If the mediation procedure calls for an external mediator, make sure that he/she is someone that you all agree on.
But no matter what, things should not get to the kind of situation we have in the picture below.
All this should obviously happen before the partnership is struck, that way conflicts – if and when they come up – will not pose a significant threat to the business.
4. Decide on the percentage of ownership
This is one of the most important elements of the partnership agreement you need to clarify before anything else. When the revenue starts to come in and you hit profit, this decision can become difficult to make.
The whole point of a partnership is that all the people involved have something that they bring to the table in terms of finance, skill set and other non-monetary resources.
Make sure that you prepare a written record of what each partner is contributing to the partnership, because this is usually the basis upon which the ownership percentage of each partner is decided.
It is not always going to be a 50-50 split; sometimes a partner might invest huge cash and little work while another will contribute the sweat equity and little cash to make the business a success.
Whatever the case, it is up to you and your partners to decide if you will divvy up the percentages equally and if not, who will get a larger percentage.
5. Decide on the allocation of profits and losses among partners in the business partnership
The convention, unless otherwise indicated, is that the partner with a higher ownership percentage in the business gets the highest profit and loss allocation.
Every business has periods of ups and downs, so you must allocate the profit and loss proportions in advance. You do not want to have financial disagreements between you and your partners when it is time to distribute profit or allocate losses.
Another important factor here is to decide if partners can take draws – an allocation of profit from the business before the actual profit distribution among partners. You will find that in some extreme cases, this may be the only way to keep the peace and prevent a partner from unnecessarily obligating the business.
6. Decide on what to do in the event of the death or exit of a partner
Preparing for the longevity of the business also means you have to be ready for a possible situation where a partner dies or decides to walk away from the business.
Before this happens, you need to draw up a buy/sell agreement that establishes how the partnership percentage of an outgoing partner is measured in terms of value. This agreement will also outline how said partnership interest can be absorbed/purchased either by the partnership or by individual partners.