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Wealthy & Wise: The Perils of Partnerships!

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April 7, 2023
Author: NCH

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About the Video: Wealthy & Wise The Perils of Partnerships!

Business partnerships can offer many benefits, such as shared resources, expertise, and risk. However, there are also several perils that can arise from entering into a partnership. One common issue is a lack of alignment in goals or values, which can lead to disagreements and tension between partners. Additionally, partners may have different levels of commitment or work ethic, which can result in one partner feeling burdened or resentful. Another risk is the possibility of financial issues, such as one partner taking on too much debt or mismanaging funds. Finally, even in the best of partnerships, there is always the risk of unforeseen circumstances, such as changes in the market or legal issues, which can jeopardize the success of the business. It is important for partners to have a clear understanding of each other’s expectations and to establish a strong legal partnership agreement at the beginning to mitigate these risks.

Prefer to read? A full transcript is provided below.

Cort:

Hello and welcome to another edition of Wealthy and Wise. I’m your host, Cort Christie, CEO and founder of NCH. Today we’re going to be talking about the perils of partnerships. You heard me right, the perils of partnerships. And I have a very special guest to come on and talk about partnerships today. We have David Vanlandingham, our senior consultant at the NCH, that works with thousands and thousands of business owners every year, helping them form and set up the right business structures for themselves. David, welcome to the program.

David:

Thank you. It’s great to be here. Great topic.

Cort:

This is a great topic and it’s going to be a lot of fun. We know how difficult partnerships are in our personal life. We could probably talk about that for the next half hour. But let’s talk about it in terms of business. Now, is it good or bad to go into a partnership with someone else in business?

David:

I’m going to give you the standard answer. It depends who your partner is. First of all, we have to look at why do you need a partner? Do you need a partner? A lot of times we will have people come to us for structuring that really don’t need a partner. It’s maybe somebody that’s going to be involved in sweat equity and other times it’s somebody that’s maybe just a lender, really, and they don’t need a partnership. But when people declare, yes, I need a partnership, we’re going to be 50/50 or 51/49, then, yeah, there’s a reason to form a partnership, but choose your partner wisely. Just like you mentioned, marriages, statistically, 50% fail. Partnerships, I read in a magazine between 50 and 80% fail, Forbes said 70%. But those just aren’t good odds and we’re in Las Vegas.

Cort:

Those are not good odds.

David:

Not want I want.

Cort:

And, you know, you think about it how much time one spends to pick the perfect marital partner in your life. You know, you court them, you date them, you go out, you make sure that this is the person that you’re going to settle down with. And what happens in business?

David:

Yeah, it’s the same thing. In business it’s, why are you attracted to this partner? Kind of like we are in life. So, does this partner bring something to the table that you’re lacking? Most failed partnerships, believe it or not, have people that are very like-minded in the same. And then now you get into a little bit battle of egos. So, in partnerships, one of the reasons most of them fail is because there’s no definition of what each other’s roles are. We have a document that is perfect for that called a partnership agreement, where it clearly says, here’s your responsibility, here’s your responsibility. What’s so important about that is partnerships are great when they work because you can cover more ground faster. But if you both have the same skill set, you walk like ducks in a line and eventually cause a rut and that’s what you want to stay away from. So, find somebody that complements maybe what you can do, but has better skills in certain areas.

Cort:

Yeah, And I think, you know, there’s having formed hundreds of thousands of business entities, as we have over the years, we’ve absolutely seen it all. In fact, there was just an email I was looking at this morning between two partners that had a dispute and one wanted to see all the corporate records that we had set up originally, but they weren’t the person that originally came to us to form the business entity. But now they were demanding other records because they were in a disagreement. And we don’t give out those records to anybody but the principle that we dealt with originally. But it gets into some really sticky areas, and I think back to all the partnerships that I’ve had over the years, you know, sometimes I was a minority shareholder that got involved in an investment opportunity and, you know, the times where these did not work out. But I had no say. There was very little that I could do to influence, you know, the direction of the company at that point. And then times where I’ve been in 50/50 partnerships, which are most traditional, which I would recommend against, unless we can talk about that, and you can talk about that in a second here. But, you know, you go in with such great intentions and things change over time. Just like any friendship, things change over time, marriages as we discussed. But when you get into business, there’s a lot that goes on and we’re talking about money and egos and attitudes and who wants to work more than the other and who’s really bought in and who isn’t. So, there’s so much you have to be thinking about. And we could spend hours talking about this.

