One of my long-time clients sold one of his businesses to two gentlemen: one, a family member who was to run the operations side, and the other, a fellow who was very capable of running the office side.
Yet, even though I insisted that these two guys work out a partnership agreement between them, they signed the purchase deal without one. They were so anxious to get the purchase agreement signed that they were not to be deterred, so I knew that day was not to be celebrated as an end to a long process of negotiation, but rather would be the beginning of a long and painful process of arguments and legal actions for both the partners and the seller of the business … and so it has been.
The most common partnership efforts I have encountered are between two best friends. Best friends often go into business together because they are best friends, not because their skill sets complement one another. Besties believe they can work out anything that comes along. It turns out that this is rarely the case because situations change as we age. Partners get married, which easily modifies the dynamic of a friendship. A myriad of other influences change as we get older that can likewise stress a solid friendship.
Rarely have I seen partnerships work at all. There have been rare cases where they work, yes, but I must say that, by the time partners have invited me in to assess the situation, only about 5 percent of the partnerships are ultimately salvageable. By that time, the disagreements have become too great and the hurt too deep to repair.
Partnership or Marriage?
What partners often fail to realize is that they are, in effect, getting married to each other. Let’s explore this analogy a bit further. Couples who wish to have a successful marriage for the long haul generally do so after a long courtship and much discussion about all the facets of carrying on as one. Before they actually step in front of the minister, they have fretted over it, tried to think of every aspect that might go right or wrong, discussed money, logistics, home styles, children … everything. Yet, people often jump into business partnerships with reckless abandon.
Of all the factors that apply to a marriage, the two that tend to contribute the most to divorce statistics are disagreements about money and jealousy. If we boil down the reasons that most people go into business, the two that top the list are money and power. And what two factors are most apt to contribute to jealousy? Money and power.
In other words, the most difficult aspects of marriage are the driving forces behind business, and the other, positive aspects of a marriage, don’t even apply. So, one would think that going into a business relationship should be considered even more carefully than if one were thinking about marriage.
Many prospective marriage mates have adopted the concept of a prenuptial agreement to protect assets or attempt to influence behavior. For instance, the prenup might say that the marriage must be exclusive and that the money of the marriage would be combined with certain guidelines about spending behavior. The prenup agreement might suggest that violations of these agreements would permanently damage the relationship; therefore, divorce would be warranted.
It would be further spelled out that the consequences of cheating or spending recklessly would cause the offender to be less eligible for support or a split of the assets as a result of the divorce. Knowing and agreeing to these consequences up front works to ensure the preservation of the relationship and the assets of the marriage.
All too often, business partners agree that one will run the office while the other runs the operation. This happens often because one partner doesn’t want anything to do with the money end of the business. In this case, without performance measures and a strong reporting mechanism, the opportunity for theft and cost overruns is enormous.
For instance, while the operations partner is happily delivering products to customers, the partner who runs the office may be fixing up the office, taking customers to lunches, and going golfing with them … generally doing what he believes a president ought to be doing. Soon come the cash-flow problems. Vendors and employees aren’t getting paid, and the operation begins to falter. The business manager blames the operations manager for not producing enough, and the operations manager blames the business manager for spending too much money unnecessarily.
On the other hand, the business manager could be very tight with money while the operations manager runs an inefficient operation and begins to blame the business manager for mis-handling the money because he believes that the operation is running just as it should be. Without performance measures and a strong reporting mechanism, this partnership will crumble as well.
In other cases, each partner believes they are responsible for the same things, like handling the money or managing the people. That will not only cause conflict, but it will also open the door for some other very important jobs to remain undone. Rarely do folks who come from the operations side of a business understand that management of a business is more than the production of product. They tend to overlook the myriad insurance policies that must be compared and purchased, or the intricacies of the accounting, or the deadlines of employment tax collection and payments.
In another instance, each partner may try to run the office while the operation crumbles for lack of attention. The business dies because of poor quality, late shipments, and cost overruns … as does the once-strong friendship. Who is to blame?
You must have a bookkeeper who understands accounting doing the posting to your accounting system. Within that system, you should have some sort of job- or product-costing in place for your business. Without these in place, I’d suggest that your failure as a partnership and as a business is inevitable, regardless of who does what.
The bookkeeper should have the month-end figures reconciled and completed by the second week of the following month. You and your partner should review the results of the indices for which each person is responsible. For instance, the partners should be able to review all of the figures, compare them to the budget, look at the details of figures that have significant variances from the budget, and discover the reason for the over- or under-runs.
This creates an amazing focus on the score, without which you will not survive. It keeps all parties honest, and promotes teamwork rather than suspicion and jealousy.
Measures of Performance
Once you understand the reporting mechanisms that you want to put into place, it is easy to include measures of performance on your job descriptions. For the operations manager, some performance measures might be to ship enough product to meet the budget sales figures and do it at the cost of goods sold (COGS) percentages suggested in the budget. If your budget is flawed, the reporting mechanism will bring that to light in no time, allowing time for a new budget to be agreed upon while there is still time to make adjustments. On the other hand, if the budget is correct and inefficiencies are highlighted, there will be pressure to get costs under control before significant damage is done.
Similarly, the business manager’s performance indices may include Average Days Receivable (ADR) and Payable (ADP). I explain these two indices in detail in the Profit Power Series. This measure will highlight the cash situation of the company. If the company begins to run out of cash, it could be that decisions made by the business manager are eroding the company’s ability to pay its bills.
