In theory, a business partnership is an exciting idea as two or more friends, relatives or acquaintances brainstorm a great idea and consider the financial possibilities.
That's not to say a partnership won't work -- plenty do -- but you'd better make sure the partners are compatible in terms of work ethic, commitment, personality and, perhaps most importantly, risk tolerance.
Say you believe you can grow your new company's revenues to $1 million in three years. That's all well and good, but if your partner thinks $20 million in revenue in three years is possible by taking a lot of chances (not to mention take on a lot of debt), you're going to clash.
So, what can you do to avoid clashes like this and reduce the risks - you'll never eliminate them completely -- that partnerships sometimes present?
In my new book "The Growth Dilemma," I suggest that each potential partner take a risk tolerance exercise and compare answers. This will give you grounds for comparing business philosophies.
Here's that exercise:
For each question, indicate one of the following scores:
1 - Would not consider.
3 - Would consider given a better understanding of the situation and the costs/benefits.
5 - Would consider, am open to the situation.
1. By providing a personal guarantee you are able to obtain a larger credit facility, a lower interest rate or other generally more favorable terms. Do you provide the personal guarantee?
2. Your business is doing well, growing organically each year, a solid management team is in place, and cash flow and earnings are robust. You are faced with the opportunity to expand (new production line, acquire a competitor, expand into a new facility) but do not need to. However, the financing is available. Do you expand?
3. Your business is growing faster than your current lender can fund. You have the option of replacing the existing low-cost lender with a higher interest accounts receivable factor. Do you replace the conventional financing source with the higher-rate factor, understanding that otherwise you will have to slow down your growth? Consider your own specific growth situation (inventory, purchase orders, additional equipment).
4. Are you willing to provide additional collateral (business or personal) in order to obtain the most appropriate funding structure for your business?
5. You are facing a path in your company's future, which can be for early-stage companies or anyone facing a significant change. Your options to address the issue have narrowed down to two choices: (1) equity partner or (2) financing. If you bring in a new equity partner, you may improve liquidity, resolve that issue, and/or improve your balance sheet, but you are now married to that new partner and you have ceded partial control of your business.
Or do you take the debt option, even if the cost of financing is high, but it means greater control for you but greater financial risk. Assuming that the equity partner is lower risk and the debt option is higher risk, how do you proceed? (if you choose the equity route - give yourself a one. If you choose the debt, give yourself a five).
5 to 12 - RISK AVERSE: Most risk adverse of the profiles choosing to take the more conservative paths that mitigate risk but also may limit growth and options. Best financing sources are conventional lenders or may opt for self-financing or equity funding only. The least leveraged of the profiles.
13 to 18 - RISK NEUTRAL: Open to risk when carefully balanced against the rewards. May see opportunity in some higher-cost, but quicker or more tailored, financing, while skewing toward more traditional sources.
19 to 25 - RISK FLEXIBLE: The intrepid entrepreneur willing to take risks knowing that can lead to larger rewards. May have the highest leverage of the profiles but seeks to match financing to asset class understanding the conditions that comes along with each.
Now look at the results.
If you score as risk flexible, but your childhood best friend is risk averse and your cousin is risk neutral, chances are high that arguments will result. On the other hand, if you're all, say, risk neutral, the chances are good that you're compatible.
As mentioned above, a myriad of family-owned businesses thrive in the business world, so there's no reason to nix the possibility right off the bat. Still, if you want to save yourself a lot of headaches (and even heartaches), take pains to determine whether that working relationship is going to be the right one.