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best practices: Breaking Up With Your Business Partner

best practices

Breaking Up With Your Business Partner

SmartMoney.com

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February 9, 2006
By Colleen DeBaise
QUESTION: I started a business four years ago with a partner. We have a 50/50 sharing of income and responsibilities. But my partner hasn't been holding up his end of the deal, and there has now been a serious breach of trust. How can I go about renegotiating the terms of the partnership to better suit the situation as it has evolved? Ultimately I want to make another person involved in the business a partner.
— Anonymous
 

ANSWER: For better or for worse, you chose to go into business with your partner — and breaking up won't be easy to do. In fact, disputes between partners often lead to a devastating consequence: the dissolution of the business.

You really have to think of your partner as a spouse of sorts. Chances are, you started this business relationship with a lot of passion and enthusiasm. "A partnership is like a marriage, without sex," says Denis Clifford, author of "The Partnership Book." "It's a really trusting, intimate relationship."

But what to do when the early warm feelings have been replaced with disappointment and frustration is another story. Hopefully, in the early days of your business life together, you crafted a written partnership agreement. That's the perfect time to do so, "when everyone has the best of intentions, and everyone still loves each other," says Michael Doherty, of Doherty & Associates, a San Francisco firm that advises start-ups.

Much like a prenuptial agreement, a partnership agreement should spell out who brings what to the relationship, such as cash and property, and what happens if either partner wants out, stops performing, dies or becomes disabled. The options — such as a buyout or sale of a partner's interest — should be outlined in a buy-sell clause or, if complex, in a separate document. It's best to seek a lawyer's advice when crafting a partnership, and also when things go sour.

So the first step, given your relationship troubles, is to check the terms of your partnership agreement. Even if you haven't drafted an agreement, there are options (below) to consider. If a calm, rational discussion with your partner doesn't seem possible, consider using a mediator or a business coach.

And, just like in love, try to avoid legal action as much as possible. Lawsuits are costly, time-consuming, and likely to lead to what you're ultimately trying to avoid: the collapse of the business.

The options:

  • A change in the compensation structure. Profits don't have to be shared 50/50. If you feel like your partner is no longer contributing adequately, suggest that each new job or contract or whatever generates revenue be split according to the percentage of work each partner puts into it. Typically, small businesses don't have a ton of equity; it's the work that brings in money. Of course, this suggestion might not fly if the relationship has already deteriorated. "It depends on how unhappy everyone is with one another," says Doherty.
  • A buyout. Offer to pay your partner a fair sum to walk away from the business you two created together. Needless to say, you and your soon-to-be-ex-partner may not agree on price. Standard methods to value a business include an assessment of tangible property, liquid assets, accounts receivable, and any "goodwill" the company has earned, such as a well-respected name. An independent appraiser can help determine the value. Your lawyer can help you mediate arguments over trade secrets or intellectual property.
  • A transfer of interest to a new partner. Depending on your powers of persuasion, you may be able to talk your underperforming partner into selling his interest to the third person you have in mind. There's incentive for all involved. Generally speaking, it's tough to sell an ownership interest in a small business. By matching your partner with a buyer, you're creating a palatable situation, especially if your partner is as unhappy as you are. If your third person wants to buy it, then you're not out any money. Just make sure you draft a partnership agreement with the new person, outlining what to do when things go wrong. (Most agreements, incidentally, contain a right-of-first-refusal clause, so that a departing partner can't transfer interest to a person you dislike.)
  • Sell or liquidate the business, and split the proceeds. Partners who aren't a match made in heaven typically are forced to dissolve the business when they can't agree on anything. "It really is like trying to put Humpty Dumpty back together, once things fall apart," Clifford says. Sure, you'll be bitter and hurt for a while. But the bad experience can help you form a great partnership down the road — or at least a sole proprietorship.