Tuesday, May 07, 2013

Why You Should NEVER Have a Business Partner

Story 1

Guy I know decides he's going to buy out an old sandwich shop and run it for his retirement plan.  He has enough money, but not enough time to manage it.  He finds an old buddy from his high school days to manage the shop.  Sure enough after mortgaging his house to the tune of $300,000, he finds out his business partner is not managing the shop effectively, they're losing money, and they guy is handing out free food to friends, almost to the point of embezzlement.  He has to take out another $150,000 from his house to buy his partner out and now manage the firm on his own which he has not the time to do.

He is depressed.  He is miserable.  He has wasted the past decade of his life and with nothing to show for it.

Story 2

Another guy I know decides to start a business with a friend.  There is are barely any real start up costs, but some and since both are young, these start up costs are significant and thusly shared 50/50.  After depleting what little savings they have, one of the partners decides he wants out and demands he get his capital back.  The guy I know has to borrow money from his father to buy the guy out, and once again, now has to manage the firm (which the other guy wasn't really doing anyway).

Story 3

A good friend of mine went and worked for this older fellow who was planning on retiring and needed somebody to take over his business.  He agreed to train my friend in and invariably give him the company for all the labor and sweat equity my friend put into learning the ropes.  My friend received a minimal wage and upon taking over the company would have to pay out 33% of the profits, but be able to keep 67% of the profits for himself until the guy inevitably died.

Unfortunately, the old man had some health problems and completely cashed out his company dishonoring this agreement he and my friend had.  My friend only managed to get a minimum wage as he no longer wished to take over an insolvent company whose accounts and assets had been raided.

I could go on, but there is no limit to the number of stories where a partnership was started, one of the partners was a loser, and the whole business went down the toilet because of it.  However, it is not so much the entertainment value of such stories that is important, as much as it is the financial lesson everyone should glean from it -




going into business with a partner.

Let me explain why.

If I were to estimate the number of partnership that failed based on my experiences in banking, I would say about 80-85% of them failed.  And they




failed because ONE partner was a loser and didn't carry his weight.

The reason such a high percentage of partnerships have this "loser partner" is because of the binary nature of partnerships.  Losers, by definition, cannot support themselves financially and are always on the cusp of insolvency.  Because of this they are constantly coming up with scams.  It is important to note the difference between a "scam" and a legitimate business idea as one could claim any loser like myself who can't hold down permanent slavery employment would be a scammer.  However, business ideas MAKE MONEY, the purpose or aim of the scammer/loser partner is to merely access somebody else's capital so they can live another year or two without having to work.  i.e.-they have no INTENTION of making money, they merely (like Solyndra) need somebody else's capital to finance their "business idea."

This brings in the nature of the second partner - the capital provider.

With the smooth-talking sales guy, looking for a sucker to finance his "idea" they naturally seek out friends, even old long lost acquaintances to finance their scam.  These capital providers usually are normal, hard working people who have saved up their pennies and dimes and are looking for a better rate of return than what they're getting on their savings account or 401k.  Sure enough they are sold on the idea, cash in their retirement account or the equity in their home and are now financing a sports bar with the "idea guy" running it into the ground and drinking the inventory on the side.

Again, 80-85% of the partnerships I saw had this binary relationship.

The irony, of course, is that this means the majority of partnerships should never have been partnerships in the first place.  They should have been sole-proprietors.  Not just because you would be jettisoning the loser partner, but out of all the partnerships I've seen 100% of them were not big enough to warrant two people to start them, either for capital or labor.  The other person was just completely unnecessary and was extra baggage, if not a risk.  Additionally, there is ALWAYS a leadership battle when the ownership of the company is 50/50.  It is the WORST of all situations in that the largest single advantage a small company has is that decisions can be made QUICKLY and thus outmaneuver their competitors.  I've seen more energy spent bickering over business decisions between two equal shareholders than energy put into managing the business.

The REAL reason people go into partnerships is psychological.  Namely they're scared and daunted by the task of embarking on a business venture and thus the perceived risk-sharing seems appetizing.  Also, a lot of people are bored and would like somebody to manage the company with.  Many friends have become enemies because while they made great friends, they made horrible business partners.  The larger point though is that starting a business is not a "fun" thing to do and your psychology should play no role in a financial decision.  Additionally, if you do have a genuine business idea, then the last thing you would want to do is SPLIT THE PROFITS WITH OTHER SHAREHOLDERS.  Again, it is a FINANCIAL decision.

Now, the reason I bring all of this up is because I know my readership.  I know my lieutenants, economists and Cappy Cappites and I know many of you are of the pro-capitalist, unemployable, self-employment types. And because of this you will likely be offered the opportunity to engage in or start a business with another person. 


Unless the company REALLY needs two people's labor or two people's capital, it's best that it is started, managed and owned by ONE person, be it you or the other guy.  The risks of having your savings plundered by some scam artist, not to mention your profits halved should the business prove successful, is just not worth it.


Cogitans Iuvenis said...

I usually hate suggesting lawyers, but in the case of creating a business where there is more than one stakeholder that is what you have to do. Anyone who is serious about runnign a business will agree to have a lawyer write up a business contract. Anyone who objects to doing so is giving you a huge red flag. I wonder if some of your friends entered the arangement on a 'gentlemans' agreement?

Anonymous said...

