Introduction by Sunny Kancherla- This piece, originally written for entrepreneurs, is an excellent one for many first time real estate investors. Because many first timers don't have the cash to go into a real esate deal by themselves, they often take partners- family, friends, and associates. There is nothing wrong with this approach and in fact it is the way most people start out. However, before moving forward with any kind of real estate partnership, I strongly urge any newbie investors to sit down with your prospective general and limited partners and discuss the issues outlined below point by point. This may save you not only money and grief down the road, but can also save your relationships.
There are many reasons why entrepreneurs start a business with a business partner such as complementary skill base or access to customers or capital. These benefits generally are viewed as offsetting the difficulties that may arise in sharing control with another individual in a very stressful undertaking.
Here are common pitfalls of having a business partner followed by three important areas that should be addressed in advance through the partnership agreement or the shareholder agreement which may lessen the potential for dispute as situations arise.
Different Perceptions About Risk or Tolerance of Risk
Being an entrepreneur is readily seen as having more risk than a full time paying job, as such entrepreneurs are often seen as risk takers. However, once in the venture each individual manages the level of risk they are willing to accept. When you and your partner are discussing steps to take, do not be surprised if this requires long discussion as you learn that your business partner has a different perception or tolerance of risk. In some instances actions may be regularly taken by one partner to continually lessen their own risk, while the other partner is taking on more risk to compensate and explore the business' full potential.
Failure to recognize and resolve this may result in friction over which party is really carrying the decision making load to grow the business.
Different Ethics
We have all been raised differently and this is very much reflected in our personal ethics. Business decisions day in and day out are based on the individual's personal values and ethics. As has been witnessed with Enron and MCI Worldcomm, business leaders may show a wide range of acceptable business conduct that may be seen in how money is handled, customer warranties are provided, financial statements are prepared etc. Once you are in business together with other individuals you will need to establish business practices that are ethical and accepted by all. Do not be surprised as to the situations that may arise where there may be discomfort with the "shortcuts'' that one partner is willing to take and you may not.
Discuss out your company's business practices and whether your company includes in its business mission to provide exemplary service and high quality products to your customers. And if not, why not? and are you both comfortable with how the other sees the role of ethics in running a business?
Different Values About Money
One of the on going conversations with your business partner will be how money should be spent. Day to day expenses such as rent and utilities will generally not be a concern, but other areas that are discretionary may result in strong differences in opinion. For instance, one partner may view money as an incentive for key employees, while another partner may feel that as much money should go to ownership and may be frugal in every aspect of the business except for his or her own compensation. Different values about money may significantly impact your company's culture and work environment.
Take a hard look at your prospective partner as to how important money is in their every day life. Do they need the Mercedes, are they prone to leaving no tip in a restaurant or do they over pay for everything? Make these observations in advance of the partnership, since what you see will be what you get once you are in the partnership. Are you comfortable?
Conflicts Surrounding Territory and Areas of Responsibility
When the business partnership is started, each partner's responsibilites should be clearly delineated. Pettiness may arise when decisions made by one partner intrudes the other's area of responsibility. In many instances these points of tension may be talked out and over time a good working relationship develops. A partner with an intrusive and controling personality may be totally resistant or unable to adjust to working well with a partner.
A number of steps may be taken to manage this including well defined job descriptions for each partner and budgeting so that decisions about spending money are spelled out and requiring less discussion. If conflict about control and intrusive behavior persists, meeting with an hr specialist who offers personality testing may help bring the issue to better light and resolution.
Different Levels of Energy
A startup and growth company requires endless amounts of energy. The eighty hour work week may be the norm, no vacations for the first three to five years, as well as working on weekends. Some individuals may be able to work endlessly without a break while not sacraficing performance at any time, while the other partner may be productive only if they are able to pace themselves by taking breaks away from the business to refresh their focus and energy. The more intense "workaholic" personality may not be understanding of this other style and become resentful of the other partner's periods away from the business...even if the periods away are very short in duration and result in better performance by the partner.
Agree upon the amount of time to be contributed by each partner and the added time that is discretionary for each, as well as recognizing and acknowledging each others different style of management and endurance level.
