• Advance Planning Can Keep Your New Business Partnership Amicable
  • August 31, 2010 | Author: Susan E. Wells
  • Law Firm: Jaburg & Wilk, P.C. - Phoenix Office
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    Advance Planning Can Keep Your New Business Partnership Amicable

    By: Susan E. Wells

    Starting a new business is be challenging!  You may be fortunate enough to have a friend or associate join your business venture as your partner who can share both the risks and the rewards in the planning and pre-opening stage as well as the operational stage. 

    As you embark on your new venture, you and your partner may operate under a number of assumptions:

    1. You both believe that each of you shares "your" vision.
    2. You both believe that each of your expectations for yourself and your partner are the same.
    3. You both believe that your relationship with your partner will endure and will be amicable indefinitely.

     Unfortunately, experience has shown that those assumptions are rarely accurate.  Therefore, it is critical to discuss with your partner what your respective visions of the business and the future are, as well as what your respective expectations of each other are.  Without a meeting of the minds as to those important issues - friction, disagreement and possibly litigation will follow.  This is particularly true when the business is experiencing other challenges, such as inadequate cash flow.  Without a clearly written statement of the parties' joint expectations and agreements, restructuring or even breaking up may be hostile, lengthy and expensive. 

    Life events happen.  It is important to determine, in writing, what happens if one of you dies, becomes disabled, gets divorced, experiences financial problems or ceases to be employed in the business.  Typically, the partner that is not experiencing the event wants to buy out the interest of the other partner, either because they are no longer contributing to the venture or because that partner's spouse, children, creditors or others may seek to participate in the business.  Similarly, the representative for the disabled or deceased partner wants to liquidate his or her investment in the company.  Upon the occurrence of any of those "triggering events," the parties' interests are obviously different from, and now adverse to, each other.  The "selling" partner wants a high value or purchase price ascribed to his or her interest in the business and the "buying" partner wants a low value or purchase price.  The "selling" partner wants to receive the purchase price as soon as possible and the "buying" partner wants, and may frequently need, a longer period of time over which to pay the purchase price. 

    Had the partners agreed upon these matters in advance, when either partner could eventually be the "selling" or "buying" partner, their positions on those points would more likely be similar or at least closer. Typically, the partners agree in advance upon a value or purchase price determined in one of three ways:

    1. The partners agree initially and then periodically upon a specific dollar figure for the business as a whole or for each percentage interest in the business,
    2. A formula for valuing the business is designated or
    3. An appraisal or formal valuation is required.  In any of those cases, you should consult with an accountant to advise you which alternative is best for valuing your type of business and, if a formula is the selected alternative, what formula would best reflect the true value of the business. 

    Jay Miller, a Certified Public Accountant experienced in consulting with new business owners as well as appraising businesses, says, "Unfortunately partners rarely remember to periodically agree upon the value of the business.  So, if that alternative is selected, I would recommend that the agreement provide for a backup plan to be used if the partners have not agreed upon the value for at least a year.  Also, agreeing upon a value is the least likely alternative to arrive at an accurate value of the business.  A formula based upon a capitalization rate applied to the business' historical revenue or net income more accurately reflects the value of the business.  Of course, an appraisal is even more accurate.  However, it is time consuming and can be expensive."  If the partners take the time up front to fix a method of valuing the business that they both believe accurately (or at least adequately) compensates them for their interests in the business, hostile dissention and litigation may be avoided.

    Being realistic about the possibility that you may not continue your business partnership can help you save your relationship with your partner and avoid litigation.  A shotgun buy-sell provision can be agreed upon in advance and is an orderly and amicable means of one partner buying the other out.  In a shotgun buy-sell arrangement, one partner makes an offer to buy out the ownership interest of the other partner.  The second partner then has the option to either accept that offer or turn the offer around and cause the first partner to be bought out on the same terms.  A shotgun buy-sell provision is advisable under some, but not all, circumstances. 

    Whether or not you and your partner agree upon a shotgun buy-sell, you should consider and agree upon a means to resolve disputes that may arise.  That may entail mediation, which employs an independent person to assist you in arriving at a mutually-acceptable agreement, or arbitration, which uses an independent person to decide the outcome, similar to a judge.   Usually arbitration costs less and is quicker than using the courts.  However, that is not always the case.  There are pros and cons to each of these options that should be considered by both partners. 

    Although you may be starting your new business with limited funds, you will ultimately save money by focusing on these and related issues at the outset, before disagreements arise, and signing an agreement that reflects your mutual understanding.  As Stephen Covey says, "Begin with the end in mind." 

    About the author:  Susan E. Wells is a partner at the Phoenix law firm of Jaburg Wilk.  She assists businesses and entrepreneurs with their legal needs, including both franchisors and franchisees.