April 5th, 2022 Taxloopholes.com Advisor
Content was originally published on Inc.com on February 11, 2020.
Starting a new business can be exciting and terrifying at the same time. There are so many variables to consider, and a million things on your to-do list. And for many business owners, they aren’t doing it alone. They have a business partner (or two…or three) that they choose to take the entrepreneurship journey with. At face value, it seems like a great idea. You have several people to divide up the workload, help make major decisions, and structure the company for growth and profit.
But what happens when a business partnership goes sour? What happens when someone wants out or has a family emergency?
Thinking about these hard questions prior to forming a business partnership is sort of like getting a prenup before you get married. You are deeply in love, and can’t imagine anything getting in the way of your happiness. But when or if it does, you are going to be happy that you took the time to work through these issues ahead of time, when the lines of communication were still open.
So, today I wanted to share with you what I refer to as the “Five D’s of Business Partnerships.” These are the five worst-case scenarios that every business partnership should talk through and address in writing before joining together for a business venture.
- Death: What happens if one of the partners of the partnership dies? No one wants to think about this, but I have seen many businesses struggle to survive after a death, so it’s a really important one to address and get in writing. Usually this is handled by a buy-sell clause that is funded with a life insurance policy.
- Disagreements: In the beginning, you are all on the same wavelength. You believe in the mission and direction of the company, and are hyper focused on bringing it into reality. But what happens if you and your partner reach an impasse? What happens when there is an irreconcilable difference on a fundamentally important issue? How will you handle it? Will one of you have the final say? Or will you instead resort to a carefully thought-through buy-sell agreement?
- Debt: Debt is another taboo topic that many business owners avoid discussing. In a partnership, it’s important that you not only discuss the topic but lay out a plan for what happens if a partner becomes financially insolvent and declares bankruptcy. Will you have to take on that partner’s creditors as your new partners? Usually, in the case of bankruptcy, the economic interest of the insolvent partner will revert back to the other partners, or at least be strictly limited to the economic interest and not any voting or controlling rights. This protects members of the partnership.
- Divorce: Fifty percent of marriages end in divorce, so there is a high likelihood that this topic will come up in your partnership. Let’s say you’re a partner with Sally. But she and her husband Jim get a divorce, and in the settlement Jim gets half of Sally’s interest in your partnership. Do you really want to be forced to take Jim into your partnership? You need to decide upfront how you want to handle this contingency.
- Disability: The final “D” on the list of must-discuss topics is disability. What happens if one of the partners is hurt and is no longer able to contribute time and talent to the partnership? How will this affect their ownership interest and the way profits are split? Get this in writing early on to prevent any issues down the road.
Discussing these topics is difficult for many business owners, but doing so will save you a ton of pain, heartache, and legal fees down the road.