Q: When a small company has opportunity for growth, but lacks funding and/or manpower, some owners consider taking on a partner or two. What are the pros and cons of this? If someone decides to bring in a partner and give an ownership stake, what are some guidelines for success? And what happens if things go bad?
A: A business partnership is a deeply personal thing. In some ways, it can be like a marriage. Such a relationship should not be entered into lightly. However, there may be some good reasons to bring in a partner:
Capital contribution – Taking on a partner who can make a cash contribution may make sense if the owner needs capital to grow the enterprise or wishes to take money out of the business.
Additional skills – The founder may decide to use an ownership stake to attract a qualified person with skills essential to the business.
Alignment of interests – Stock ownership can motivate employees and align their interests with the founder.
Compatible business – An entrepreneur may decide that the value of his or her business will be enhanced by merging with another enterprise. The synergy may be created by an addition to the product or service offerings, a geographic expansion, forward or backward integration, economies of scale, or the elimination of a competitor. Regardless of the rationale for the partnership, there are some important tips to keep in mind.
Maintain a controlling interest – If possible, we advise founders to maintain a controlling interest in their business. If this is lost, the fate of the business and potentially that of the owner himself or herself rests in the hands of others. If it is not possible to maintain control, negotiate a generous exit package so you will be fairly rewarded for your work if the time comes when you are asked to leave the company.
Avoid a stalemate – A 50/50 partnership arrangement can be as bad as losing control. When marriages break up, they can often turn vicious — sadly, we’ve all seen it. When a business partnership goes wrong, the result can be the same. If a stalemate occurs, the business can die while partners fight. We advise having a tiebreaker. For example, a 49/49/2 split would avoid the dysfunction of a stalemate.
Be fair to minority shareholders – In a privately-held company, minority shareholders can invest money or sweat equity in a business and see no return while the controlling partner gets rich. For example, the majority shareholder can pull money out of the business by increasing his or her salary, while never declaring a dividend that would be shared with minority investors. The interests of minority shareholders can be protected with fair contracts, but they have to be negotiated. Don’t count on the goodwill of others to protect you.
Have an exit strategy – When taking on a business partner, a good prenuptial agreement is critical. Anticipate the business unwinding before it does. Consider all of the possibilities. What happens if a partner needs to cash out, dies or becomes incapacitated? What happens if irreconcilable differences arise between shareholders? It’s much easier to negotiate an equitable arrangement before heated emotions take over. Under certain circumstances taking on a business partner can make sense, but there are many dangers. The tips above can help you avoid many of the potential traps.