David:

Hours. I mean, it’s like different partners may have different philosophies in business and what they’re trying to see. And one of the things we’re running into from time to time is where one partner has the idea of, I’m doing this to make money and the other partner is doing this to grow something. Well, those are two different concepts, really, you know, because if you’re looking at growth minded people, you’re putting money back into the company, not taking so much out. So, all of those things need to be worked out. And when do partnerships fail? Most often the trouble in paradise starts happening is simply when things go wrong. Business isn’t doing as well as we thought it was going to be. Now finger pointing starts. Egos get into play. I told you so’s get into play. It gets nasty. It really parallels marriage sometimes. I’m not saying marriage is bad, but the same things that happen in a partnership in a marriage is likely to follow in business. And married partners, boy, now we’re really getting some murky waters.

Cort:

And we see those things well, they don’t end well, unfortunately. You know, however, I will say that when you think about starting a business and all the clients that we have that do come in as partners, sometimes that’s really the only way of getting a business launched and getting it successful because of what you bring to the table, both you and your partner. And even if you’re married to your partner in business, you know, someone’s focused on one side of the business and your partners focused on the other. And that can be a great thing to bring together those skills for the development of the business. But you have to think long term and, you know, as as I’ve seen so many of these scenarios, it comes down to, as you mentioned, finances, like are we reinvesting our success? Are we taking it to go pay for our fancy cars or the next house we want or the vacations we want? And these are all things that should be looked at upfront. So how are you going to know these things? Well, there’s actually documents, like you mentioned, the partnership agreement, that can be brought to the table to address some of these things. And money is probably one of the biggest issues.

David:

Absolutely.

Cort:

And I think the second one is the amount of time and energy that you put into the business is the second one, because there are different expectations. One person might have a spouse that expects him home for dinner every night. Okay? If you’re going into business with that person, I just wouldn’t. I’d recommend against it, you know, because oftentimes it takes weekends and nights to build and grow anything. And you both have to be fully committed to that.

David:

Yeah.

Cort:

What about a buy sell agreement? Where does that fit in?

David:

Well, it’s right there with the partnership agreement. These things need to be done in the beginning because when there’s nothing to squabble about, let’s get all this stuff ironed out. Right? So, the buy sell agreement is so important because it handles the voluntary or involuntary succession of a partner. Somebody dies or somebody wants out. How do we unravel this? It’s kind of a backup plan to somewhat of a revocable living trust, because if somebody does die, we want to keep everything out of probate. But the buy sell agreement to me is such an important document because it really sets the standard. It’s kind of like a prenuptial, right. If things don’t work and I’m sorry to bring up a negativity when we’re getting ready to get married or join a partnership, but we have to plan for these things because partnerships do unravel. And what it really comes down to is your responsibility to the company that you’re starting, right? Because if somebody walks away, I’ve had a case where equal partners, 50/50 partners, each of them have their own areas of expertise. But the guy that wanted out and quit, he owned the domain, he owned the website. He owned everything else. Now the other partner is really starting all over again because he didn’t have access to that as well as business credit. The other partner had developed and built the business credit. So, they didn’t have all these things ironed out. How do we unravel it? So, we have to have that. And you know, if you and I are partners, which I’d, you know, love to be your partner, but if something happened to me and I’m married and I die, maybe next in line for my partnership with you would be my wife.

Cort:

So, I’m going into business with your wife.

David:

Yeah. And she may have different skill sets than I. And, you know, you may not want to work with her.

Cort:

And I think it’s, you know, one of those things that no one’s bringing to the table, no one’s discussing with you. If you’re going to start a business with somebody else, that there’s some things you want to have worked out from day one. And for anyone that’s been through a second marriage that had any kind of, you know, wealth or assets that they wanted to address prior to, you have a prenuptial agreement. And, you know, I went through it. I know it very well. These are difficult conversations, but there are adult conversations and it all stems around what happens if things don’t work out and how do we address things that can happen in the future. And these adult conversations all too often don’t happen between partners in business, which is where the catastrophes occur. And your story about you know, one person building the business credit on their name and someone else owning all the, you know, the branded assets of the business, you know, those are like little compared to some of the things that I’ve seen where only one signer on a bank account and they started to drain the bank account and the other person didn’t have access to it. I mean, just crazy stuff. But if you deal with these things in advance, like the death of a partner, what happens then? Do you want to go into business with their kids and their spouse? Is that what your intention was?

David:

Potentially, yeah.

Cort:

That’s exactly what could happen.

David:

Yeah, and mentioning you know the partnership agreement side of it you know what are your duties what are your responsibilities? How much time are you committing to this because in a good partnership agreement is going to be a dereliction of duty in there as well. So, if you’re not holding up your end of the bargain, you could be voted out. A lot of times people come to me with a family partnership. Those are interesting dynamics. I mean, you still want to talk to these people at Thanksgiving and Christmas. So, people say, well, I don’t need it. I’m getting into business with my family. Okay, I get that you need it more than ever. You need to keep that a business relationship and have expectations in place. And unfortunately, there may be a time when, let’s say, you know, family business, one of the kids isn’t holding up their end of the deal that they need to be removed from the partnership. There needs to be those instruments in there as well.

