Pitfalls of Business Partnerships

Recently I had coffee with a friend who is an accountant who was in the process of deciding whether to form a partnership with another individual with a complimentary business. The concept was to contribute their mutual skills and talents to create a more integrated and rounded business structure. In the course of the conversation, he asked for some advice on the things to avoid when contemplating forming a partnership. That discussion led to further contemplation and reflection on my prior partnerships.

Entrepreneurs are very much A type personalities and, in general, have trouble in letting go and sharing with respect to their own individual business pursuits.Pitfalls abound when entrepreneurs decide to become partners. Know what they are ahead of time so you can set up guidelines that allow people to walk away if things go wrong.  

Business partnershipsare an important part of entrepreneurship and startup success. The reasons are simple: complementary skill sets, shared equipment or expenses, and the idea that one person with "hard" money capital can create synergy with the intellectual capital of another person so both can profit from their venture.In theory, a partnership is a great way to start in or extend a business. In my experience, however, it's not always the best way for the typical entrepreneur to organize a business. 

The tough thing about most partnerships is that they are just like marriages, and if you know anything about those statistics, you know half of all marriages don't survive. Making a marriage work involves handling a volatile mix of partnership issues: ego, money, stress, monthly overhead and day-to-day expenses. Throw in some employees you must manage, and you have a good idea of the work required to make a business partnership successful. 

If you're thinking about a partnership, consider the following list and avoid the potential pitfalls:

1. Sharing capital instead of expenses: Whenever you share your own capital ( money, resources, information or property) you automatically give away your enterprise ability. In a perfect world, the person you are partnering with is upright, full of integrity, and not at all tempted to take this gift and run with it as his own. However, the world's not perfect. So be careful. Instead, work out an arrangement where expenses are shared in an "associative" arrangement. It also makes it easier to walk away if things go wrong. 

2. Partnering with someone because you can't afford to hire: This is a partnership killer right from the start. The scene is always the same: Bob has a business idea and Fred has the business skills, but Bob can't afford to hire Fred as an employee, so they decide to share duties, expenses and profits. What happens is both Bob and Fred end up working against each other, and Bob finds himself liable for Fred's obligations (financial and otherwise) under the partnership agreement. If you've got the idea and someone else has the skill, simply hire him or work out an independent contractor agreement. Don't give away what you don't have to. 

3. Lacking a written and signed partnership agreement: Due to the nature of partnerships, every detail and obligation must be clearly defined and written out, and agreed upon by all parties. This is best done with a written legal agreement drafted by a well-qualified, mutually agreed-upon lawyer. Just make sure the attorney is well-versed in business partnerships, and be sure to keep their card handy at all times. You may need that person again when things go wrong.  

4. Overlooking a limited partnership: One of the main downfalls of a partnership agreement is the assumption of liability each partner makes for the other. A way around this is a limited partnership, where the limited partner is not liable for the actions or obligations of the general partner. Again, make sure an attorney well-versed in partnership agreements writes this arrangement. 

5. Lacking an out or an exit strategy: Some marriages start with a pre-nuptial agreement. In business and contractual terms, a pre-nuptial agreement  is analogous to an exit agreement. In any partnership agreement, define the terms of an exit strategy that allows you or your partner to walk away from the partnership, or that provides options to buy out the other party. This can be done very clearly and simplyand without imploding the operations of a successful business. 

6. Expecting the friendship to outlast the breakup of the partnership: From the perspective of a marriage, how many ex-couples do you know who are truly friends? Not many. So don't go into any partnership with a friend expecting to remain friends after a partnership breakup. It may sound great to do business with your friends, but remember, in the business world, it's always business first and friendships second. Also remember, most times when the business ends, so does the friendship.

 7. Having a 50/50 partnership: Every business, including partnerships, needs a boss. If you decide to go the partnership route, make it a 60/40 or 70/30 split. Then you and the business have a point person for accountability and overall operational control. Also, keep your buyout or exit strategy clear and in your favor thus benefitting you and saving problems down the road.

When first considering partnering, each individual should work on their own businesses for a few years before combining under one name. Only after successfully launching and running their own separate businesses will subsequent partnerships actually work.  

As a final note, I leave you with an interesting option to the partnership issue. Consider a test drive of a potential partnership before formalizing it. Operate loosely in the partnership for at least six months before finalizing everything. That way, any potential pitfalls may be detected and remedied before finalizing the partnership agreement. You may also choose to walk away before things become too formally integrated. Hopefully, this provides additional perspective.

Comments

Steve,

You have some valid points here. Spending some time and getting to know your prosepctive partner is important. Your other points are all valid and considerate.

AS in a marrage there are risks and no guarantees. I beleive you also need to use good old fashioned intuituion to decide on a prospective partnership arrangement.

PM