PARTNERSHIP CHALLENGES

By SCOTT FLEGAL, Flegal Law Office , PA

One of the most challenging aspects for lawyers who work with start-up businesses involves dealing with partnership issues. Whether a new venture is structured as a corporation, a limited liability company or as a proprietorship, the presence of more than one owner significantly complicates the enterprise.

In many instances, parties embarking on a new venture have not identified partnership issues as a cause for concern. Their focus is understandably on the business at hand. Their relationship is in the honeymoon phase. Few entrepreneurs are inclined to envision divorce scenarios on their wedding night.

In many instances, it is the company lawyer who is charged with the task of getting the business owners to think about partnership issues. The conversation is not always pleasant. Almost invariably, for instance, when I ask two people starting a business how they intend to allocate the ownership, the answer is "50--50. We're equal partners in this." That's my cue to deliver the standard lecture.

"Doesn't somebody want to be the boss? A 50-50 ownership allocation is a formula for deadlock. Deadlock, in New Hampshire and in most jurisdictions, is an affliction for the business for which there is no palatable cure. Ultimately, dissolution of the venture - perhaps even court ordered - is likely to occur. So, please consider an alternative ownership allocation that will avoid deadlock, and save yourselves and the company from this agony….." Generally, it takes the parties at least five or ten seconds to ignore this plea and inform me that they intend to move forward as equal partners.

If the business founders are not yet convinced that their lawyer is the purveyor of nothing other than doom and gloom, they usually arrive at that conclusion once the issue of owner agreements is raised. A written agreement between the owners of a business as to management of the business and control over the ownership interests is essential. It's also just about the last thing new partners want to consider. Again, their focus is on future success, not partnership failure.

Unfortunately, however, partnerships fail for any number of reasons. Not all of these reasons are even within the control of the individuals. I have seen more than one partnership fail, for instance, due to health problems suffered by one partner. A physical (or psychological) ailment that renders one partner incapable of devoting the necessary hours to the enterprise poses a huge challenge for the business. Similarly, a partner with a sick child, or sick spouse, may not be able to meet the expectations of the other partner. The death of a partner, needless to say, would have an enormous impact on the remaining partner and the business. A good ownership agreement can provide the partners with a mechanism for at least resolving these problems should they occur. Whether the business survives such an occurrence, of course, is an entirely different matter.

Sometimes partners in a business just don't want to work anymore. If one partner wants out, how will he or she be compensated for their interest in the business? Is the partner leaving to open a competing business across the street? Or is he or she relocating due to the transfer of his or her spouse? Again, an ownership agreement permits the partners to plan for these contingencies before they occur. Different valuation and payment mechanisms can be put in place to account for the differing circumstances of departure.

It has often been said that a business partnership is quite similar to a marriage. In many respects, the ownership agreement is analagous to the pre-nuptial agreements often signed by couples prior to marriage. Unfortunately, in each instance the agreements represent the best the parties can do in a disaster scenario. Each document begs the question: what can the parties do to insure that the partnership, or marriage, survives?

As in a marriage, communication is the key. Have the partners openly discussed their own expectations? How much time will each commit to the business? How will the partners balance work and family commitments? If the partners are at different stages of their lives, how will the partnership be impacted? How will compensation be determined? Are there philosophical differences or simply differences in personality that could surface as challenges to the partnership?

In many instances, for business partners the foregoing questions fall in the "personal" category. Business partners too often make the mistake of assuming that there is a line between "business" and "personal", and fail to address personal issues at the outset of the venture. Entrepreneurs are often loathe to discuss "feelings", and yet it is the failure to take feelings into account often provides the greatest partnership challenge.