Cort:

Yeah. And I’ve seen the, you know, spouses come in like, hey, we’re shorthanded. So, you bring your spouse in to take calls or, you know, do work in the office. And then once that happens, what about the dynamics that have now shifted you and your partner working together? Great. Now all of a sudden there’s a spouse in there who’s inputting, having a say in the affairs of the business that wasn’t there before.

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David:

Sure.

Cort:

It can blow up really quickly, David. Years ago, I had a partnership. It was a 50/50 partnership, was almost 20 years ago, and my partner went through a divorce. And we’re in Las Vegas here. And so, he went kind of wild after his divorce. And instead of using his personal credit card to pay for some of the fun that he was having, it was a business credit card. So, I started to see these bills come in and he’d tell me, well, no, I took some of our managers out. I took the staff out for an event. Well, okay, there was staff there, but it was his way of going out and celebrating and enjoying life at the expense of the organization. And so, we had some difficult conversations about what’s okay and what isn’t. And, you know, our relationship shifted after that because I felt like I was taking advantage of, that we always had open communications about these types of things. But now all of a sudden, he was expecting the organization to pick up some personal costs just because he spun in some managers and staff to his partying that he was doing.

David:

Absolutely, I wasn’t around for that by the way. Well, I mean, those things happen. I mean, you know you really get to know people when they go through certain life crises that can impact how they behave, how they conduct business, what they contribute to the business. And that’s one thing when you’re picking a partner is making sure that you’re aligned, you know, with what direction are we taking this company and have that from the very beginning. Those things can be written into those documents. A partnership agreement can say, we’re going to take X-number dollars out. But you know, investor or reinvest that money back into the company. So, the company has cost of capital to keep growing, because without that capital, it won’t grow.

Cort:

And you hit one bumpy economy. All of a sudden you need the cash, but you’ve been distributing it. And oftentimes what happens is one partner actually, you know, put some money away, the other one spent it all. Then you have a capital call where you have to put some money back in the company because things got soft in the economy or your business model shifted and one has to carry it for the other. And that becomes really interesting as well. So, you know, all these details matter and laying it out in front of doing a formal, you know, consummation of the business is always the best.

David:

Yeah, and then talk about basically what we’re talking about is equal vesting in the partnership where, we’ve both kicked in the same amount of money. We started the company together. Companies got to get fed some more money. You know, you’ve got the money to put in, I don’t. Right? So how do we how do we deal with that, that vesting part?

Because when it comes time to distribute profits, that needs to be considered. Right? So, there needs to be promissory notes in place. There needs to be documents that back up that additional funding that you put in to set aside from the original contribution to the company. So, all these things are important. I mentioned earlier, you know, people talking about I’m the partner for sweat equity. How do you quantify that? Right? And usually, you know, you’ve got one person that has the money, you’ve got one person that has some skills and talent. But how do you quantify that as far as how much of the company? So, there may be a time period that you want to vest that partner from a 30% ownership up to 49%, you know, to cover your backside as well.

Cort:

And I always think when you run into those situations, David, that you want to maintain control.

David:

Yeah.

Cort:

You know, you don’t go 50/50, you go 49/51. So, at least if things got bad, you could make the decision to terminate the other person that’s got a chunk of your business. Even if they still have equity, they don’t have to be involved in the control and they lose their voting, you know, basically rights in this case over the organization.

David:

Yeah. And let’s roll Nevada into this for a second. Nevada protects against the reverse pierce, which can sometimes come from within the organization. So, if you have one partner that’s being pushed out and now they’re going to start pointing fingers and, you know, I’m going to take this company, I’m going to force you out. So, you’ve got the documentation in place to do that. They can’t turn around with the reverse pierce and take back the company.

Cort:

Yeah. Interesting.

David:

Yeah.

Cort:

Very interesting. You know, and when you are in business and then you bring on some talent and we’ve seen this as well as far as giving up equity, having a minority partner even. I always think that the best way to do it is to figure out a way to compensate them, but not in the form of equity in the company, but in the form of payment. And so, you mentioned, you know, someone that you maybe couldn’t afford and you gave them some equity in the company for the time that they put in. You know, you could always have a promissory note that you gave them for what they were contributing when the money came into the organization. So, you don’t owe them that. Or if you’re bringing someone in that says, I really want equity in the business, I want to help you grow and build the business, I say, That’s fantastic. I’m excited about that. So, I’m going to build you a comp plan that you are going to be paid very, very well on the growth of the company and you’ll be very happy with that. But I’m not going to give you up any, give up equity. And one point I always bring up too is being a minority shareholder in someone else’s business isn’t necessarily a great thing, you know, because as you mentioned, you don’t have a lot of rights. You can get locked out. There’s ways of diluting your interest If you did give somebody, you know, some equity in the organization where they lose control, they lose rights to those shares. There’s just a whole bunch of things that the majority shareholder can do to basically force you out of the organization. And I always think it’s best on both sides, just come up with a compensation plan that’s very lucrative. And even if they can fire you or you can fire them is you can, you know, put protections in there, that if you do terminate somebody, you know, basically they still will get some income off the organization. There’s a lot you can do.

