Entering into business with a partner can be great. In fact, you are more likely to succeed in business if you have a partner. However, entering into a partnership requires more thought as you now need to work in sync with another party. Many times, partners rush into business excited at the prospect of future riches and riding the high off launching a venture.
This excitement can lead partners to skip over crucial discussions that should be held before starting a business. Instead of having these essential talks, many partners pull a standard template off the web, never read it, and execute it. Only when a problem arises do they realize that the template was inadequate and that they made a mistake not addressing foreseeable issues. This can lead to you losing control of your company, financial hardships, and litigation. Here are five key mistakes to avoid when entering into a partnership.
Not Discussing Roles and Responsibilities One common pitfall is neglecting to clearly define roles and responsibilities. This is more of a business oversight than a legal one. Here’s why it matters: - Clarifies Expectations: Helps each partner understand their duties and what is expected of them. - Enhances Accountability: Assigns specific tasks to each partner, making it easier to track performance. - Promotes Efficiency: Reduces overlap and ensures that all aspects of the business are covered. Think of your business as a well-coordinated sports team, where each player has a specific role. Just as in sports, every team member in a business partnership needs to understand their position and responsibilities. Clearly defining roles not only ensures smooth operations but also maximizes each partner’s strengths, driving the team—and the business—towards success.
Splitting Equity 50/50 Often, partners believe that each one of their contributions is of equal value. That may be out of sincerity, politeness, or because they have not considered their roles and responsibilities. Though splitting equity 50/50 may make sense at first glance, it can cause issues whenever partners disagree and there is a deadlock. In that moment, the company is paralyzed as neither partner has company authority to act on behalf of the company. Consider granting a third party a nominal percent of the company who can be the tiebreaker. For instance, a tech startup faced a deadlock when the two co-founders couldn't agree on a critical decision. They resolved this by giving a trusted advisor a 1% equity stake, granting them the tiebreaker vote. This simple solution prevented potential gridlock and kept the company moving forward. Or, if partners are hellbent on splitting their equity down the middle, then they should consider drafting deadlock provisions that provide a procedure the company follows when partners cannot come to an agreement.
Not Putting in Vesting Provisions In a similar vein, companies should consider placing their equity on a vesting schedule (i.e., restricted equity). Placing equity on a vesting schedule means that a partner will receive her equity in tranches. For venture-backed companies, the standard vesting schedule is that a partner will receive 25% of her equity a year after grant and the rest over the following three years in monthly increments. But these should be specific to your company. In order to determine an appropriate vesting schedule, consider consulting legal or business counsel.
Not Putting in a Provision to Leave the Partnership or to Expel a Partner The most common issue that we see partners fail to account for is what happens if you wish to expel a partner out of the company. Many boilerplate partnership agreements don’t account for this scenario. At the beginning of a venture, parties often don’t think about ever leaving or at least do not wish to think about it. It is like a couple discussing a prenup before their marriage. No one wants to talk about what happens if the marriage doesn’t work out. It is almost blasphemous for one to suggest the thought. However, having this tough conversation will minimize the harm experienced by you or your partner(s) if the partnership dissolves. You all need to discuss the process of dissolution in advance of formalizing a partnership. It is an uncomfortable conversation centered around the prospect of their business failing or them falling out. But you will be extremely grateful that you had it if that event does occur. Also, it helps to hire counsel not only to navigate through the legalities of the agreement but to act as an intermediary who can absorb the awkwardness of the conversation.
Not Properly Drafting Your Partnership Agreement Taking the time to properly draft your partnership agreement provides huge dividends. It is a great way to start your venture out on the right footing. Not only does it provide downside protection in the case of something not working out, but it also allows you to get on the same page as your partners, increasing the likelihood that your business will be successful. Your business is a significant investment and safeguarding it should be a top priority. By implementing these measures, you protect your interests and set your venture up for success.
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