How to protect yourself and your business startup when the partnership falls apart.
Whereas 50% of marriages end in divorce, the number is closer to 80% for business partnerships- Amanda Neville, forbes.com
Consulting with peers is great, but when I am working on something of great significance, I seek out mentors. I want to spend time with people who have already successfully navigated an endeavor similar to that which I am about to undertake. While this applies in many areas of life, starting a new business is an area where a great mentor is of intangible value. Over the course of my 30’s I have started and led 8 new business ventures. Each and every one of these startup initiatives has involved a partnership of some sort. This means that I have spent a lot of time seeking out and learning from successful entrepreneurs.
I am now 40 years old. As I reflect on my conversations with startup mentors over the last decade, I see that there are a lot of diverse routes to success. The interesting thing is 2 commonalities seem to always show up amongst my business mentors:
- They have all achieved significant wealth. Now, I will admit that this one is tainted. I only sought out successful entrepreneurs; so, it stands to reason that my particular points of data would have some measure of financial achievement.
- They have all severed relations with their former partners. This one was a bit surprising to me. I knew a lot of partnerships had struggles, but I assumed this was most often due to a failing company. What I now realize is that partnerships most often fall apart regardless of the company’s progress.
To this point in time, none of my business partnerships have broken up. This does not mean that there have not been battles, heated debates and opposing views; it just means that we have been able to work through those issues…so far.
While I am a confident person, I am neither so naive nor arrogant as to believe my partnering capabilities surpass those of every chosen mentor in my life. I just don’t think I am so good at being a partner and selecting partners that I will consistently outperform the vast majority of successful entrepreneurs. My partnerships will eventually fail. My business ventures will succeed (there’s a bit of that arrogance coming through). Knowing this is true, I have put many safeguards in place to protect my personal and business interest when the inevitable occurs.
4 Ways to Protect Yourself When the Business Partnership Fails:
Sweat Equity Arrangement
When forming a startup business, one of the first discussions generally centers around ownership (equity). Many factors come into play when determining the equity each partner will hold: knowledge, skill, in-kind, cash investment, effort (sweat), etc. It is important to document expectations in all of these areas of contribution when forming the company. This will require the development of a formal cap table. Many partnership disruptions center around the value of time vs. money. Defining these items clearly from the beginning will serve as a valuable reference for future discussions.
Many founders don’t consider this one until it’s too late. The excitement and adrenaline of getting started leads to a kumbaya atmosphere where all things are equal. This spills over into salaries. Sooner or later, the amount of time, effort and energy expended by the partners is no longer equal, but their salaries are. Tensions begin to rise. One way to avoid this is by clearly separating ownership compensation from position compensation. Pay owners with respect to their ownership percentage. Pay employees market value for the positions they fill. For partners, ownership pay + employee pay = total compensation.
I am amazed at the number of privately held business partnerships that do not have a formal buy/sell agreement in place. This one is absolutely essential. When forming your business, you chose your partner; make sure you have some rights when it comes to who your partner will be as time goes on too.
Key Man Life Insurance
Remember, that partnerships can fail for many reasons, including the death of a founder. Key man life insurance enables you to transition without financial strain. Further, this type of insurance can be utilized to fund a buy/sell agreement – not many people like the idea of replacing their business partner with their partner’s spouse or estate after death or a nasty divorce. Without an appropriate buy/sell agreement and key man insurance, you may not have a choice.
Your Partnership will Fail! continued..
Part 2 – Sweat Equity – Clarity Helps Protect Startup Businesses
Part 3 – Partner Salary Agreement – 4 Questions to Mitigate Partnership Failure
Part 4 – Buy-Sell Agreement – What, Why, and How?