COVID Funding Tips for Small Businesses
History is filled with inspiring stories about many successful business partnerships, including Apple, Google, and Facebook.
Having a business partner gives you a great sounding board to help you make the best decisions to grow your business.
When partnerships work at their best, they can help you see through your own blind spots and capture ideas you may have missed on your own.
Ideally, if you and your partner are on the same page, you can help each other stay on the path to growth and success.
On the downside of that equation, my observation over the years is that the businesses with the most issues and lawsuits are the ones involving partners.
There are endless stories about one partner blaming the other for a business failure, taking off with the money from a successful business, or charging huge personal bills on the company credit card.
Here are the top 6 areas of agreement to get partners on the same page:
- The vision. You must agree on the company’s vision and what your short and long-term goals will be. You may disagree on how you will get there, but a common understanding of the vision is essential.
If both partners have a different vision from the start, that usually creates problems unless one partner is the majority owner and has the final say. This is especially important when the business partners are husband and wife. The short-term vision may be “just to pay the bills,” which should be replaced by something more compelling for the long term.
If you’re not clear on your business vision, take 1-2 hours to brainstorm together about where you want to take the company. You may be surprised at the input from your partner and what they really have in mind.
- Capitalization. When partners start up a company, there’s often a lot of confusion over the money used to capitalize.
Many times when I’ve met with partners in my conference room and asked them how they were going to divide the responsibility for capital, they ended up abandoning their business plans.
In the end, it was for the best because the business was likely to go nowhere without clear agreement on how much money each partner expected to put in and take out over the life of the business. Here’s the common miscommunication:
One partner may say, “I will put in $20K into the company, and you do the work.” What does “I will put $20K” into the company really mean? Is that capitalization, which means NONE of the $20K, will be paid back? Or is it mostly a loan that has to be paid back when the company generates profits? What typically happens is a few months into the business, the partner who put in the $20K will expect part of that “loan” to be paid back, and there’s the beginning of the conflict. “What do you mean, pay back the loan? That was your investment in the company!”
In another scenario, let’s say the company is failing a year down the road. The partner who kicked in the $20K may say, “we need to pay back my $20K loan before we go under.” The other partner may have assumed that the $20K was capitalization. I’ve also seen it work the other way, where one partner puts in $20K, and the company takes off and is bought out for millions. The second partner may say, “Here’s your $20K loan back plus interest.” The first partner might ask, “Are you crazy? That was my capitalization for 50% of this company – NOT a loan!” Another frequent disconnect is between a financial partner and the one that provides “sweat equity” or services for their company’s percentage ownership.
Usually, at some point, the “sweat equity” partner regrets the amount of work they’re doing compared to the effort put in by the financial partner unless they were extra clear about ownership value from the beginning.
- Roles, responsibilities, and time commitment. Partners must also be on the same page about their roles in the company.
It sounds easy to throw titles around like President and CEO or Managers of the LLC, but have you really defined the responsibilities of those roles, and have you taken the time to discuss them? Do you have an organization chart for your company?
If it’s just your spouse and you, do you have roles clearly defined and a way to measure them to determine each other’s effectiveness? What about the amount of time that each person can commit to the company? Does one partner have a family, and the other partner is single? Are you both expected to work 70 hours per week?
If you agree upon certain roles and one role takes a lot less time because your partner has a skill set in a certain area, you can’t get upset if you’re working more than that the other partner if those are the roles you agreed on.
It’s important to have realistic metrics in place so that both partners can fairly measure progress and make proportional improvements.
- Compensation. A vital question is when and how much each partner will be paid from the business. This is a special concern if one partner has a tighter personal budget than the other.
The partner who does not need the income is more likely to want to reinvest all the money into the business to grow faster. The other partner that needs to make some money from the business will be more likely to want to take money out of business for income purposes.
You need to be clear from the beginning how each partner will be compensation. This assumes that you’ve agreed on a budget with real numbers on it as part of your business plan.
If one partner has loaned the company money, the repayment terms must also be spelled out. Is that money coming out of profits first before the partners are paid? This must be worked out in advance.
- Buy-sell agreement. This allows you or your partner to gracefully sell their ownership in the company and exit when desired on agreeable terms versus ending up in a legal battle.
This agreement sets forth an agreed-upon accounting formula to evaluate the company’s value before you sell and take your share. As you can imagine, the selling partner’s CPA will evaluate high, and the buying partner’s CPA will evaluate low. This also handles the process if one partner wants to sell their shares, and the other partner does not want to buy them.
Now the selling partner has the option to go out to the open market. The buy-sell agreement also outlines the payment arrangement for the partner selling their ownership stake back to the other partner or the company.
Typically, the payment may be 20% paid out upfront and the other 80% over a 4 year period of time. Not many companies have enough cash lying around to pay out 100% of your ownership stake when you leave the company. It is also important to have a term life insurance policy for each partner to pass away. The surviving partner will need the insurance proceeds to pay off the deceased partner’s estate and move forward with the business.
A buy-sell agreement through a law firm may cost about $2500. A standard buy-sell agreement legal form costs under $50, and you can save a lot of money by taking it to a law firm and having them customize it for you. Should you set up a buy-sell agreement from the start of your business? Yes, but it doesn’t happen this way in most cases because owners wait to see if the business is successful before spending money on additional legal services.
Revisit the buy-sell agreement during the first year to ensure it’s in place and current for year two!
- Exit strategy. Do you have an end in mind? Do you know from the start whether you want your company to be acquired, or do you plan to stick with it and make it grow bigger and bigger?
You and your partners need to talk about your goals in the beginning. If your goal is to sell the business, you’ll also want to talk with your CPA firm about the tax ramifications.
The buy-sell agreement will be an invaluable tool if you can’t decide on an exit strategy right now but want a mechanism in place to facilitate things fairly should one partner decides to exit earlier than the other.
In conclusion, having a business partner can take a lot of the burden of running a business off your shoulders and offer welcome inspiration and encouragement during tough times.
The partnership also provides extra growth opportunities for a business, especially when the partners have complementary skill sets.
Unfortunately, partnerships also happen to have the highest legal issues that I’ve seen over the years.
This means it’s especially important to get on the same page at the start and during the first year to commit to long term success!