A cautionary tale about partnership from Richard Fox on the Kauffman eVenturing site is an absolute must read. Fox shares how he thought his legal background would protect him well as he created shareholder agreements, buy/sell agreements, voting trusts, special bylaws and articles of incorporation when he entered into a business partnership. But even he was surprised when a 50 percent partner tried to sell the company out from underneath him after his father’s funeral. To make matters worse the partner tried to sell the company to their number one competitor.
Fortunately for Fox he was able to ultimately sell the company for a handsome price because he continued to concentrate on building the business rather than retaliating against his partner. But it’s pretty clear Fox believes any business person should be extremely careful when taking on partner. He offers the following priceless advice (with my comments following):
- Know Your Existing Shareholders’ Rights. Shareholders of private companies—even minority shareholders—hold the same legal rights as shareholders of public companies. When you accept shareholders, you accept the same scrutiny that comes with being a public company without the benefits. Understand that you can never be adequately prepared for a shareholder who wants to maliciously assert their shareholder rights to cause you problems.
(Comment: In Iowa, all shareholders are entitled to the financial information of the company as well as copies of all corporate documents I strongly suggest you keep all copies of all important corporate documents and financial information routinely, not just when you need them. In particular make sure you have any documents that would evidence ownership rights. It is my experience that often one partner will have access to the corporate documentation while the other partner does not. Don’t let that happen to you).
- Avoid Taking on New "Legal" Shareholders. Entrepreneurs sometimes give ownership interests to key employees to allow them to share in the equity growth of the business. For the reason stated immediately above, you might consider offering "phantom stock," (read this article for more on phantom stocks) which carries all the economic benefits of common stock ownership without the potentially abusive rights of legal ownership. A lawyer should be able to advise you on the details.
(Comment: My experience with clients is that most employees really want to be paid more. I know entrepreneurs often want employees to feel as though they have a "piece of the action". But I also caution you to think twice about employee ownership).
- Take the high road. Rather than counter-suing the partner, Fox chose to put his energy into building the business. Not only was it good for the business, but it kept from muddying the waters any further and made a much needed ally out of the company’s other corporate director.
(Comment: This is very difficult to do is some situations. Sometimes you may have no alternative but to fight back. But I agree it is critical to continue growing the business).
- Be prepared for anything. Pushed to the edge, some people will fight back with extreme measures. Although secretly passing legislation is extreme, be prepared for the unexpected.
(Comment: I have learned this lesson the hard way myself with business partners in a few of my endeavors. Do everything you can to protect yourself. Start by knowing your rights and make sure to document, document, document. Adversity often brings out the worst in people but amazingly people also change with substantial success. Researchers have found the mere presence of money changes people. It is also a good idea to have a trusted confidant that can help you vet a potential partnership without emotion).
- Sell on your way up. Entrepreneurs are "hard-wired" to grow businesses. The idea of selling is usually a far-away concept that is considered, but knowing the best time to sell is not intuitive. Don’t wait until you can see the peak because chances are your buyers can see it too and will discount the price accordingly. Plan on a full year for the sale process to be completed; if you pull the trigger too late, you may miss.
(Comment: This is a tough one for most business people. You need to have a little luck on your side to sell at the right time. But it’s just like investing in the stock market. You will likely never sell at the peak so don’t be greedy. A business sale should be a win-win for the buyer and seller).
Overall, I just can’t stress enough the importance of carefully considering whether a business partnership is right for you. I often joke that it is not a matter of "if" but a matter of "when" the partnership will end. But this is one joke I don’t consider to be a laughing matter. Fox’s tale proves it.