David:

Yeah, absolutely. And, you know, when you talk about partnerships in general, we have to always remember we’re talking about a legally formed partnership, not a general partnership. General partnership is two sole proprietors just working together. Misery seeks company is what I call it, and those have no protection whatsoever. These documents that we’re talking about specifically are to a legal partnership. And when it comes to tax time, it’s very important to understand too, those distributions go out. A lot of people get confused in a partnership structure that you’re going to be getting W-2 income and you’re not. You’re going to be getting distributions and you’re not responsible for what your partner does or if they pay taxes on those distributions because they’re going to them. So, it’s just another layer of protection, not just from liability, but also from taxes.

Cort:

And then so as you say that, then we think about, you know, what state should I register that first business entity in for my partnership and, you know, the laws specific to the state of Nevada and as you mention, are very unique. You think of a partner that could have a problem, a personal bankruptcy and a partner that goes through a divorce, a partner that gets in a bad accident and injures somebody. Knowing that the state where you form your business entity and together will protect you from those types of events coming back and affecting the business itself, therefore affecting your interests of the business is very important. And that’s really one of the things that sets Nevada apart.

David:

It does. And you know, Nevada is very unique to that. There are other jurisdictions that have certain protections and laws. But one of the things also unique about Nevada is the business court, right? You’re dealing with a judge in a situation like this. If and when this does go to court that understands all the dynamics of a business and all of these different things. And when they see that these things are in place, they’ll make sure they’re enforced. And that’s what’s nice about it.

Cort:

Yeah, I think that’s so important is, you know, you might decide, hey, I ultimately just want to form an LLC in my home state, let’s say you’re in New York or California, Florida, which is wonderful. But knowing that there’s a state that has some unique laws that in the event that something goes wrong with your business model or with one of the two partners or three partners that you might have in there, you’ve got a state that understands how to adjudicate these types of things, as a court system to protect you and as the laws behind it to protect the interests of those partners within that organization. That’s one of many uniqueness’s that sets Nevada apart. So, David, what if somebody wants to have a conversation with you about their partnership? How do they reach you? How do they go about doing that?

David:

We’ve got a great team at NCH. We’ve got a great division that handles all of these things, whether it’s just general business or real estate across the table. So, if they just go to NCHinc.com, there’s a link on there to schedule a consultation with one of our reps. And I’ll tell you, it’ll make a difference. Just give us a chance to talk to you about it. And I think you’ll feel the difference. And that’s what’s most important.

Cort:

And when we’re talking to you literally, you know, thousands and thousands of business owners every year, and having done that for over 30 years now, there is really not a circumstance that we haven’t experienced. You know, there really isn’t. I’m not surprised anymore. It’s kind of like, okay, here’s another one of these and there’s another one of those. And we help people through it, whether it’s a tax situation that you get yourself involved with or need support on. Or, whether it’s a legal situation and a partnership or something else that might occur in running your operation is, we have people on the tax side, on the legal side, on the support side to make sure that everything that you may run across in your business, we have people to help you with that.

David:

Absolutely. I mean, it’s sometimes fun to get something new, right? You’re like you’ve never heard of before. But just on a call today and I know the road that they’re going down already and I let them talk because that’s my job is to listen. But at the end, we’ve already got a solution because this this is not unique to us. It may be unique to them. That’s the big difference.

Cort:

So, when you think about going into a partnership with anyone, know the pros and cons, know that it doesn’t always work out. And if you plan ahead for that outcome, as David mentioned, those crazy statistics of, you know, partnership failures in business. Two people building the company together, getting along for the long term, and by getting ahead of it, having your business prenuptial agreement, a buy sell agreement and in a properly built partnership agreement, starting off and laying the foundation properly is one of the ways you’re going to get ahead in any type of partnership.

David:

Absolutely. All about getting out alive.

Cort:

Absolutely. That’s great. Well, everyone, thanks for tuning in to another episode of Wealthy and Wise. Please be sure to like and subscribe to our program today. And there’s also a link at the bottom here that you can click on, which will go right to a page as David mentioned on our Web site, where you can set up a call with one of our experts like David Vanlandingham and many others that work with our clients day in and day out, about your particular situation. And we’ll just have a conversation with you. It’s free of charge to you so that they can discuss with you exactly what you’re trying to do and how we can help you achieve your goals. Thanks for tuning in!

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

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