StartupEdge Minnesota Business Guide - Partnership and co-ownership information

Only you can answer this for yourself. Working alone is more tolerable to some than others. There is nothing in the literature of entrepreneurship that suggests partnering is better than not partnering, when it comes to starting a small business.

That said, businesses tend to do better when the people running them are experienced at management and in their particular industry. Of course, partnering is one way to harness that experience if you don't have it yourself.

Another advantage of co-owning a business is that you can share the burdens of financing and labor. You might even be able to go on vacation, which is a concept foreign to many new business owners who choose to go solo.

Like a good marriage, a synergy can arise that makes the partnership greater than the sum of the partners themselves. However, like divorce, tearing down a partnership is emotionally painful, time-consuming and, often, financially devastating. And, the divorce rate in business partnerships is a lot higher than for marriages.

Before entering into a co-ownership arrangement, it is important to be introspective about your reasons for doing so. Often people are of the mistaken belief that bringing in a co-owner to help with a failing business will somehow turn things around. If anything, it may make things deteriorate more rapidly. However, in some cases where the only thing holding a business back is the very thing a partner can bring to the table, co-ownership may turn a business around for the better.

In sum, the best reason for co-owning a business rather than owning it individually is to supplement the talent, money, time and experience that you bring to the table individually.

What problems can arise with having a partner?

Much can go wrong when you bring in a co-owner to your business.

Disputes about money; how to spend it, when to save & how much to save.
Disagreements over fundamental decisions that need to be made to keep the business operating efficiently.
Disputes about work ethic; how hard to work; when to take vacations; how long of vacations are acceptable; whether other work is frowned upon
Division of power and authority that's perceived as unfair
An unplanned death of a co-owner that leaving power in the business to a widow or widower.
Relocation or disability that leaves one co-owner doing all the work.
Dissatisfaction with performance of a co-owner
Seizure of ownership over a co-owner's stock or membership interest in a business by that person's individual creditors.

To mitigate the effects of these dramatic life events, co-owners should have an attorney draft a buy-sell agreement that spells out when and how ownership interests will transfer when there is such an event. These agreements will typically address what events should trigger a buy-out, how much the seller should get paid for their shares, etc. Add-on provisions for controlling voting rights, deciding on procedures for handling deadlock, or assuring a clear division of authority and labor can also be invaluable.

How does one owner buy out another?

There are no hard and fast rules for how this happens. One thing for certain is that any kind of buyout is going to be made smoother, and will probably less expensive to execute, if the partners already have a carefully considered buy-sell agreement prior to any problems arising.

If no buy-sell agreement exists, and if partners are not getting along well, the partner who wants to be bought out will typically have to either take a ridiculously low payment to sell his/her business interests, or he/she can try to get a court involved. But, because litigating a partnership valuation is costly, most small business owners find it more cost effective to accept the ridiculously low offer and walk away.

For co-owners who want to deal with each other fairly, there are several methods for valuing the business. A valuation specialist should be sought. Once a price is set, the purchase of a co-owners interest happens much like the purchase of any existing business; typically through the transfer of shares or membership interests in exchange for immediate payment funded through lenders or other investors. In the case of death or disability, an insurance policy might be available to fund some or all of the buyout price.

It is important to seek professional legal and tax advice as early as possible whenever a buyout might occur. Professionals can help ensure the buyout will be negotiated in your favor, and structured favorably in order to minimize your tax consequences.

How does a co-owner's personal debt jeopardize our company?

If a creditor of a partner obtains a judgment against the partner, the creditor may be able to seize ownership over the non-exempt property of the partner. Non-exempt property includes things like homesteads and a certain small amount of personal property. It doesn't include stock interests. Therefore, it's possible that a creditor could seize ownership over the stock of a company and sell it to the company's competitors. This may seem unlikely, but if you're the creditor, can you imagine how much leverage you would have over a debtor if you threatened to take over their business? A debtor in that situation would most likely take out a high-interest loan just to pay you off.

A buy-sell agreement can specify that if a transfer of stock occurs that is not authorized by the remaining shareholders, that stock is either null & void or has no voting rights or financial rights. While the enforceability of such provisions in a buy-sell are not 100% guaranteed, having no such provisions may leave a company wide open to the partners' personal creditors.

What happens if a co-owner dies, becomes disabled, or is divorced?

Death
If a co-owner of a business dies, and there is no buy-sell agreement in place, the shares or member interests of that partner will transfer to the partner's heirs. If there is a will, the partner can specify who shall receive the business interests. Without a will, then MN state law will dictate who the business interests will go to.

However, if you have a buy-sell agreement, your company or its owners can decide how to divide that partner's interests, and the agreement written advance can offer flexibility in making those determinations at the time of death, rather than having to foresee circumstances into the future.

It is usually unwise to rely on wills for the purpose of transferring business interests. Wills can be re-written before death and without the company's approval. Wills can also be contested and invalidated by emotional heirs.

Disability
Disability is harder to accommodate than death, when it comes to a buy-sell. The reason is that death is permanent, and disability is not. Often, owners want to accommodate a disabled partner, but they also don't want to have their hands tied to that partner if the disability prevents the partner from working. Further, the disabled partner may be unwilling to sell their interest in the business with the lingering hope they will recover. A buy-sell written prior to any disability can save much heartache in this situation. By specifying in advance what parameters need to exist to trigger a buyout when a partner becomes disabled, the business can move forward more easily and the partner knows what he/she can expect. Disability insurance, if obtained, can make this delicate and difficult situation easier to deal with by funding the buyout.

Divorce
In the case of divorce, the company without a buy-sell agreement in place may find that the ex-spouse of one of the partners suddenly has a legal interest in the business. A buy-sell agreement could trigger a buy-back provision so that the company (or the non-divorcing partners) won't have to answer to the ex-spouse. Even if the ex-spouse has no voting control or interest in the company, as long as he/she has a financial right to dividends, he/she will have a legal foothold on the company that could be leveraged out of revenge, and wreak havoc on the company.

How might an organizational psychologist help before there are problems?

Many small business owners go into business with family or friends with whom they've never had experience working together under pressure. Yet, it's especially important when partnering with family members to be savvy about psychological dynamics that may interfere with an efficiently operating business.

If nothing else, if you want to preserve the relationship, it's a good idea to learn to respect each other's different work styles and communication styles. An organizational psychologist can do some compatibility testing to help you determine how to work together despite the differences in your personalities. Psychologists can help you identify what work-style challenges might arise, given your different styles. They can also provide specific contextual advice about how to work around those individual styles. In short, they can intervene to help save a relationship, just as a marital counselor attempts to do.