A 50-50 partnership often ends up creating more problems than it solves. Here’s why.
Far too often, business partnerships fail because of poor planning in the beginning stages. Two friends decide to make their dreams come true by starting a business together. Every aspect of the business—including ownership and decision-making—is split 50-50. Often times, one partner provides the money and the other contributes sweat equity. While it’s happening, it all seems like the best and most brilliant idea. Eventually, however, differences of opinion can cause a company to stagnate—and can be fatal when there is no structure in place to break the tie.
How to Negotiate Partnership Equity
It makes sense that giving each partner equal shares seems the simplest and fairest way to divide profits and ownership. No need for difficult discussions regarding who gets a greater portion or who controls the decision-making process. However, business partners will never agree on everything, even if your partner is a close friend. And most people never stop to think about the negative ramifications that can stem from a 50-50 partnership until its too late, and they are at an impasse.
Because it’s far trickier than it seems, it is imperative in a 50-50 relationship that you come up with an efficient decision-making method or management structure early in the business formation process. Plan that there will be conflicting management opinions and create the mechanism required to solve them without slowing down operations.
The attempt to avoid this conundrum is why some people have a 51-49 partnership. The partner with the larger share can be the one who provides the bulk of the capital, for example. This involves a great deal of trust on the behalf of the 49% partner since her counterpart will always have veto power. Counterintuitively, however, this is often of far greater benefit to the momentum and sustainability of a company.
How to Split a Business Partnership
So you chose a 50-50 partnership and you want to know what to do next.
Decisions that have a major impact on your business—how you will sell, what materials you will buy, whether or not you will borrow more capital, merge with a competitor or ultimately sell the business—are to be resolved at the partner level. In a perfect world, both partners will agree on these important decisions; but, when disagreement inevitably arises, this is where the structure you put into place for decision-making will come into play.
Smaller operational issues, on the other hand, are handled much more easily if each partner has specific responsibilities and manages the operations in her own department. These departmental decisions can then be handled within their respective departments, recognizing each of the partners’ skills and authority, while ensuring the business operates fluidly. Day to day operations can continue unhindered by debate or discussion. This simple delineation of power will remove most of the issues over which partners disagree.
Partnerships require an explicit decision-making procedure to succeed. 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 affecting 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 considered the operative defining matter. The partner who invests the most money 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% 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 efficient 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, tiebreaker in which management cannot make important decisions. A “tiebreaker” 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 company 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.
It will be considered at an impasse, and if sued 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 split. This frequently satisfies the partners on fairness by sharing profits equally, while attributing control to one of the partners.
Alternatively, you can have an even profit split and divide 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 ultimately the result you want is to have a tie breaker situation, having one person with final control, so there will be no impasse.
If you are encountering this issue, it may be too late. It is, however, never too late to change your business organization plan but knows 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 concrete 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 efficiently and profitably. There are many traps for the unwary that can be removed with early planning.