In 2009, business start-ups reached their highest level in fourteen years.[1] This is an exciting statistic, and shows the entrepreneurial spirit is still alive and well in this difficult economy. Many of these new businesses are founded by “corporate refugees,” those who were either laid off from their positions due to economic downturn, or those who grew disillusioned with the culture of their workplaces. Some stayed in the same field, while others started brand-new careers in areas where they have never worked but always dreamed of providing a product or service.
There are many issues to consider before starting a new business. Many times, the excitement, stress and to-do list associated with a new partnership can divert attention and resources away from important issues.[2] In this article, we will focus on the area of business partnerships, and effective strategies to create, maintain and terminate those relationships.
Creating Business Relationships
Before entering a business relationship, you should carefully consider the advantages and disadvantages of taking on business partners. There are many reasons to partner with others when starting a company. For instance, partnering with others means there are more people to add capital to the company, to offer complimentary skill sets, to do the work and build the business, and to share the risks associated with starting a new business. However, taking on business partners can make a company less nimble in a competitive environment, and it is important to analyze the pros and cons of entering into business with others before taking that leap.
Sometimes it pays to bring on business partners that you may not know well but who are a great fit in terms of experience, knowledge or business development skills. Before you partner with persons whom you do not know well, you should perform a background check, and offer to have one done for yourself as well. This simple, inexpensive step has saved many new business owners from entering into business relationships that are destined to fail.
You should also consider requesting personal financial statements from a prospective business partner whom you do not know well. Though this can be a sensitive request, it is important to understand the implications of entering into business partnerships with others when there is a large net worth discrepancy among the partners. The partners who are strongest financially will likely be taking on more financial risk with respect to the business if the business needs to enter into a lease for commercial space or borrow money from a bank. This is because the landlord or bank will require the partners to personally guarantee the lease or repayment of the loan. If the landlord or bank ever make a claim under the guarantees, they are likely to look first to the partners with the strongest balance sheets.
Once comfortable with the prospective partners involved, at a minimum, you should work through the issues outlined below before proceeding with the relationship. Too many partnerships begin without parties thinking through key issues. By working through these issues upfront, the partners will decrease the chances of the relationship ending poorly. Also, when partnering with someone you do not know well, negotiating these issues at the outset will offer a glimpse of what it will be like to be in business with the person.
Money Issues
- Will each partner make an initial contribution to start the company? If so, should any portion of that contribution be treated as a loan, or is it all a capital contribution?
- If the company gets into a financial bind down the road, what are the obligations of the partners to put in additional capital? Will the company try to secure a loan or a line of credit, or will each partner have to contribute an equal amount? Is there a cap on how much everyone is required to put in?
- How will owners be compensated? Will each partner draw a salary, and if times are tough, will that salary be deferred?
Operational Issues
- Is a certain partner going to be in charge of day-to-day operations? What are the limits on the authority of the partner in charge of day-to-day operations?
- How much of a time commitment is expected of each partner?
Legal Issues
- What are the partners’ “duty of loyalty” expectations? In other words, can a partner work for or be involved with a company in the same industry as the partners’ business?
- Are there restrictive covenants you want to impose on the partners?
- If the business is successful, at what point do you want to sell? If it is not profitable, at what point do you pull the plug?
These understandings may not need to be in a definitive agreement, but it is important that there is a discussion and general agreement on these issues.
If the business partners agree to proceed with the relationship after discussing all of the issues described above, all of the understandings of the business partners should be memorialized in an agreement. In addition to the points above, the agreement should also handle other important issues, including the following:
- The occurrence of events that would trigger the end of the relationship, such as death, disability, divorce and the termination of a partner’s employment with the company;
- Minority owner issues, such as the inclusion of drag along rights and tag along rights;
- Transferability of ownership interests (How liquid do the partners want their investments to be?);
- The timing and amount of dividend or distribution payments; and
- Mechanisms for breaking a deadlock.
Ultimately, regardless of the size or scope of the business being contemplated, it is important to establish expectations. By working through the issues described above with the help of their professional advisors, and memorializing their agreements in a written document, the business partners will have maximized the opportunity for a successful business partnership.
Maintaining Business Relationships
If you answer all the questions above in advance, maintaining a business relationship should be a fairly smooth process. But like all relationships, some basic maintenance is recommended, if not required. It is important that all partners play some role in monitoring, maintaining, and when necessary, modifying, the business and their role in it.
An important part of this maintenance is a regular review of company records, including bank and credit card statements, accounts receivable, and balance sheets. You will also want to periodically review – and update if necessary – your corporate documents to ensure that they still reflect the goals and value of your business. Day-to-day operational items like leases, vendor contracts, and employment agreements should also be reviewed from time-to-time to make sure they don’t need updating based on company growth or some other reason.
