Ken Kaufman's picture

4 Signs Your Business Partnership will Fail

Business partnerships are one of the most unique and trying relationships we will ever enter.  Some work, but most fail.  I did a quick test.  I searched Google for "business partner problems" and found about 169 million results.  Compared to only 143 million results for what I assumed would be the more common term of "business partner," I think it is clear that many struggle to make these arrangements work.  Here are four warning signs that our relationship with our business partner(s) may be headed for failure.  Please note that this article assumes that business partnerships are in the common form of a Limited Liability Company (LLC).   hands shaking

1.   No Operating Agreement - many states do not require an LLC to have an operating agreement, and, therefore, many business owners and entrepreneurs do not understand the importance of this legal document.  The operating agreement is the agreement between all of the owners, or members, on how the business will run, who will be in charge, and so much more.  Let me share one brief example to portray the need for an operating agreement.   While at a social event recently with my wife, we connected with one of her friends from college.  He has started a business and his product is starting to sell and pick up some nice momentum.  He spoke for quite some time about how excited he was, how much fun he was having, and his new-found joy in finally pursuing his passion.  I asked if anyone else was involved with the business, and he said he had two partners.  The entire tone of the conversation changed as he described how his "partnership" had evolved, or perhaps a better description would be disintegrated.  It started with three friends getting excited about an idea.  They decided to split everything three ways and they failed to put anything into writing (namely, an operating agreement).  As time passed the expectations, time commitments, investment, and basically everything else related to these "equal" partners fell completely out of balance.  Arguments replaced friendship and greed supplanted a desire to share everything equally.  The problem - they never created an operating agreement that defined all of the important legal, financial, management, and time issues for their business.  The lack of an operating agreement has sent this budding partnership into a death spiral that will likely end in a painful and expensive divorce.   Please know that I have many more examples like this than I do of successful partnerships.  One thing all of the successful partnerships have in common - they have an operating agreement.  While certain online resources can help entrepreneurs organize their entities legally, special care and consideration should be paid to the operating agreement.  It is very wise to seek appropriate legal counsel as well as have healthy and lengthy discussions with your partners before you finalize this agreement.   

2.  Partner Pride -This is something that usually shows up when a partnership begins to have struggles and accelerates its demise.  Here is one real-world example of partner pride.  Two men started a business, each owned about 45%.  The remaining 10% went to other key employees.  As the business grew and became quite successful,  one of the 45% owners took great pride in the success of the company.  He began to tell his family and close friends that it was his company and that he was the major contributor to its success.  His pride allowed him to minimize his main partner and falsely establish himself as something he was not.  When this partnership began to fall apart and his partner extended a very fair offer to buy him out, he refused.  Why?  In his mind, he could not communicate to all of his family and friends that the business could exist after he left.  He was so infatuated with his fictitious position that he could not make reasonable or logical decisions.  The matter was finally resolved, but not without great distractions and damage to the business.   The best way I have seen to keep pride out of a partnership is to regularly review the contributions of all involved as well as discuss how each partner can improve.  If done correctly, this serves to keep everyone grounded and grateful for each other.  

3.  Compensation and equity are confused -Let me be as straight-forward as I can with this topic.  Too often I see entrepreneurs, founders, and business owners that confuse equity and pay/compensation.  These two items must be separated in order to set your partnership up for success.  A few years ago I was introduced to a business with 50/50 partners.  12 months earlier one of the partners had become permanently disabled and unable to further participate in the business.  The partner remaining in the business was frustrated that the other partner put zero time into the business yet was still getting 50% of everything the remaining partner generated.  This partnership was about to fall apart until we set a fair and reasonable wage for the partner still working in the business.  The other partner's wage was reduced to zero since he was not working in the business, although he was still entitled to 50% of the profits based on his ownership stake in the business.  Problem solved.   Ownership does not mean you should receive a wage or guaranteed payment.  Ownership means you participate in profits after all expenses are paid, including the wages of those working in the business.  In the spirit of understanding the difference between equity and pay, each partner's compensation should be reviewed at least annually.  In this scenario, it would not be uncommon for one partner to receive a higher salary than another, especially if there is a difference in the amount of time put into the business.  Please note that the legal and tax structure of the business may determine the best ways to receive both wages and profits, but that should not dictate the separation, at least mentally and emotionally, of the two.   puzzle

4.   Beginning without the end in mind -perhaps all of these points lead to this one - the need to contemplate every way the partnership will need to end or be dissolved.  Here is just a brief list of the different life events that could impact a partnership: death, disability, lack of interest, relocation, new opportunities, family changes, and more.  How will each of these situations be handled by the partnership?  An operating agreement and potentially a buy/sell agreement should contemplate these events.    In addition, beginning with the end in mind implies that a partnership will have planned exits as well.  Selling a business can be very rewarding, and a partnership needs to look down the road to how each of the partners will exit.  For example, one partnership for which I serve as the part-time CFO consists of three partners under forty and the fourth partner is almost 65.  The younger three want to stay in the business for a long time while the older partner is hoping to exit the business and retire in a few years.  Orchestrating this partner's exit while not hurting the business from a cash flow and leadership perspective take thought, consideration, and planning.     The point is this - if a partnership does not properly plan for expected and unexpected exits, it will likely fail.  

