On too many occasions, I have seen partnerships fail because of poor planning in the beginning. Two friends decide to make their dreams come true by starting a business together where everything including ownership and decision-making is split 50-50. One friend typically brings the money in and the other typically brings sweat equity, the work. It seems like the right thing to do, the partners think, mutually respectful, fair, but it eventually ends up in a disaster because of differences in opinions in how to run the business and with no method to break the tie that a 50/50% partnership supports.
On many occasions, business partners believe that equal shares are the simplest and fairest way to share profits and ownership. They usually opt for this in an attempt to avoid difficult discussions regarding which partner should get more and who should control the business decision making process, and thus they often default into 50/50. However, this is rarely the best decision. A 50-50 partnership ends up creating more problems than it solves. Many people fail to see the potential negative ramifications that can stem from a 50-50 partnership until its too late, and then are trapped in a situation where there is deadlock, an inability to move forward, the death knell of the partnership.
Business partners will never agree on everything and this eventually becomes apparent even if your business partner is a close friend. When in disagreement, if a 50/50 relationship, an impasse can frequently be the result. With an impasse, each partner wanting opposite results or actions, resulting in a deadlock as neither can control, thus nothing occurs. This can be hugely detrimental to the underlying business if the issue is critical. Even if the disagreement is not about a critical issue, the mere fact that the partners cannot agree can erode in a polarization and disintegration of the entire working relationship and the partnership ceases to be workable. For this reason, it is imperative that as business partners you come up with a more effective decision making method or management structure early in the business formation process in order to prevent future deadlock problems and create the mechanism required to solve conflicting management opinions in an effective manner.
First of all, this issue should only occur when regarding conflicts that truly affect the value and mission of the core business. Such issues include material decisions, selling, buying, merging, borrowing and closing issues. They are important matters that are the “make or break” issues, which can cause deep divisions, lawsuits or liquidation between partners. They are to be resolved at the partners level. Resolving smaller operational issues are made much easier if the business is designed in such a way that each partner recognizes their specific responsibilities and are in control of their departments on an operational basis. Operational matters are to be broken up into their respective departments and decisions at that level should be controlled by the partner responsible for that department. This is an allocation of power which recognizes both individual skills and the needs of the business to operate fluently and unhindered by constant debate and discussion requiring agreement to move forward on basic operational matters. Thus many conflicting issues are eliminated if an appropriate designation is made regarding who has decision making control over each part of the operation of the business. This will eliminate most of the issues partners disagree over.
The larger, more important issues which affect the very nature of the business is where the partners need to determine a decision making path more effective than a 50/50 shared responsibility.
I understand how easy it can be to enter a 50-50 ownership/decision-making relationship, and I understand the respect you may have for each other as partners. Sharing the hard work, the good times and the bad times together may seem like a meaningful concept and the right thing to do. However, this is the stuff movies are made of. The expectation that every matter will be agreed upon together and that everything will work just dandy is highly unrealistic and results in endless debate and discussion with no decision being made. The partners attempt to convince each other of their view and the business decision languishes unhandled.
Partnerships require a clear decision-making procedure to succeed. In order for things to get done and for decisions to be made, there must be an allocation of responsibility within a business in which each partner has controlling decision making authority. On larger issues effecting the entire business a “tie-breaker” concept must be established. One partner must have the final word when disagreements arise.
Which partner? A disproportion in the investment of time, capital, credit, assets, or skills invested usually exists and these factors should determine which partner will control the ultimate larger decisions if a disagreement occurs. Typically cash invested is usually considered the operative defining matter. The partner who invests the most cash, should have decision making control, leaving that partner with at least a 51% majority position with the remaining partner having 49% minority position.
When dealing with a 51/49 split, when push comes to shove, the “money partner” can vote their extra 2% in order to control important material decisions, in essence allowing that partner to protect his financial investment. As a result, the importance of the cash investment is respected and decisions are made effectively because there is no tie.
While I completely understand the value of sweat equity, cash is king in today’s business environment.
The main point here is to avoid 50-50 business ownership relationships as they can result in disaster, a business in which management cannot make important decisions. A “tie-breaker” mechanism and a final word will always be necessary, or the business will be challenged and possibly destroyed by differing opinions on important matters, resulting in endless discussion and debate while the business is locked in non-action.
In fact, the legal resolutions for these situations are as follows: when a material disagreement exists within a 50/50 relationship of ownership interests, the business will be incapable of advancing and it will be considered at an impasse and if sued on by one of the partners, the court will order a liquidation of assets for the benefit of the shareholders. Killing the business to resolve the dispute is the result, everyone loses.
Here’s one way an LLC can provide a safe path through this issue: profits, capital gains, and losses can be shared differently than that of decision-making in an LLC. For example, you may maintain a 50/50 profit split and hold a 51/49 decision making split. This frequently satisfies the partners on fairness by sharing profits equally, while attributing control to one of the partners.
Or you can have an even profit split and split the decision-making into two thirds majority wins, if there are more than two partners, called a super majority requirement. There are various ways to go about this resolving this potential conflict, but the result you want is ultimately to have a tie breaker situation, having one person with final control so there will be no impasse.
If you’re encountering this issue, it may be too late. It is however, never too late to change your business organization plan but know that it will be difficult once the business is well established. Far better to accommodate this situation in the formative stages of the business and make the appropriate adjustments in the beginning, before an issue arises and when all partners are reasonable and nothing specific is at risk.
Better this path than having a judge order a sale of assets.
Second Wind can guide you through the organizational design, so that your business will run effectively and profitably. There are many traps for the unwary that can be removed with early planning.
(See our more recent blog entry: “More About Structuring a 50/50 Partnership Successfully,”)
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