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How to start a business partnership without hurting your finances

Rule no. 1: Know your business partner well and put guardrails in place to prevent misunderstandings down the road

Summary

Launching a business venture with a partner can be exciting – or a total nightmare if disagreements about money put the business relationship at risk. Here are the steps entrepreneurs can take to start a business relationship on the right footing.

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There’s nothing more exciting than teaming up with a fellow entrepreneur who shares your vision for starting or growing a business. Some of the biggest businesses in the world – Google among them – have two co-founders.

But not all business partnerships work out as well, and some break up. Disagreements about money are a common reason.

These disagreements can develop around how much startup money you will each put in, what purchases are OK to make, how quickly you will each start to take a paycheck, how decisions related to credit will be handled and a host of other issues.

Missteps can sometimes have serious consequences – like ruined credit.

“There are plenty of minefields if you’re putting together your business with one or more partners,” says Peter Mahler, partner in the law firm Farrell Fritz in New York City and head of the firm’s business divorce practice. “The best answer is vigilance. No matter what your partnership agreement says about who can do what, if the partners have company credit cards, how else will you know what is going on unless you are vigilant?”

Fortunately, if you take time to get to know a potential partner, have candid conversations about money before you team up and put the right processes and documents in place, it’s possible to create a partnership you both can benefit from.

Here are some steps to take.

See related: Who is responsible for business card debt?

Get to know each other first

Teaming up with a partner you’ve worked with before can take some of the guesswork out of choosing one and give you a chance to align on business-related matters.

Jason Martin and Patrick Falvey worked together at a tech startup before forming their software development agency, DjangoForce, in Boise, Idaho, in 2016.

They had become close friends before forming their 50-50 partnership – which both agree has been extremely smooth – and do ultramarathon running together.

Knowing each other well has made it easy to work out issues like who would take out credit cards for the business.

“We’ve taken them out in both of our names, and in the business’s name as well,” says Martin.

What if you’ve just met someone who seems like the perfect partner? Find a way to work on a few small projects together. Get to know them outside of work, too.

Go out for a beer or play tennis – more than once – so you feel comfortable discussing your true aspirations for the business. You should also discuss what personal resources you can bring to the table, whether you need to take a paycheck from the business in the first six months and any ongoing personal or business situations that may affect your finances, like a divorce or lawsuit.

“If you don’t have a good understanding of who they are and where they want to go, it will put a strain on the business partnership,” says Bob Gavreau, a CPA and partner in Gavreau & Associates, an accounting firm in Toronto. “A lot comes down to how finances will be managed. Who is investing what money and time to make it successful?”

Keep good records

As you dive into starting your business, make sure to keep accurate, up-to-date financial records.

Find an accounting software program you like (Freshbooks, QuickBooks and Xero are popular options) or an outsourced bookkeeping service, such as Bench or Bookkeeping Express, so you always know where the business stands financially.

Gavreau said it’s easier to prevent disagreements about finances and costly mistakes if you can address the following key questions accurately and make adjustments in response:

  • Are you making money?
  • Are you selling what you initially said you are going to sell?
  • Could you run into trouble because your costs are higher than expected?

“So many small business owners are running their businesses blind instead of being able to say, ‘We are on track to realizing our vision,’” says Gavreau.

Put cash flow front and center

Many business partnerships fall apart when the company’s bank account runs dry. By building good invoicing and accounts receivable processes into your daily operations, you can prevent that strain on the relationship.

If you’re not selling a product where it’s customary to get paid at the time of purchase, ask for deposits, advises Gavreau.

“When people are getting started, this is one area where they fail,” says Gavreau. “They deliver so much but are not collecting. They get into debt because their cash management is so poor.”

See related: How can I improve cash flow for my business?

Decide how you’ll handle credit

Falvey and Martin each had good access to credit, so they had the option to divide up any debts the business incurred. However, sometimes one partner is in better financial shape than the other. This may be the case when, for instance, a seasoned industry veteran teams up with a young college graduate.

“If one individual has better credit than the other, they have more borrowing power,” says Mahler. “The partnership will be leaning on them more to get started.”

One way to prevent resentment is to ensure your partnership or shareholder agreement addresses how you will handle debt. For instance, there might be an agreement that debts will be paid back before profits or proceeds are distributed.

“It’s very important to have these conversations with your business partners to make sure there is a very clear understanding of how any profits or cash management are being completed inside of the business,” says Mahler.

If there is a big disparity in how much debt you and your partner will be taking on, consider adjusting how much equity you each have, recommends attorney Andrew Sherman, a partner with Seyfarth Shaw in Washington, D.C.

“If you’re the deeper pocket and are assuming more risk, there should be a reward,” he says.

Address how you’ll handle big purchases

Some partners adopt a policy that each has discretion to make purchases unless they exceed a certain dollar amount, for transparency’s sake.

At DjangoForce, Martin and Falvey have decided it’s OK to make small, routine purchases for the business without running them past each other. However, says Falvey, “for larger stuff, we’ll talk with each other.”  

If you’re working with a partner you don’t know as well, you may want to formalize an agreement like this.

Sherman recommends detailing in your charter and bylaws or operating agreement what will happen if there is an unauthorized purchase that’s not in keeping with the business plan of the company.

That way you won’t have to worry as much about a partner unexpectedly doing something like buying a sports car on the company dime.

“Clearly, buying a Lamborghini would be inconsistent with the business plan,” says Sherman.

Some businesses create an escrow account in case of unexpected liabilities like this, says Sherman.

“If you don’t know your partners very well, that’s all the more reason not to assume trust,” he says. A general liability insurance may also offer some protection, though, he says, many policies do not cover fraud.

Figure out what will happen if the partnership ends

Sometimes partnerships come to a sudden end because one partner gets sick or injured – or passes away. Unpleasant as that scenario is, make sure you and your partner cover how you would handle it in the buy-sell agreement for your business.

If you don’t address this, one of you could someday find yourself in business with your partner’s spouse, who may or may not have any knowledge of the business.

Martin and Falvey, who are both married, made sure neither will have to deal with that scenario by purchasing a life insurance policy. “The life insurance policy would be used to buy out the other half of the business,” says Martin.

Hopefully it’ll never come to this, but if you’re building a valuable business, you’ll sleep easier knowing that the only business partner you have will be one you have chosen voluntarily.

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