"partnership" ie LLP/LLC can work if everyone has enough skin in the game. If you are the capital provider you should have 67-80% of the equity plus control plus make the other guy put some real money in. Also have an exit strategy for scenario 2. I have used "fine we're losing money now just sign over your share" and "you price it and I get to choose whether you buy me out at that price or I buy you out. Starting and running a business is hard. As I tell my equity partners "our business motto is March or Die". Also the new secondary motto when they whine about regulations/government/taxes is "Enjoy the decline".

atahualpa said...

Good post. Totally agree, conforms 100% with my experience. Am currently in a partnership now, but that is because the other guy is more senior than I, has more contacts with potential clients and investors. I keep thinking that if I were he, I wouldn't be partners with me, I would keep sole proprietorship. He does need my investment of labor, though.

And he's smart enough to have kept 2/3 control of the company, which in practice (other than the distribution of the profits) means that he gets to call all of the shots.

The only weakness in this arrangement is that I could take advantage by not doing my work and still taking my cut of the profits, but if I didn't do my part there would be no profits. So not really a weakness at this stage of things.

Anonymous said...

I would say, never attempt partnerships with friends.

With people you know and respect, and can evaluate more or less objectively, it can work.

Leif said...

As a number of other folks here have already said, a good lawyer can anticipate and mitigate most of the problems of a partnership. The fact is that one person seldom has all of the skills, and a partner is often a welcome addition. The trick, therefore, is (get a good lawyer to draw upon the agreement, and (b) realistically appraise the respective skill sets each partner brings to the table, and plan accordingly.

LordSomber said...

As they say, friends should not become business partners, although friendships can grow out of partnerships.

Dry end of the Titanic said...

While I agree with your basic premis and have seen the scenario you describe many times, my one experience in a 50/50 partnership actually worked out quite well. The company ran for seven years and when the financial crisis hit five years ago, we both agreed to end the partnership due to lack of new business to sustain it. We closed the office, let go the remaining staff (and paid them all statutary severence) and still managed to walk away with a decent nest egg each. We remain friends. I guess we must be in the 10-15% you described above. That said, you are still correct in your general idea, I have seen far more partnerships disolve in acrimony than friendship.

Dry end of the Titanic said...

While I agree with your basic premis and have seen the scenario you describe many times, my one experience in a 50/50 partnership actually worked out quite well. The company ran for seven years and when the financial crisis hit five years ago, we both agreed to end the partnership due to lack of new business to sustain it. We closed the office, let go the remaining staff (and paid them all statutary severence)and still managed to walk away with a decent nest egg each. We remain friends. I guess we must be in the 10-15% you described above. That said, you are still correct in your general idea, I have seen far more partnerships disolve in acrimony than friendship.

Anonymous said...

My grandfather ran a spice importing business when he was working and when he retired he wanted to handed it to his children, but given that neither of his daughters were interested he sold it off to a big company and made his retirement money that way.
He also maintained that he would never let the business get so big that he couldn't oversee every transaction himself because when you're dealing with foreign currencies and the mentalities of people from other countries, there's a risk you'll get cleaned out, even by your employees.
Similar message as your message about partners. If he'd allowed others to manage his company's deals he may not have had a company to sell when everything was done.

Alan Jackson said...

Well, business partnership have advantage and disadvantage and it is still up to you if you need a partner to run your business or you can do it by your own. And looking for a trusted and good business partner is really a hard challenge.

Karl said...


Partnerships that work are ones where each is issued 2% of the company rather than 50% at the start, and any new shares are earned with specific milestones that are agreed by all. If someone flakes, the pain in minimized.

Second - your advice is correct but runs counter to the investment priorities of angels, VCs. They want a team with each startup, and can't fathom a good idea that is backed by only one principle. One reason - granted, from an entrepreneur's perspective - is they can't fire a sole leader, or play partners off each other.

Could the Commie Obama hat have been designed better by a committee? I think not!

Unknown said...

Dunno, Brown and Root, Morrison Knudsen, Hewlett Packard did ok until successors messed stuff up. Maybe you heard of the little firm that Larry Page and Sergey Brin started. Ben Cohen and Jerry Greenfield? Gordon Moore and Bob Noyce took a flyer on integrated circuits and that worked out ok.

If you presume to give advice, don't base it on anecdotes from Minnesota losers.

Rumbear said...

I love partnerships....they are born to fail. Business contract? Pffft....I spent a year in law school learning how to make the perfect contract. Then you take an elective for a semester and learn how to tear it up. Made a good living since doing Business Litigation. Nice hourly work.

Stay frosty.

Doktor Bill said...

Holy Crap! LISTEN to this man, children! He knows of what he speaks. Said it better than I. If you have a business idea, and it is viable, Do It Yourself-it requires more hours/work, but it is Worth it.nothing will ruin a life-long friendship quicker than a business partnership. yup.Also: NEVER RENT TO A FRIEND. ever. Enjoy the Decline!

Anonymous said...

Spot on. A business can only succeed if ONE person is firmly in control and making decisions. Running a business by committee does not work.

Anonymous said...

Absolutely right. Dave Ramsey agrees. If you need help, own the business yourself and pay for the help you need.

Very difficult to fire a do-nothing partner.

RAJ said...

So true, but its weird the way i work, i read about all of the mistakes done and gone before me from great men that makes history, and yet i cant seem to learn from other peoples mistakes, i have to get burned myself only then do i actually learn it from it. I've just been burned by a friend, im glad i only trusted him with less than 10% of my wealth.