A friend of ours founded a growing and profitable business. She was passionate about the enterprise. Aside from family, it meant more to her than anything in the world. She decided to take on a partner who brought some different skills to the table. She gave him 50 percent of the business as part of the agreement.
Over time, differences between the partners surfaced. Tensions escalated. The partners couldn’t be in the same room without fighting. Both partners knew they needed to make critical decisions to keep the business from deteriorating, but couldn’t agree. A stalemate ensued. After many gut wrenching months of trench warfare, they sold the business. It’s a tragic story -- taking on an equal partner cost our friend much anguish, many millions of dollars and the love of her life.
Knowing when and how to take on a business partner can save you tremendous angst and a lot of money. A business partnership is deeply personal. In some ways, it is like a marriage. You should only enter into either relationship after much thought and deliberation.
Here are four reasons why you might want to attain a partner or partners for your business:
1. Capital contribution. A partner who can make cash contributions may make sense if you need capital to grow your enterprise or wish to take money out of the business. Accepting an equity investment to make payroll (i.e., sustain the company through a losing period) is risky business for all involved. It may be a good idea, but only if there is a clear plan to move the business back into the black.
2. Additional skills. You may decide to use an ownership stake to attract a qualified person with skills essential to the business. This is particularly true when a business cannot afford to pay the compensation needed to attract such an employee.
3. Alignment of interests. Stock ownership can motivate employees and align their interests with yours. While there are other ways to accomplish this (such as profit sharing plans), in certain circumstances employee stock ownership can make sense.
4. Synergistic merger. Merging with the right company may increase the value of a business. An addition to the product or service offerings, a geographic expansion, forward or backward integration, economies of scale, or the elimination of a competitor may create synergy.
Our friend had the “why” for taking on a partner, but did not execute the “how” correctly. Keep these tips in mind before you make a commitment:
1. Maintain a controlling interest. If this is lost, the fate of the business and potentially your fate rests in the hands of others. If it is not possible to maintain control, negotiate a generous exit package so you will be fairly rewarded for your work if the time comes when you are asked to leave the company.
2. Avoid a stalemate. A 50/50 partnership arrangement can be as bad as losing control. When business partnerships go wrong, the result can be brutal. If a stalemate occurs, the business can die while partners fight. Have a tiebreaker. For example, a 49/49/2 split would avoid the dysfunction of a stalemate.
3. Be fair to minority shareholders. In a privately held company, minority shareholders can invest money or sweat equity in a business and see no return while the controlling partner gets rich. For example, the majority shareholder can pull money out of the business by increasing his or her salary, while never declaring a dividend. If the majority owner doesn’t sell the business, the minority investor has essentially lost his or her money. Protect the minority shareholder with fairly negotiated contracts.
4. Have an exit strategy. When taking on a business partner, a good prenuptial agreement is critical. Anticipate the business unwinding before it does. What happens if a partner needs to cash out, dies or becomes incapacitated? What happens if irreconcilable differences arise? It’s much easier to negotiate an equitable arrangement before heated emotions take over.
Under certain circumstances taking on a business partner can make sense, but there are many dangers. The eight essentials above can help you avoid many of the traps.