The dramatic court case in the UK involving the Barclay Brothers (owners of the Ritz Hotel and Telegraph Newspapers) highlights the difficulties that can arise from having business partners and, particularly, family business partners.
I thought I would consider some of these problems and possible solutions in this blog, particularly in relation to private companies or small partnerships.
(Legally speaking, a “partnership” can arise either from having fellow shareholders in a limited company, or being partners in a pure partnership. For the sake of this blog I will consider shareholders and partners as being basically the same thing.)
Should I or shouldn’t I ?
Most business owners face the dilemma sooner or later of whether they:
- Should trade on their own, or
- Go into a form of partnership.
They will weigh up the advantages of having a partner against the advantages of not having one before reaching a decision.
However, although the advantages of having a partner can be obvious, the disadvantages are not so obvious. This is true especially for those contemplating having a partner for the first time.
The advantages of a partnership
The main advantages of a partnership can be summarised as follows:
Most of us are good at some things and not at others. Many business owners start a business because they have a technical ability in their chosen industry. This could be this mechanical, technical, or creative. However, these technocrats often lack other skills necessary for a successful business. These other skills could marketing, selling, people management or financial management. Therefore, taking on a partner or partners with skills to fill the gaps makes good sense.
Many startup owners need finance they don’t possess to develop and grow their businesses. However, they can raise finance though various sources, one of which is to bring in a partner with capital. The ideal arrangement is where a partner has both the complementary business skills and the necessary capital.
Sole traders can find business very lonely. Just having someone to talk is a great help, especially in the early days. Working in a team environment can also be stimulating and invigorating. Therefore, bringing in a business partner to overcome loneliness and for more personal stimulation could be a solution.
The obvious disadvantages of a partnership
This where things get a bit tricky. Let’s examine the obvious disadvantages first and then we will look at the not-so-obvious ones.
- One of the advantages of taking on a partner, covered above, is the introduction of capital required to set up and develop a business. However, a fundamental purpose of a business is to generate an adequate living for its owners and some businesses are unable to provide a living for more than one person in the long term.
- A common problem in business is that partners fall out. This is particularly true in small businesses where partners are under each others’ feet all the time. The reasons for the fall out can include a mismatch of business abilities, or jarring personal chemistry, or a disagreement on job descriptions and responsibilities.
- Destabilising pressures can be put on a partnership. For example, pressures from spouses who believe that their partner is taking on too much work and/or responsibility, or is not being rewarded fairly for the work they are doing.
- It is an unfortunate fact of life that some people are dishonest. Many partners have stolen from their businesses, with devastating consequences for their business partners and families. Think of Robert Maxwell in the UK and Bernie Madoff in the US. Consider how their dishonesty ruined their businesses and shattered the lives of their business partners and children, who in some cases where the same people.
The not-so-obvious disadvantageous of a partnership
Partners do not always consider what could happen when they enter into partnerships. These include the following circumstances:
- The sale of the whole business, arising from a severe fall out between partners and a break up of the partnership.
- One of the partners leaving prematurely for reasons of ill health and wishing to dispose of their interests.
- One of the partners behaving in such a way (for example, bringing the partnership into disrepute) that the other partners wish to remove them from the business and compel them to sell their shares.
- The majority partner wishing to sell the whole business for reasons not necessarily related to retirement or partnership fall out.
These circumstances can lead to numerous problems for the leaving or remaining partners and are considered below.
1. Any partner wishes to sell their share of the business
The most obvious problem with any sale of a share in the business is the resultant disruption. But there are also other important questions that arise, including the following:
- Is the partner entitled to sell their share in the business to a party other than the remaining partners?
- If so, to what other parties?
- If the sale has to be to remaining partners, how is the share to be valued and who will be entrusted to value it?
2. The majority shareholder wishes to sell the whole business
Some of the following issues can arise:
- Minority shareholders or partners are happy to sell at the price stipulated by the majority shareholder/partner.
- Partners or minority shareholders are happy to sell, if a price to be paid for their minority interests can be agreed.
- Minority shareholders or partners refuse to sell their shares.
A properly drawn up shareholders’ or partnership agreement is the solution to most of the problems outlined. Importantly, you should draw this up at the same time as the initial shares or partnership interests are sold or allocated.
1. The sale of interests by any partner or shareholder
The shareholders agreement should include the following:
- Agreement as to whom a leaving shareholder or partner is allowed to sell their interests. This could be to the remaining shareholders, or to nominated parties such as family members, or to anyone at all.
- Agreement as to how the interests being sold are to be valued. Is this, for example, at a predetermined set price? Or at a price based on an agreed multiple of profits (or turnover) over an agreed period? Or at a nominal price only?
- Agreement as to who will undertake the valuation. For example will it be an independent valuer appointed by the majority partner?
- Recognition that the circumstances of sale may vary. For example, a partner may be forced to sell due to fraud or negligence on their part. (This is known as a “bad exit”). Alternatively, a partner may leave in a “good exit”. This includes leaving due to natural age retirement. Importantly, should the agreement on the acceptable buyers and the calculation of the sale price differ between a bad exit and a good exit?
- Provision to enable remaining shareholders to purchase the interest of the departing one. In the case of death, this will usually be in the form of “cross-insurance”. It is more difficult to provide funding in the case of age retirement,
2. The majority shareholder wishes to sell all of the business
Although many small shareholder and partnership holdings are equal between shareholders and partners, many are not equal. Often, a founder owner will introduce minority partners into the business. Additionally, he may issue shares to employees as a reward or incentive to remain with the business. These shares or partnership interests are often only a very small percentage of the total shareholding.
When the majority shareholder receives an offer to buy the whole business he must be able to deliver the whole business to the offeror. He does not want to be reliant on the minority shareholders’ agreement to sell their interests for the sale to complete.
There is a way to avoid the need to request the minority shareholders’ agreement to sell. That is to have a shareholders’ agreement in place that compels minority shareholders to sell their shares when the majority shareholder wishes to sell the whole business.
The shareholders’ agreement should also address the question of the price to be paid for the minority shareholders’ shares. This price could be:
- The same price as the majority shareholder’s price.
- A discounted price in recognition of the fact that minority interests are usually valued at a lower price that majority interests.
- A premium price in recognition of the sacrifice the minority shareholders are making where they have not themselves chosen to sell.
In theory, a properly prepared shareholder’s agreement should overcome many of the difficulties that arise from shareholder disputes, or the sale of shareholder’s interests. However, like all written agreements it is not a certain cure-all solution and relies on human goodwill to ensure even relatively trouble-free relations between partners.
In the real world of business the crucial decisions facing business owners, are:
- Deciding whether they really need business partners, and
- Choosing the right ones!
An interesting article on how to find a business partner can be seen at: https://articles.bplans.com/how-to-find-a-business-partner/