Do any of you have good or bad partnership experiences to share?

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Comments

[...] prospective partner turned out to be someone much different that anyone suspected. Please refer to 4 Signs Your Business Partnership will Fail for more on this [...]

I hope none of these are about me. ha ha I hope everything's well with you.

Just like a marriage, new business partners go through a honeymoon phase and then migrate to a more mature relationship. Operating agreements are often opportunities to avoid strife when things go bad.

Unfortunately, not all partnerships are for life. The time to create the exit strategy for the dissolution of the partnership is during the "honeymoon" phase when all parties are working together and can create a fair method for a partner to exit. Think of it as a "pre-nuptial" agreement.

A good one will allow for the very common outcome of partners moving in different directions without the acrimony often associated with this kind of event.

Just sayin'..... :>

I found this article so very interesting. I am the owner of a small business- recently I was thinking about making someone a partner- who I have known for some time. However after reading this especially about being on the same page- made me realize that this would not be a good arrangement.

Thank you
Janet
3-1-2010

Kin,

I agree. Capital calls cause major issues in partnerships, and an operating agreement usually defines how this should be handled!

a 5th problem comes when the operation falters, and additional capital is needed. In most cases this is not adressed until a crisis occurs.

Feeling Stupidly - I agre with Mark...you should seek legal counsel. There are a lot of potential issues and you will need to maneuver through your situation carefully.

Jim B - Thanks for your thoughts.

Feeling Stupid,

Definitely get an attorney on this. That's my advice.

Excellent summary!
Founder's syndrome, egocentric response to success, undervaluing contributions, delusional systems, confabulation and in the end irony! All will crop up in a business partnership if you permit yourself to overlook the tell-tale signs early on.

JB is a 30 yr. successful entrepreneur who helps people fly rather than flapping their wings and has a well-earned reputation as a constructive disrupter.

About 6 months ago, a close relative and a cousin along with myself were very excited about going into business together. We had grand ideas about going into business together even though we (the close relative and myself) had heard bad information about this distant cousin and were warned that we should steer clear. Fast forward to today. Myself and the close relative have decided to walk away from the business and left the remaining partner with the business. We've been asking this person to file an amendment to remove us from the business and it seems the remaining person is dragging their feet. I wish like hell we'd dissolved the company instead of walking away from this company. If anyone has any advise on what we should do now, I'd be glad to hear it.

Feeling Stupid for trusting in this person.

Diane, P., & Mark - Thanks for leaving a comment on this blog post. Your feedback is appreciated.

Christine, that is a powerful story you shared. Thanks for your insights!

Ken K.

Great article....I used to set up legal entities and explaining to people why they needed an operating agreement was usually a waste of time. Most people only care whether it's statutorily required. One of my first LLC clients is now in litigation because one partner was embezzling money from the company without the other's knowledge. There was clearly a communication problem between them near the end of their relationship. Unfortunately, the partner who was honest found out too late -- the other partner stole nearly $40k worth of money from the business -- and the guy who stole the money had not put up any capital. The partner who embezzled the money filed bankruptcy and the honest partner was out the money that was stolen.

A business partnership is a lot like marriage -- you have to be on the same page or have something in writing that governs how the business will be run. Otherwise, it really is doomed. Each party should retain a separate attorney and the operating agreement should be memorialized BEFORE anyone commits capital to start the company. Otherwise, it's just too late -- there's no incentive to get the other member(s) to sign the agreement.

Also, I'd personally think twice about going into business with someone who doesn't have an equal amount of capital to invest. As illustrated in the story above, a well meaning, trusting partner can ultimately get screwed by someone who has no skin in the game. We'd all like to think people won't screw us, but this happens all the time and is an expensive mistake that can be avoided if memorialized in the operating agreement.

If you can't have a real discussion with your potential business partner about how to run the company, it's a warning sign that you should pay attention and think twice about entering into a partnership with them.

I was referred here by Anita Campbell at BizSugar. This post is particularly insightful; it gets right to the human dynamics that make stuff not work.

Thank you.

All of this is true. Partner Pride was the cause of our partnership failure which damaged the company beyond repair. Great article.

I found this very interesting.

Dianne