Agreements up front can ease the pain of partnership breakups.
People go into business together every day, but the euphoria of taking an idea and turning it into something prosperous can wane over time—especially when partners stop getting along.
Sorting out troubles is much easier if there is a contract, or operating agreement, that spells out how the business works. Absent such a document, it gets dicey, and partners start enlisting attorneys to settle their grievances. Sometimes it works and the partners continue in business; other times the doors are closed or the business is sold.
Bailey Cavalieri attorney Jamie Ryan has seen his share of those clients through the years and sees similarities among business partners who abstain from pre-planning and go it alone, so to speak.
“Business people can conflate ownership issues,” he says. “They don't understand who is going to contribute what to the business and who is going to do the day-to-day work. Also, many business owners don't understand tax structure, while the notion of an LLC or S-Corp is often confusing to the uninitiated.”
One of his clients—we'll call him Partner B—was recruited by Partner A to invest in a 50-50 partnership to build and run a restaurant. They had no operating agreement.
Partner A owned the land for the restaurant through a separate company and asked Partner B to run it, even though the latter had no experience in restaurant management. The restaurant was a hit, but the partnership experienced a hiccup when the landlord—Partner A—decided to charge the business more rent.
Partner B thought it was unfair because, in essence, more money was leaving his pocket and headed into his partner's. Partner A countered by saying he took a risk on Partner B. That's when Partner B reached out to Ryan, who told him to pay the increase because the issue was never addressed contractually before the restaurant opened.
“The business is still running and it's still successful,” Ryan says. “But they still have that friction.”
Partnership disagreements are part of human existence. Couples fight. Athletes complain about playing time. Political parties don't play nice in Congress.
There's little data illustrating the number of small businesses that dissolve because of partner disagreements, but Ryan and others say there are a few common thorns that can poke the veil of mutual interest and ignite friction: expectations, money and personalities.
And whatever issues arise are magnified depending upon the number of partners or shareholders involved.
“It's all about the expectations,” says Rob Cohen, business litigator at Kegler Brown Hill + Ritter. “What I term as a business divorce, normally a smaller business with a few owners, the issues are more emotional and … you have strong personalities that you must deal with.”
As a litigator, Cohen says he gets cases at the end of the relationship when the animus among partners reaches the trial stage. “We see it more on the back end, but we could be more effective on the front end.”
In his autobiography, Random Reminiscences of Men and Events, oil tycoon John D. Rockefeller wrote that a friendship founded on business is a good deal better than a business founded on friendship. It's good advice and a cautionary tale for friends who go into business together convinced they'll remain friendly even if the venture goes south.
Behal Law Group founder Bob Behal says every partnership has a terminus shaped by success, failure or personalities. The US Small Business Administration estimates that two out of every three small businesses don't last beyond 10 years.
“As long as two people are in agreement, they can do anything,” Behal says. “But sometimes they fail to think through all the prep issues like death or dissolution of enterprise.”
How bad can it get? The lawyers say disagreements arise, generally, because partners think others are not working hard, because someone wants to leave and open a competing business, or because a shareholder feels his or her contributions are not respected.
Joe Patchen of Carlile Patchen & Murphy talks about two medical professionals who formed a limited liability company in the mid-2000s that didn't go as planned. The pair couldn't decide upon a leadership hierarchy, which is something Ohio's LLC guidelines strongly encourage, along with implementing operating agreements. “I think one of them was in love with the idea of fighting.”
This went on for a year as outside mediators were brought in with little success. Finally, Patchen's client sued to force the issue and won in court. The business was dissolved, and the client started the same type of practice with many of her former clients.
Even when a hierarchy is established, Behal says things won't always be peachy. Somebody at some point “has to cave in” for the company's sake. “It is impossible to agree with everything, and there will be issues that can mean a lot to the passive person,” he says.
Jim Meaney of the Zaino Law Group in Dublin says there's another reason for businesses to form an official entity and write an operating agreement. Without them, partners can find themselves liable for another's actions.
Hammering out the details should entail playing a game of what-ifs before the stress of running a company shades anyone's view, says John Lucas at Isaac Wiles.
“I see my role on the front end, addressing all of the what-ifs should something go wrong,” Lucas says. “What if one of the partners leaves or dies or life happens? I think it would be great if we can address all those what-ifs when everyone is happy and in agreement.”
Lawyers are the logical people to seek out when starting a business, but so are accountants, insurance representatives, family members and outside mediators. “Heck, even if it's a good bookkeeper for a really small business, it is something I think is critical,” Lucas says.
Accountants, for example, are essential to project a company's value should that become an issue with a partner's departure or death.
Behal and Meaney provide mediation services to businesses seeking to resolve their operating disagreements. Meaney terms some of those encounters as “come to Jesus meetings,” where the parties' eyes are opened to the possible upsides and downsides of their stances. Behal details the weaknesses for the parties with hopes to forge some type of an accord.
“If it looks like trouble is brewing, it's not a bad idea to mediate it,” Meaney says.
Partnerships often work out for all the right reasons. Bailey Cavalieri's Ryan says those companies and the partners in them appreciate each other's contributions. Role clarity is essential, he says. One partner might have great ideas and vision, but others help make them a reality.
There are no short cuts.
Several lawyers expressed disdain for companies that download incorporation forms and operating agreement from the internet.
“I think sensible people seek general counsel early on,” Patchen says. “But I think there's a larger population who believe they can learn everything from Google.”
Operating agreements are just a piece of paper. They don't guarantee everyone will follow them or even remember them until they need their protection. Meaney places a higher value on them and says shareholders should always remember that they have a fiduciary responsibility to treat each other fairly.
Remember Partner B, the restaurateur who enlisted Ryan during his dispute with Partner A? During those discussions, Ryan counseled that it's better for business owners to come in on the front end—before incorporating—to address potential pitfalls their partnerships can bring.
“Many of the people who come in to see me have been burned once before,” Ryan says. Partner B opened another business and sought Ryan's advice prior to incorporating.
Craig Lovelace is a freelance writer.