The Secrets to Avoiding Bad Partnerships

May 26, 2011
Executive Insights | May 2011 | By John Morell
The Secrets to Avoiding Bad Partnerships

Business partnerships can help quick-serve entrepreneurs make big profits, but if everyone’s expectations aren’t clear, they can ruin relationships—and businesses.
Emerald City Smoothie was founded by a group of business partners.

Business partnerships, like marriages, start with a courtship, a honeymoon, and then either years of bliss or a torturous separation. Although most partnerships have their own form of prenuptial agreement with ownership arrangements and corporate papers, those can’t prevent turbulence and breakups from occurring.

Experts say that learning more about a potential business partner is a critical first step to any such partnership, but also one that many entrepreneurs don’t emphasize enough. “People are blinded by what they see as a great opportunity that’s going to go away if they don’t jump on it now, so they might make bad quick decisions,” says Pam Faber, a partner with the corporate law firm LeClairRyan who specializes in the restaurant industry. “You find partners coming together because one might have restaurant expertise and the other has access to capital, but that’s usually not enough. There are some key areas you have to discuss, because if you don’t, you may be in for trouble in the long run.”

“What’s made our group work is the fact that we’ve worked together and we know each other’s strengths and weaknesses,” says Al Schriber, vice president of administration for Emerald City Smoothie, which has 55 units.

Great partners tend to have complementary strengths, Faber says, and these strengths are critical to consider from the outset. For instance, one person might thrive at the day-to-day operational elements of a business, while the other might be better with financing and spending, she says.

However, even partners who are seemingly perfect for each other may have underlying issues. “I saw one partnership that on paper looked like a great success,” Faber says. “Both people had complementary personalities and skill sets. They were both very focused on the business and it looked like a slam dunk for them.”

The company began to do well, as expected, but the partners began to argue about where profits should go, which led to an irreconcilable breakup. “One of them was looking at the business for supplementary income and just wanted the profits in his pocket,” she says. “The other partner had a bigger vision, which included growing the company by pumping profits back into operations.”

The result? Faber helped them get rid of the business. “They couldn’t resolve their issues and sold the company over a question that should have been discussed the first day they met: What do you want from this business?”

For Chad Smith and Kurt Prestwich, the answer to that question was easy when they went into business together. Their families had known each other for years, and the two Las Vegas–based entrepreneurs had talked for a long time about leaving their jobs to do something together.

The friends had been watching the growth of Yogurtland, the frozen yogurt operation with locations in 13 states, and thought it was time to bring it to Las Vegas. “Kurt’s family was in the restaurant business, so he knew how to run the operations side, and I knew the financial end, which worked for us,” Smith says.

The two own and operate four Yogurtlands in the Las Vegas area and say that after three years, their partnership has survived the stresses of getting the business going. “It can be a challenge, but it works for us since he’s more reflective and doesn’t react to issues like I do,” Smith says. “If we were both type-A personalities, we might not get along as well.”

Having both partners understand the franchise they’re buying into and the functions of a business is critical to a successful partnership, says Kelcey Lehrich, franchise director for Fresh Planet, a fast-casual concept with four stores in the Cleveland, Ohio, area.

“Good partnerships aren’t made just because people have the money and they’re willing to work. They need to have some business sense,” Lehrich says. “I’ve seen people who come together and one is a businessperson and the other doesn’t have that same savvy. They’re enthusiastic and positive about buying a franchise, but I can tell that it’s not going to work for them. It’s like a marriage where one person thinks they can change the other. That doesn’t happen, and if you think you’re going to make your partner a good businessman, that’s not likely to happen either.”

When talking to potential franchisees, Lehrich says he asks them for proof that legal details have been agreed upon already. “If they’ve reached the point where they’ve had an attorney draw up agreements and contracts, that usually means they’re serious and they’ve passed an important milestone,” he says. “You can’t get into a business like this on just a handshake. It takes a commitment from all the partners involved.”

For her part, Faber says she usually gives a questionnaire to potential partners who are interested in co-ownership. “Besides the basics like, ‘What’s your business plan?’ and ‘Where do you see the franchise in five years?’, we look at the tougher questions: ‘What do you want your exit strategy to be?’ and ‘How will you handle the business if it fails?’”

Among the issues that Faber says need to be looked at are bad actions. “This is when you find that buddy you’ve known for a long time and whom you’ve been in business with for a few years is skimming money from the register,” she says. “Or he’s disgruntled with you and sabotaging the business.”

A succession plan is critical for a partnership because if the relationship gets shaky or unforeseen issues occur, it could destroy the business. “I’ve seen situations where one partner is in a coma and the other has to do two jobs or hire someone to fill in,” Faber says. “That’s where you may have to exercise a clause in your contract to buy the other person out.”

Another issue with forming a partnership is how to organize it. The trend of the past decade, Faber says, has been to create a limited liability company (llc) because of the flexibility it provides.

“You can more easily carve up everyone’s duties, specifying, for instance, that one person will spend 25 percent of his time on the business while another will spend 75 percent,” she says. “If you have a general partner who is running the business, you can set up how much oversight the other partners have in the day-to-day operations.”
“Good partnerships aren’t made just because people have the money and they’re willing to work. They need to have some business sense.”

But figuring out who does what and when can become the source of resentment over time. It’s not uncommon for someone with capital to team up with someone with operations experience as a partnership in a franchise, but divvying up profits can vary.

“With Kurt and I, we’re 50/50, but we may be the exception,” Smith says. “I know of other partnerships where it’s 75-25 or 85-15 in favor of the partner with the capital. I didn’t want that; Kurt and I are equals in this and we both need each other to make it a success.”

Despite the advantages, an LLC may not be for everyone. For instance, creating a corporation can be more beneficial for some tax considerations, but it limits the ability of dividing up business duties, Faber says.

While getting two people to agree on and succeed at a business partnership can be daunting, getting 10 people to do so can seem downright impossible. But that’s exactly how Schriber’s Seattle-based chain Emerald City Smoothie operates.

“Two of us are full time, three of us are available on an as-needed basis,” he says, “and we regularly update the other five on what’s happening in the company.”

Schriber says that element of communication is the key for any partnership to be successful. “You need each person to give an honest assessment of what’s going on so that no one is in the dark about what’s happening,” he says. “You don’t want any surprises since you’ve got money in the game and you want to see your operation succeed.”

Another potential minefield is a partnership made up of family members. “Many times people will bring the family issues into the business, where they’re not needed,” Faber says. “A parent who’s used to having the final say may not like his daughter having an equal voice in the business, so there’s some growing up that has to occur to make some of these successful.”

For brother and sister Tom and Cheryl Jones, owning four Cousins Subs shops together in the Milwaukee area has been a natural partnership. “We really took to our jobs with me handling marketing and back-office work and her doing the daily operations,” Tom says. “One advantage over any other partnership is that we know each other so well. I know she’s not going to steal from me, and she trusts me the same way.”

Still, spending holidays with your business partner can make it feel like you never get away from work.

“At family events, we don’t talk about business,” Tom says. “So hopefully we can keep it going that way.”