Partnerships: Thinking Through the Issues Before You Start Business
Have you ever considered having a partner in your business? I’m sure you have thought: “If I had a partner, I could divide up the work, take time off, share the responsibilities and pressure, and possibly make more money.” All of those things may be true, but if it is not the right partnership or if you don’t go into it correctly, it can be a nightmare. A bad partnership can be worse than a bad marriage.
If you are thinking about forming a partnership (and this includes forming a corporation with more than one owner), answer the following questions before you start business:
What will each partner bring to the business? For a new business, all partners usually put in an equal amount of cash and then build the business. If your business has been operating for some time, you may be contributing your existing contracts, client list, employees, business know-how, equipment and goodwill. Is your partner putting in money to match the value? How do you determine the value? If your partner is contributing labor, does his interest accrue over time or does he get his entire interest immediately with the hope that he will perform in the future? Caveat: If one partner is contributing labor, there may be negative tax effects — see your accountant.
What will each partner do in the business? If both of you are great salespeople, but neither of you can manage a crew, you are going to have problems. Usually you want to look for someone who has strengths in areas where you have weaknesses. But don’t assume that just because you think Joe is a great people manager that Joe will want to manage the crew for the business. Maybe Joe is tired of management and wants to try his hand at sales. Discuss these roles in advance. Make a list of all the functions that need to be covered for the business and equitably assign those tasks.
How do you terminate the partnership? I know it sounds funny to talk about termination when you haven’t even started business, but better to address the issue while you are friends instead of when you can’t stand each other. Is one partner going to have priority at buying out the other? How will the business be valued? How is payment going to be made? If you simply terminate the business, who is going to get what, in particular the client list, phone number and business name?
What if one partner dies? If you are not fond of your partner’s spouse, you probably do not want to have the spouse as a partner. But that is exactly what can happen if your partner dies and her interest passes to her spouse. This can be prevented through a document which forces the spouse to sell their interest to the surviving partner. But such a document needs to be signed before the partner dies and should include a method for valuing the business. Think about getting life insurance on each other to help with the cost of the buyout.
How will you get paid? Making money is the bottom line for having your own business. How much are you going to pay yourselves to do the work you are doing?
As a sole owner you simply paid yourself when you needed money, or at least when there was money in the business. Not so easy with a partnership. Is each of you going to take regular paychecks? If there is not enough money, how much can each of you take? Are your vacation days limited so that if you exceed your allotted time your pay is reduced? Does each of you have an expense account? How do you review the expenses?
Reviewing these questions with your potential partner can be an eye-opening experience. You may find that each of you had very different expectations and a partnership is not right for you — better to find that out in advance.
Or you may find that talking through these issues helped you to clarify the terms of your partnership, resolve areas where there was uncertainty and allow you to get your business off on the right foot. If you decide to form the partnership, make sure you have an agreement which fully documents your understanding.