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Staying off the road to a nasty business divorce

Staying off the road to a nasty business divorce

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You’re best of friends. You play golf together. Your families go on vacation together. Why wouldn’t you make good business partners?

The hard truth is that friendships can be lost in entrepreneurial ventures and businesses destroyed. A business isn’t a friendship. It’s not a marriage. It’s a profit-making venture, hopefully a successful one.

When it isn’t, many times the failure can be tied to the delusion that equality among friends is a good way to run a business.

We counsel our business clients that the road to a nasty business divorce begins with the dreaded words, “We’re friends, we have a great business idea and want the company to be a 50-50 partnership.” No matter how close budding entrepreneurs are, someone has to be the boss.

Both professionals and blue-collar founders tend to fall into the “best buddies” trap, thinking there will never be a dispute they cannot resolve between themselves. Inevitably, though, an irritant surfaces. One partner doesn’t appear to work as hard as the other. A relative or friend is hired without the other partner knowing. Unspoken differences about profits get exposed. The friendship and partnership spirals downward toward a nasty business divorce.

The ruin of a business and lifetime friendships through unpleasant litigation can be avoided if partners come to a sensible agreement very early on leadership, goals, policies and exit strategy. Consider the following.

Establish a realistic expectation of roles. The basic business model is finders, minders and grinders. Someone has to prospect for new business, someone has to mind the service to customer, and someone has to do the work for which the company was hired.

There are talented individuals who can do all three, but most are really proficient at one, maybe two of the tasks. In its very simplest form, entrepreneurs need to figure out who is going to be responsible for the storefront and who runs the back room.

Stick to core skills. Decide what your product or service is going to be and make sure everyone stays on task. Even with appropriate “role definition,” each party should stay informed of what the other participants are doing to achieve corporate goals.

Understand the fiduciary duty. Being partners or co-owners of a small business means you have a special relationship of trust, one that has serious legal consequences. The assets and opportunities that arise are those of the companies, not the individuals. A partner in an IT business cannot be using its resources and contacts to start up a sideline web design business that benefits only the initiator of the new business line.

Stay informed on finances. You may not be the “money” person, but make sure all the principals are involved in quarterly reviews on the financial end of the business. Not tracking unauthorized or inappropriate expenditures early-on dooms many start-ups.

Trust, but verify. Have an accountant check the books and inventory at least once a year. This seems fairly obvious, but many times a “trusted” partner with a financial background is given this duty. It is an expense, but a necessary one for everyone’s benefit, including the bookkeeper.

Establish the rules of the business. Adopt an operating agreement or shareholders agreement for the company. Too often this aspect of a business start-up gets ignored. Business partners will assume they understand and agree on the basic terms of their business arrangement. However, without a written agreement documenting the arrangement, many more problems can arise in the event of a disagreement.

A business venture necessarily begins with high expectations of success. However, entrepreneurs must consider all possibilities:

• Besides your operating or shareholders agreement, the next document on the start-up list should be a buy-sell agreement that incorporates the agreed valuation method for the company. This is important in the event of a transfer of an owner’s company interest by sale or by death. Don’t wait until there is a problem. Work with your accountant to come up with an agreed method to value the business at any time. This is especially important for small, closely-held companies because there is no open market for its shares.

• Give careful consideration to what happens in the event of a partner’s death. You may be happy being in business with your partner, but do you want to be in business with your partner’s spouse or kids if he or she is no longer around?

• Have a limited non-compete/non-solicitation agreement in place. If a partner departs, you don’t want to pay him off only to have him set up a competing shop next door. These agreements protect the good name and sweat equity built up over the years. However, they cannot bar someone from working indefinitely as a competitor and typically last less than a year.

Even if business owners manage to follow all of the above guidelines, they ultimately have to face perhaps the most difficult and potentially fatal decision in the life of a company -- succession planning.

Answers are needed to vital questions, such as, “Who can do the job?” “Who do I want to take over?” “Do they want to take over?” “Who can continue the company in the way I want it to?” Sitting down and mapping out succession planning with your partners and business advisors periodically throughout the lifetime of your company is essential to generational success.

You may also consider incorporating your business plan into your own estate plan, which can be an important element for the future of the business.

Hopefully, your friendship will be mirrored in your business success for many years. However, believing that friendship will “carry the day” on a business break-up is foolish. Unchecked business divorces can be brutal, nasty and lead to the destruction of everything you have built and eventual financial ruin for all involved. Investing in the prenuptial groundwork is essential, even among the best of friends.

DON SCHOEMAKER is an officer in the litigation practice group of the law firm Greensfelder, Hemker & Gale, P.C. in Belleville.

GARRETT REUTER JR. is an associate in the firm's trusts and estates practice group. 


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