Business Partners: How to Avoid Pitfalls

blog post by Stev Stegner

People often toy with the idea of going into business with a friend or relative.   This can be a grand idea or a colossal mistake.   The partnership can create synergies that propel the business to success or the partnership can bring out the insecurities and create challenges.  

So you have a great idea for a business and need some capital, bringing on a financial partner seems like the right thing to do in the short term.  Having someone who can help fund the startup is always tempting, but at what cost.  The key to a successful partnership is a clear expectation of responsibilities for all partners.  Before any money changes hands, draw up an agreement between all parties.  This agreement should be part of the business plan or strategic plan.  I can hear moans and almost see eye rolling.  All partnerships are forged with the euphoric expectations of the first day of your new diet.  You can see yourself easily dropping 20 lbs without hardly trying.  Then by the end of the first day, you convince yourself that perhaps you should lighten up on yourself.  By the end of the first week, you have likely scaled back to agreeing with yourself to just “eat healthier”.  

No one goes into a partnership thinking they will be the problem.  Most of the time, the problem is the other person (of course), their family, their work ethic or they are not fair.   Setting clear expectations is not a foreshadowing of mistrust, quite the opposite, it is sowing seeds with the expectation of a fruitful harvest.  Utilizing the five core principles below will help you avoid a challenging partnership as you swing for the fences.

Set up a budget for the business and the responsibilities for each partner to contribute, raise money and collect debt.  According to the U.S. Bureau of Labor Statistics (BLS), “approximately 20% of new businesses fail during the first two years of being open.  There are dozens of reasons they fail, mostly due to management and finances.   Create a five-year plan for income and expenses.  Where is the revenue coming from, will the income from the business cover expenses from day one or something further down the line?  What are each of the partners responsibilities and expected salaries?  If you cannot agree on salaries and funding, your partnership is on shaky ground.”

Set up work schedules with measurables, segregation of duties and responsibilities.  Just because someone shows up at work does not equate to performance.  Having key performance indicators will help the company stay on track.  Segregation of duties is critical to the success of the partnership.  There are literally dozens of ways of doing tasks in the business.  Assign one of the partners and let them figure out the best way to accomplish the goal. There is no reason for duplication of efforts or overlapping responsibilities unless there comes a time where one partner is no longer performing at an acceptable level.

Set up production goals.  This can be for widgets, service calls or services. Think of this as an income goal, broken out into the revenue streams from each part of your business.  If you are selling widgets, this could be three revenue streams: Wholesale, retail and website sales.  If you are selling an App for phones, this could be: Apple, Android, website integrated widgets and ad revenue on the App. The more categories of revenue streams the more likely you can evaluate and redirect resources. If all your revenue comes from one source like a retail store, each product category should be assigned a revenue goal. In simplest terms. If you owned a grocery store and your revenue goal was $50K per week and you were missing your target by 30%, it would be hard to see where your expectations vs reality missed the mark and it would be difficult to redirect energies into growing sales.  However, if the same grocery store had six departments all with specific revenue goals, it would be easier to see where the sales are sluggish.  When the revenue goals are not being met, the burn rate (the rate you use more cash in expenses than revenue coming in) could be unsustainable. The business needs to plan for cash shortfalls as well as spending cash in excess of predictions.  Having too much cash is a problem for some businesses. Excess cash can be used to pay back debt, fund expansion or taken as distributions. It is very important that there is a clear use of excess funds within your strategic plan/business plan. While one partner may decide the business can afford a Hawaiian retreat, another investor might want to recoup their investment or expand the business. 

You need an Exit Plan in writing!  The exit plan can be part of a Buy/Sell Agreement or repayment of the investment. Nearly all investors want to be repaid in a defined fashion. The repayment plan can be tied to gross revenue, net profit or any other number of formulas. It is not simply the partners who think about the exit plan, it is also the spouses/significant others. Some things are difficult to plan for like death or a divorce.  Often the investment is part of the estate or marital assets. A $100K investment pre-revenue might be worth over $1MM, but without a Buy/Sell Agreement it could be challenging to come up with the business value. Having a new partner due to a divorce or the death of a partner could be a nightmare. An Exit Plan protects both parties and ensures smooth sailing!

A written contract is critical to the success of the partnership. The budget, list of responsibilities, KPI (key performance indicators, such as sales/production goals) and the Exit Plan need to be in writing and notarized. If you prefer not to use an attorney to set this up in the beginning, you may end up paying one in the end. A qualified attorney will be able to set up the contract to protect both parties and ensure a long successful partnership.

Partner with people who make you strive to be better; partnerships are tough and should not be taken lightly. A million-dollar idea with the wrong partners will be very challenging, meanwhile the same idea with everyone rowing in the same direction will open doors for even more opportunities. Select a business partner just as you would a spouse, vet them well, date for a while (metaphorically) and do not rush into anything. A business partnership can be a home run! Take your time and wait for the right pitch. Batter-up!