For instance, if the business manager does not like to collect receivables, the business will begin to falter because small customers tend to pay only those vendors who actively collect. If the performance measure suggests an ADR of 50 or less, he will be encouraged to find a way to keep that index in line and, therefore, keep the cash of the business flowing.
Why would he be so encouraged? Because the consequences of not meeting his performance indices are spelled out in the pre-partnership agreement along with the other indices which he must monitor and maintain.
I strongly recommend that you work out your pre-partnership, or ‘divorce’, agreement before you become partners. Use separate personal attorneys to write this agreement. If you use the same attorney that you plan to use for your business, when the time comes, he or she will have a conflict of interest in the dissolution of your partnership, whether it be a buyout or a divorce.
The business divorce agreement should include fairly detailed job descriptions … including what each partner is responsible for in the partnership, measures of performance for those responsibilities, how often you will meet to go over the sales and budget figures, how and when you will determine and pay dividends from the profits, and how much each partner will be paid for the job they will perform. It should also include the consequences of violations to those agreements in terms that would hurt enough to influence behavior toward ensuring the continuity of the business and your partnership.
Consequences
What is a consequence that would cause a manager, or an employee for that matter, to work diligently toward a certain score?
Let me ask you this. Why do people stop at stop lights? Most people tend to answer, “Because if you don’t, you’ll get a ticket.” Do you get a ticket if you exceed the speed limit? “Yes.” Do you speed? I usually hear a more subdued “yes”. Now, tell me, why do people stop at stop lights? “Because they might die.”
Consequences have to be something that either affects people’s bank accounts, their standing, or their livelihood. In other words, something significant. In the ‘divorce’ section of your partnership agreement, you must define what happens if each partner does NOT perform as you both expect. The performance measures must be reasonable, and the consequences must be clear.
For instance, if the business manager does not like to collect payments and, therefore, won’t do it, then the business is in danger. Therefore, the consequence of that inaction should be substantial. After all, he signed up for the job description, for the score, and for the consequence before you even went into business together, right? He must be encouraged, by the threat of consequences, to ‘manage’ his weakness by, perhaps, hiring a bookkeeper who loves to do collections or by changing your terms from 30 days to half down, half on delivery. But be careful not to shoot yourselves in the foot by implementing something that might negatively affect another index, like sales, for instance.
The operations manager whose materials costs are out of control may be encouraged to work to identify which operation is causing the most rework and initiate more training or the purchase of better-quality materials. If the requirements are not met or are changed by consensus in a reasonable amount of time (defined in the agreement), the partner or manager, might be subject to the consequences recommended in the partnership agreement.
The point is that, without consequences, there may be no incentive to ‘color within the lines’. Overhead costs should be handled the same way. Spending on entertainment that, in the opinion of one partner, is excessive, will also show up in the reporting mechanism, and the consequences spelled out in the partnership agreement will encourage the business manager to control his spending.
So, the partnership agreement must define performance expectations (indices) and the repercussions if each partner does not perform as expected. How does one partner get out of the agreement if the other is not performing? How does one partner relieve the other of his job? Does relieving one partner of his job allow for him to keep his shares? How will a partner be paid for his shares should he be relieved of his job and want to sell his shares? Can he keep his shares? Can he sell his shares to someone else?
This list may sound a little morbid, as most prospective partners I know tell me that they will “never have any disagreements like that”. But the fact is that things will change, and I guarantee you that you and your partner will have disagreements. The proof? People who get married tend to do so because they think their relationship will be able to last forever. But folks get divorced at an alarming rate in this country … and the rate of small business bankruptcy filings is much higher.
So, take at least a couple of weeks and think of all the things that might go wrong and what you might or might not be willing to accept if they do. Then, sit down with separate attorneys … SEPARATE attorneys … and write up the partnership dissolution agreement before you ever begin the process of buying or starting a business with a partner. Your business, your partner, and your families will thank you.
So, What Happened to the Clients I Mentioned at the Beginning?
This is an example of everything that could go wrong did go wrong. The business manager fired his partner, the operations manager, for failure to perform his duties. In this case, there were job descriptions, but because there was no partnership agreement, the operations manager didn’t feel that the job description he was given was what he was actually expected to do. Therefore, the other partner, who needed that job done, fired him.
The operations manager then sued his partner and the corporation. Now, they won’t, and can’t, speak to each other. Because there is a lawsuit pending against the company, the business manager wasn’t able to get a loan to pay off the balloon payment that was due to the seller. So, the company went into default on the original loan, and the business manager was unable to find a suitable replacement to run the operations side of the business.
Because the partners used a single attorney to negotiate the purchase, neither partner could use that attorney when the breakup occurred. So, new attorneys who were not party to the original negotiations had to be brought up to speed to defend their respective parties. The client who sold the business used an attorney who could not defend him in the state in which the purchase occurred, so he too had to hire and bring up to speed a new attorney.
The former owner had sufficient fears about the ability of the operation to continue to produce at a rate which would allow for payment of the purchase note, and with the company in default, he took it back and had to begin the sales process all over again. For lack of a partnership agreement, everyone was back to square one … or worse.
Forty-five employees were concerned, and rightly so, about whether their jobs were secure since the former owner reclaimed the business but without an operations manager.
Don’t make the same mistake. Always have a partnership agreement, and in it, focus on what can go wrong, not just how you will behave if everything goes as you expect because I guarantee that it won’t.
© Business is Booming! 2021