Keys to Avoiding Poor Partnerships
So, you and your partners just started a business. The future looks bright, everyone expects the company to grow quickly and you’re even fantasizing about your successful exit strategy … sound familiar? While some business partnerships end on a positive note, others often don’t. I know from experience. For 20 years, I have been representing owners of closely held businesses, and I also own several businesses with partners. In my time, I have seen some poor partnerships and watched as they negatively impacted healthy businesses. Here are a few examples of partnerships gone bad, as well as some tips that could help you avoid a similar fate:
Failing to Plan is Planning to Fail
Six family members own an equal interest in a company that owns a lot of real estate, and nobody can agree on anything pertaining to the operation of the company. They have deadlock on virtually every significant company decision, and the assets of the company are wasting away. Litigation for eight years follows. All of this could have been avoided with a partnership agreement. The purpose of a partnership agreement is to plan for events that are likely to arise, and then provide direction as to what happens when they do. Your partnership agreement is one of the most important documents you will ever sign. Whether your partners are family members or not, eventually issues will arise that will be very difficult to resolve without one.
Money is Everything
Three partners—equal owners—start a company with each contributing equal capital. In the following year, with the company growing better than expected, more money is needed. One of the three partners is wealthier than the other two, and the other two cannot afford to put in their equal share of capital. The wealthy partner makes a loan to the company at 18-percent interest, and then leaves the loan unpaid for an extended period of time, collecting interest to the detriment of his partners and to his sole benefit. This could have been avoided if the partnership had a capital call provision that specifies under what terms money can be provided to the company by the partners, and how that money is to be treated. Not having one can put your business and finances in harm’s way.
I Want that Equity Back
Your equal partner dies and his widow becomes your new partner. You have no buy-out provision in the event of the death of a partner, with the outcome being that you are stuck with her or you end up in court litigating a buy-out. Now the widow gets 50 percent of the profit, and never contributes even a day of work. How could this have been avoided? Every partnership needs provisions to deal with the departure of a partner: by death, disability, the desire of a partner to sell their equity to a third party, or termination. Failing to have them can create unpleasant consequences; at best, the inability to recapture equity from a departing partner who continues to receive distributions of profit from the company without contributing work, and at worst, becoming stuck with a new partner that you don’t want.
Arm Wrestling Doesn’t Work in Business
Two equal partners cannot agree on anything. The company is deadlocked and the inability of the partners to find resolution threatens the ability of the company to continue in business. One partner sues the other, and during the lengthy litigation process, the company falters and ultimately fails. A provision providing for the use of a third-party mediator or advisor to help resolve the deadlock could have meant the difference between continuing in business or liquidation. If the deadlock cannot be resolved, then a secondary provision should provide for the right of the partners to buy each other out, or require the company to be sold.
These examples touch on only a small sampling of the issues that can arise between business partners. Effective planning, a properly drafted partnership agreement and instituting the right provisions in advance enables a company to survive even the worst of circumstances, while treating the partners equitably in the process.
Kurt Olender is the founding partner of Olender-Feldman LLP, a full-service corporate law firm. Fun fact: Kurt is an avid motorcyclist who, when not working around the clock, rides thousands of miles a year.