Prepare to Hate your Business Partners

I’m not sure I have ever written an article with such a depressing title before, but it does succinctly and accurately capture one of the single most important pieces of advice I give to entrepreneurs and business owners.  Contrary to what you might think, however, the underlying message is intended to help avoid future conflict and strife in your business. Read on and you’ll understand what I mean.

In the early days of a new business venture, typically everyone loves everyone else.  The future appears bright with promise and visions of happy customers, plentiful profits, and a multi-million dollar exit just a handful of years away.  It’s nearly impossible to devote any thought or energy to the notion that at some point you may encounter disagreements with your co-founders that are so significant they could not only jeopardize the entire business but cost you your personal financial security as well.

There are a variety of statistics out there relating to the failure rate of new businesses, and they vary by industry and how one defines success.  Suffice it to say that fewer than half of all new businesses are still alive after four years, so the evidence tells us it is likely your venture will fail.  For this reason, it is imperative that from the beginning, you and your business partners have a plan for when times get rough. One of the most important elements of this plan must be how disputes among the owners are resolved.  This is not a comprehensive list (in fact it barely scratches the surface), but here are some of the points that should be agreed to in writing by all of the business owners prior to launching a new venture:

  • How are day to day decisions going to be made?  Typically there are managers or officers who have the ability to make certain decisions in the normal course of business.  This allows the business to operate efficiently because it avoids having to seek a vote of the ownership every time a decision needs to be made.  It is critical that measurable parameters be set (such as dollar amount thresholds) so that the officers or managers have a clear understanding of the limits of their authority.
  • How are big picture decisions going to be made?  Significant company decisions in most cases should require the approval of a board of directors or even the owners.  Like my comment above regarding day to day decisions, what constitutes a big picture decision should be agreed to in writing using measurable criteria.  Examples of typical big picture decisions are acquiring or merging with another company, buying a building or piece of real estate, or winding up the company’s operations.  It should also be clear whether a majority, supermajority, or unanimous vote is required in each case.
  • What happens if one of the business partners wants out?  Historically it has not been common for an owner of a closely held business to be able to require the business to buy her out, but at our firm we are seeing this issue come up more frequently.  I still think by far the most typical arrangement for an owner who wants out is to simply abandon her ownership interest in the business and walk away empty handed (and in some cases even that might not be an option).
  • What happens if some of the business partners want to force another partner out?  Here again, it has historically not been customary to allow owners to remove another owner from the business at will, although we certainly do encounter clients who want to have this as an option.  In this type of scenario, we would expect there to be a formula agreed to in writing by which the value of the forced out partner’s ownership interest is calculated and paid.

Special attention should be paid to business structures where there are an even number of partners who have equal ownership percentages (i.e. two 50/50 owners or four 25/25/25/25 owners, etc.)  These are particularly problematic because it is possible for there to be a voting deadlock. Attention and creativity should be given (again in advance, in writing) to how tie votes are resolved.  For companies with more than two owners one option might be to require a supermajority vote, but if your company has only two equal owners your choices are more limited. In my experience a dispute between two equal owners of a company are the most difficult to address, but there are mechanisms you can put in place to handle them when they arise.

It may seem counter-intuitive, but preparing for the day when you hate your business partners by addressing the points above (and others) helps avoid a costly, emotional, time-consuming legal crisis.  Hopefully the early stage feelings of respect and admiration you have toward your co-owners will never go away. Unfortunately, the statistics tell us you will likely face hardships along the way, and being prepared to deal with an ownership dispute might mean the difference between long-term success and failure for you and your business.