It pays to have regularly scheduled meetings of all business partners on a monthly or quarterly basis. Communication is the cornerstone of any productive relationship, and a lack of it between business partners can eventually breed distrust. Make sure you have an open and regular dialogue on financial and operational issues so small challenges can be addressed before they become large ones. These meetings are also a great time to talk about short-and long-term planning, so your company is always functioning as it should. Issues like ownership structure, as well as partner responsibilities, workload, and compensation should be openly discussed to make certain everyone is still on the same page. It also gives those that would like to see a change a forum to discuss it with the rest of the partners.
Terminating Business Relationships
All good things must come to an end, and business partnerships are not meant to last forever. Goals change. Markets shift. Partners retire, lose interest, or simply decide to pursue other opportunities. It’s important to plan for such contingencies.
When it is time for your business partnership to end, there are many ways to unwind that relationship. Ideally, the separation can occur amicably, and there are many ways to do this. Three of the most common frameworks are:
- Wind down – You can simply “wind down” and cease operations, sell the company’s assets, pay off your creditors and distribute the rest among the partners, pro rata.
- Buy-Sell – One partner may be in a position to buy out the ownership interest of the one that is interested in leaving.
- Sell – The partners can sell the business entirely to a third party.
A well-defined relationship from the beginning, and the documents to back it up, is a good start. Sometimes though, good corporate documents are not enough to keep a partnership breakup amicable. Even business partners who start off with the best of intentions can find themselves at odds with each other due to a variety of circumstances.
When intractable disputes arise between business partners, it is likely time for the partnership to end. In these instances, it is important to quickly assess and establish the rights and responsibilities of the respective parties, as well as your own goals for exiting the relationship.
A good first step is the exercise your right to inspect company documents. Georgia law allows partners, LLC members, and shareholders in a corporation to inspect the books and records of a business at a reasonable notice. Armed with this information, you can determine what your own rights are, and what duties or obligations your partners may have to you and/or may have violated.
If an analysis of the underlying corporate documents reveals that one or more owners or managers in the business failed to fulfill obligations to the business and/or to other owners, this information can be a powerful chip with which to negotiate a more favorable exit from the business yourself. Should a partner refuse to come to the negotiating table, filing a lawsuit will compel his or her participation in the windup of the business relationship whether he or she wants to or not. The law recognizes a number of potential claims aimed at resolving disputes between former business partners, including:
- Breach of Contract: A contract is breached when a party that is bound by its provision to perform a duty declines or fails to do so without legal excuse and through no fault of the opposite party.
- Breach of Fiduciary Duty: A fiduciary duty is an obligation to act in the best interest of another party (business partner) and is breached when the partner acts in any manner contrary to the interests of the company or for his own benefit.
- Tortious Deprivation of Corporate Interest: All too often, business ownership interests are not properly documented. While this makes the ownership interest harder to prove, it does not deny its existence. When one partner takes steps to deny another owner the benefits of ownership, they may be liable for tortuous deprivation of corporate interest.
- Usurpation of Corporate Opportunity: A corporate opportunity is a business opportunity that a corporation is financially able to undertake, in the same line of business as the company, provides a practical advantage to the partnership and is in an area where the corporation has an interest. It is usurped when current or former officers exploit for their own interest opportunities that came to their attention during their tenure with the corporation. It can also be usurped if a partner engages in a line of business on their own that could have been pursued by the company.
- Tortious Interference with Contractual and/or Prospective Business Relations: A contract or business relationship is tortuously interfered with when a contract or beneficial relationship is unfairly interfered with by an outside contractual relationship, a third party or a breach of contract.
- Declaratory Judgment: A ruling by the court on the legality and impact of anticipated actions or inactions. It is often used for ownership and management rights disputes and disagreements regarding non-competes and non-solicit agreements.
- Judicial Dissolution: If partners become so deadlocked in decisions about the operations and direction of the company that the business can no longer function, the courts can appoint a receiver to marshal and sell the company assets.
While the courtroom is not an ideal place to terminate a business relationship, it has the advantage of being the one compulsory forum in which your adversary’s consent is not required.
It pays to have the proper conversations, checks and documents prepared on the front end, so none of these claims come into play at the end. The old saying, “an ounce of prevention is worth a pound of cure,” really rings true here, and we recommend you get the legal advice and assistance you need to ensure your business partnership starts on the right foot and is established in a way that will allow you to pursue and reach your long-term personal and financial goals.
[1] Kauffman Index of Entrepreneurial Activity.
[2] When we use the term “partnership” in this article, we do not use it in the legal sense, but rather as a term to describe the relationship among entrepreneurs starting a business, regardless of their choice of entity.
Healthy business relationships are an essential component of business success. When disputes cause business relationships to sour, declining productivity and revenues are sure to follow. Bill works with business owners to bring successful and efficient resolution to a wide variety.
