8 Questions to Ask Before Incorporating Your Business Partnership
Given the unstable job market, and the risk of going it alone, many people are currently seeking to start businesses together. The rub, however, is that starting a partnership can be very challenging, says Ebong Eka, a CPA who also pens his own blog about the world of entrepreneurship at MoneyMentoringMinutes.com. "I have often said the only ship that won't sail is a partnership," he says. "Many new entrepreneurs fall in love with the business idea but fail because of the lack of execution and because the responsibilities of the partners aren't clearly laid out before starting." In other words, before you even get to the stage where you want to make your partnership official, you have some work to do in building the foundation for your shared business.
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To help you set the stage for a successful partnership, John Gerber, founder of UpstartLegal.com, suggests asking yourselves the following eight questions:
1. Are You Good Partners?
In any new business, but especially in a small company run by the partners, everyone is going to be stretched in terms of time and capabilities, says Gerber. The business needs a mix of talent from a small number of individuals to cover a large variety of work, i.e., management, finance, creative, technology, etc. "The balance is in finding partners who can work together to deliver a great service or product (a creative design team, for example), while also ensuring that someone is willing and able to manage the finances or reboot the computers," says Gerber.
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2. What Are You Bringing to the Relationship? And How Do You Value It?
"A partnership doesn't have to be a marriage of equals," says Gerber. "Sometimes relationships work better when one person is in charge or has a majority stake." The key to a successful relationship, then, is that the relative contributions of the partners are clearly established and that everyone agrees on the value of each partner's contribution. Maybe the business can't start without financing and one partner invests all of the cash, for example, while the others put in sweat equity. Maybe it needs a critical customer deal that one partner establishes. Maybe one of the partners invents a brilliant new technology. Maybe the right mix comes from a combination of all of the above. "So long as expectations are aligned about what each partner will contribute and that the partners truly embrace the priority and value of the contributions each is making, the partnership will have an internal fairness that will translate to a common understanding of ownership, control, economics, and other important issues in the relationship," Gerber says.
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3. Is Everyone Committed?
Before starting to work together, partners need to address any individual commitments that might interfere with their commitment to the partnership, says Gerber. For example, one partner might want to start the business to maintain a certain work-life balance, with a limited commitment to the work side. Alternatively, necessity might require less than a full-time commitment if a partner has responsibilities caring for children or extended family. There could also be questions of timing. "It's possible that a partner might make an 'All in' commitment until the business gets going but then back off on active participation to pursue other business interests," says Gerber. "Establishing a strong common understanding going in about the time and effort each partner is willing to commit and how the partners will handle competing commitments and life circumstances down the road will create a sense of fairness and trust that starts the partnership on common ground and also anticipates what will happen in the event these circumstances arise."
4. Is There Anything Important That Hasn't Been Discussed?
Above all, transparency and completeness are critical in any relationship, says Gerber. That means it's not uncommon, then, that as partners talk about formalizing their relationship that new and potentially problematic issues be brought to light as soon as possible. For example, how would you like to find out that your partner is pregnant and won’t be interested or able to work for the first year or so of your new business launch, after you quit your corporate job to start the business with her?
5. Do You Have Sufficient Funding?
As in marriage, the financial aspects of a partnership can be stressful. The partners should develop a budget for both the business and for their personal needs, says Gerber. The budget should identify how much is needed to start the business and where that investment is coming from. It also needs to identify what is needed until the business starts generating profit to the owners. "Stress on personal finances is an issue for all entrepreneurs during startup," says Gerber. "Going in, the partners should be confident that they are both able to handle the loss of income for a similar duration. Otherwise, their financial needs won't be aligned and their interests may differ in how, or how long, to sustain or conduct the business."
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6. How Are You Going to Make Decisions?
Essentially, the partners need to decide who decides, says Gerber. Many times, partners share investment and responsibility equally and agree to decide major issues jointly. Other times, a majority or founding partner has ultimate control over the future of the company, while a junior partner reserves the right to veto major decisions, such as selling the company or bringing on a new partner. “Whatever works for a particular partnership, the partners need to get on the same page up front in order to avoid major confusion and grief both in day-to-day operations and over significant transactions,” says Gerber.
7. What Happens If the Partnership Ends?
“Breaking up is one of those things most people don’t want to think about, but it’s very important to consider the reasons a partnership might break up,” says Gerber. Sometimes, a break up results from a problem, like the partners have a dispute over finances or approach or one of them does something adverse to the business. But, often, it’s simply that circumstances change. For example, one partner might need to take a job elsewhere, be ready to pursue another opportunity or retirement, die or become ill and unable to work. Partners need to plan ahead for what might happen if scenarios such as these play out, says Gerber. Will the remaining partner retain ownership of the company? Will there be a buyout of the exiting partner? If so, under what terms? “Having a realistic exit plan before it is needed, and before emotions or animosity are running high, is invaluable,” says Gerber. “Again, deciding early on is key to having a successful partnership.”
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8. Should You Form a Legal Entity? And What Should Your Partnership Agreement Address?
Whether an LLC or a corporation (the choice of which is beyond the scope of this article and should involve getting an experienced attorney involved), the partners should establish a legal entity as early as possible to give the business a separate identity and protect themselves from personal liability. “If a business partnership is like a marriage, at least in some ways, the agreement among the partners is the prenuptial agreement,” says Gerber. “It should be put in place at the outset of the relationship.” A good agreement will cover all of the issues identified above, including:
- The relative authority, roles, and responsibilities of the partners
- Their initial contributions to the business and percentage ownership
- Economic rights relative to the cash, profits, and loss of the venture
- Governance and disputes
- Exit rights and buyout obligations
“In doing so, the written agreement will embrace the understandings and underlying sense of fairness in the relationship established by the partners when they work through these issues,” says Gerber.
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