Different Levels of Contribution to the Venture's Success
Very often a partnership is set up 50-50 as determined by equal amounts of capital contributed and each partner taking on a title. What sometimes emerges is that one partner may have a greater role in the success of the venture that becomes apparent over time. This may occur in the very first year as one partner is well suited to the entrepreneurial lifestyle, while the other may be ill suited. Or it may occur later on when the business has become a multiple employee company and one partner's skills are unable to grow to meet the new challenges. Gradually, one partner begins to truly lead the company, while the other partner's decision making role recedes, and yet each is entitled to an equal share of the business' profits.
This may be the hardest issue to tackle and resolve while maintaining the partnership. If one partner has the belief that they are carrying the other partner (whether perceived or really true) it may eventually result in squabbling and resentment. Once the partnership share is established it is very rare that one partner will willingly give up part of their ownership and recognize the other partners greater contribution.
Be sure of your prospective partner's skill base prior to establishing the business partnership. There is a greater chance of a mismatch happening if the partners have not worked closely together prior to forming the business. Think hard and twice before offering an equal share to an individual who has not proven their mettle and skill base.
Different Views on the Meaning of the Business' Success
Very often the stress and energy to make the business succeed requires the business partners to be in a narrow focused tunnel, blocking out virtually all distractions and other opportunities. Once the business gets to firm ground each partner may have a different view on what success means to them. One partner may decide that this is the opportunity to spend more time with their family or take more vacation time, while the other partner may feel that with more effort the business can grow even further. Success gives each partner opportunities that were not possible while the business was struggling to succeed. Jockeying may emerge by each partner to optimize what they now feel are the fruits of a successful business. This may significantly impact the comradery that existed during the startup and early years.
Reevaluating the business plan is a tool that will elicite discussion among partners about the change of priorities emerging from business success. Re-establishing explicit understandings about priorities and what will be required to achieve the next stage of growth may be helpful, as well as considering growing the contribution of key employees who may take on some of the load and lessen the demands on the owners for future growth.
The Three Areas Your Partnership or Shareholder Agreement Should Set Out
When you are starting a business with partners or shareholders, you should have prepared with an attorney's assistance either a partnership agreement or shareholder agreement. Here are three important areas provided by Rick Pinto, managing partner of Stevens & Lee, that should be covered in these agreements:
1. Management/control related issues. Decide who is going to do what (now and later). Set out clearly how the business will be operated, how management decisions will be made, and how disagreements will be resolved. Spell out how certain major actions (such as changing, financing, or selling the business or admitting new partners) will be taken and whether or not all (or most) partners need participate or consent.
2. Finance/sale related issues. Decide who is going to contribute what (now and later). State whether partners have either the obligation or the right to make future investments. Indicate how you will adjust individual partner compensation or investment shares (if at all) should, in future, one contribute more than planned or another contribute less. Have rules to deal with a partner who leaves the business early. If the business or its remaining partner(s) gets to buy out the partner who dies or leaves, have rules regarding how the buy-out will be valued and paid.
3. Proprietary issues. Decide (i) confidentiality obligations, (ii) under what circumstances, if any, will individual partners co-own or be allowed to use information, rights and property (including intellectual property) created by, or contributed to, the partnership, and (iii) under what circumstances, if any, will individual partners be permitted to undertake separate activities in competition with the business of the partnership.
In summary, deciding to share business ownership is a very very important decision when setting up a business venture and often individuals are not wary enough of the potential for conflict arising from personality or business issues that may occur at any stage of the business. The partnership and shareholders agreements offer some help in addressing the more common business related issues, but the entrepreneur should have strong knowledge about their prospective partner's personality and skill base with whom they are going into business, as well as their own.
Jeanne Gray is founder of Enterprising Solutions Inc., a consulting firm specializing in growth strategies for small and entrepreneurial stage businesses. She is also the publisher of NJEntrepreneur.com. Jeanne may be contacted at jgray@NJEntrepreneur.com or by calling 732-662-9106.
Special thanks to Rick Pinto, Managing Partner of Stevens & Lee, a Pennsylvania law firm with offices in Princeton, New Jersey. Rick Chairs the firm's Venture, Technology and Entrepreneurial Services Practices and is a member of its Corporate, Finance and Capital Markets and Health Care Departments. He represents public and private companies and non-profit entities in all phases of organization, financing and operations. Rick may be contacted at rjp@stevenslee.com.
