Most business partnerships are formed when its all sunshine and rainbows. This type of optimism is crucial to entrepreneurship but can also create blind spots. At the moment when everyone is hopeful and getting along is when great concessions are made which can come back to haunt the partners and business. I have learned through experience that protecting the downside and thinking through worst case scenarios before they happen is invaluable to any business partnership. The old adage of “you don’t know what you don’t know” applies when forming business partnerships.
I am a big fan of thinking philosophically in many areas of life and especially in business. Philosophical thinking is crucial in defining the parameters of a new business, in essence it is logically thinking and reasoning through circumstances that have yet to happen. To get started, below are three questions to consider when forming a business partnership. This will hopefully help to spur the philosophical thinking and avoid the long term issues that arise from difficult circumstances or at least give the partners a map to navigate the circumstances.
How will Big Decisions Be Made? In theory we all want to believe that everyone can make decisions collectively and equally. In practice I found this theory to be false nearly every time and will eventually lead to more indecisiveness than decisiveness. In the formation of a business the partners typically have a shared goal and vision that bring them together. Because of the positive emotions and hope it is easy to concede on certain issues and during this time of business ecstasy its hard to see there ever being an issue or disagreement. I can tell you from my own first hand experience and many others I have observed that this is not the case.
To be in business is to be in a constant flux of conflict and change. There will be dissension and big decisions will still have to be made. This is why most businesses have a board of directors and voting system to navigate big strategic decisions and allow for smaller tactical decisions to be made without their approval in order to respect expediency. It is important that any new partnership think through corporate governance and how big decisions will be made and how conflicts will be resolved. Try to create a worst case scenario and work through how the partnership would deal with the scenario, this is a good practice and will help outline what will need to be in place.
What is the reasoning and logic behind the ownership structure? Business partnerships are typically formed for the sole reason of offering a product or service that will ultimately generate a profit and wealth creation for the partnership. The big question is who will get what when it comes to disbursing the profit and long term proceeds? This is the point in business formation where the partners must have an honest discussion regarding value. What is each individual bringing to the table and what value does that represent? Defining value is an extremely important exercise in avoiding long term resentment. If there is a misconception in value it can easily lead to long term disputes with partners. For example, if partner one puts up capital and receives his fair value for that capital and partner two puts up his time and receives his value for that time but the value is not illustrated across all domains then it would be natural for partner one to blame partner two for putting no time into the business. His value was not built on time but on capital. This seems like a simple misunderstanding but something that is far too common. The partners must find a mutually agreed upon way to value their investments.
Typically, the three big areas where value is brought to a business are 1) capital, 2) time, and 3) knowledge/experience. Capital is by far the easiest to assign value which makes the other two categories the challenge in negotiating percentage of ownership. When using capital as the standard for setting the ultimate value then it is best to measure the other two areas against this standard. For example, if partner one gives $100,000 in capital for 10% of the company then partner two would need to give the equivalent amount in time in order to obtain the same percentage. Since time can not be given but earned then partner two would have to put in the time in order to gain the value and percentage ownership. Knowledge and experience is much more difficult to value and in many cases it becomes an arbitrary negotiation or tied to certain goals. If the value of partner three is his network then his value could be in obtaining strategic partners or customers. This too puts a specific value that has to be earned but in some cases experience and knowledge will have to be given value without necessarily being earned. It is not a perfect system but it gives the partnership a basis in which to work from and acknowledge how value is perceived.
Is there alignment of interests on the core values and goals? This becomes a major proponent for long term success. In any endeavor if there is not a true alignment of interest among partners then failure is a likely result. The easiest to point out and often the most overlooked is the exit strategy. Is the purpose to build the company to a certain level and sell? If yes, then what is the trigger for that sale? If partners have differing opinions of exit strategies this could greatly impact many strategic decisions starting from day one. If one partner wants to build slowly through organic growth while the other wants to build quickly through leveraging outside capital this will create major issues within the business. Obviously there will be tactical and day to day issues that do not need to be defined but the core founding issues and principles will need to be aligned before anything happens.
I am a big fan of living life by principles and I think business formation should be looked at from a set of principles as well. Without principles there is nothing to fall back on when conflict arises and emotions are at their peak. Below are a few guiding principles for business formation and partnerships.
Leave The Emotions and Ego At The Door: The ultimate goal of business is to make a profit. Plain and simple. There are many other sub-goals to business other than that but without profit there is no existence of a business. This is even true of a non-profit, thus, the reason for this principle. Business is not about self-esteem or emotions and when this enters the equation it is disastrous. This is easier said than done and why it must be an agreed upon principle at the time of business formation. Level heads will always prevail and when the heat gets turned up then business partners must do their best to set aside emotions and feelings and focus on the issues and facts at hand. There will always be an element of emotion but being aware and accepting this element will put the partnership at an advantage when dealing with issues. Protecting ego and self esteem at the expense of the business making profit is unacceptable and will result in failure.
Be Strategic and Realistic: Businesses are run best when big decisions are made through logic and backed by passion and positive emotion. This is best accomplished through well thought out strategic planning. I believe all partnerships should get into the habit of regular strategic planning sessions. I have always adopted a yearly strategic planning retreat with quarterly sessions to monitor the progress and make changes where they need to be made. Again, this falls into alignment with typical board of director structures and corporate governance best practices. Strategic planning allows the partnership to work together on the big strategic vision of the business on a fairly regular basis. When there is consensus with strategic planning it sets the stage to work through the day to day tactical with little or no conflict. Conflicts usually arise when there are major strategic differences in the direction of the business and the likelihood of this happening increases with increased time between strategic planning sessions. Find a schedule and process that works best for the partners to get together to think and plan strategically. Get out of the office and go somewhere inspiring, make it a fun and positive experience.
Seek Outside Counsel For Guidance: This goes hand in hand with the above issues. When emotions are high and the situation is tense it is always wise to bring someone not emotionally involved to help see the situation objectively. I am a big fan of having a board of directors or advisory board to help guide the business and partnership through tough scenarios. It is true that we can’t see the forest through the trees when we get heavily involved in our businesses. Having an independent and objective set of eye’s is crucial in avoiding the pitfalls. Through my experience I have seen a significant difference in businesses with a board of directors or advisors and those that go it alone. As much as we want to believe we are always objective and reasonable its just not the case and especially true when passion and money are intertwined. A strand of three is always stronger than one strand. I highly recommend seeking a group of individuals to help the partnership navigate the ups and downs of business ownership, even if its an unofficial advisory board.
Business partnerships are no walk in the park and I have had my fair share of failures and mistakes but done correctly they can be a wonderful experience. The above comments are what I have learned along the way and hopefully tools for new partners to use while they navigate their new business relationships. I can not emphasize enough how important it is to not get stuck in the honeymoon phase and fail to objectively look at potential downsides. When there are well established and pre-existing guiding principles and tools for making difficult decisions it will greatly help navigate the inevitable tough spots that all businesses go through. Easier said than done but cool heads do prevail and when in doubt check the emotions at the door and use your best logic and reason to find a strategic path out of tough situations. Good Luck!