Often times it absolutely makes sense why a solo entrepreneur at some point or another would want to enter into a partnership with someone else, such as a friend, family member, or random business partner. For one, two heads are better than one and also because it helps ease the loneliness that can sometimes come with solo entrepreneurship.
Additionally, it might appear to be the easiest solution for partners to elect to have a 50/50 partnership on everything because it’s easier to accept equal shares than having the awkward conversation about who should get more shares. However, before you enter a 50-50 partnership, it is important to understand why this is not necessarily in your best interest and why it is important to tackle this awkward conversation early on before the business is fully established and it becomes messy.
Imagine your business has taken off and you are eight months in and thus far everything has been going smoothly, all of a sudden, you and your partner cannot agree on a major decision, you reach a deadlock and the company can’t seem to move on until a decision is made. This can be the death knell of any partnership, which could ultimately lead to litigation and the court ordering liquidation of the business which could be devastating for both partners from a financial standpoint or from an emotional standpoint because EVERYONE loses. Let’s assume the deadlock is not a critical decision, this can still cause bad blood if it continues to happen if there is constantly a stand still situation because both parties cannot agree and can ultimately still lead to dissolution.
So, while partnerships have their benefits, they can also quickly turn into an ugly, nasty nightmare if you do not have proper operating agreements or bylaws determining how to deal with deadlocks. You want to do this before you begin spending a dime on the business as you could ultimately lose all your hard earned sweat or financial equity in the company.
So here are four steps you can take to solve potential deadlock pitfalls of 50/50 partnerships while still giving the partners a relatively equal share in the profits and losses:
1. You can elect to form your partnership as a corporation and appoint at least three boards of directors, including the two partners. This way you have one additional non-shareholder on the board as a potential deadlock tie breaker for decisions that affect the company that you and your partner cannot agree on.
2. Create a deadlock proof operating agreement or By- Laws. While in some states, you are not required to have an operating agreement if you have an LLC, it would serve you well to have one. Include important provisions such how the business will move forward with a decision in the case of a deadlock situation. Such as a trusted third party to bring in to break the deadlock.
3. A 49/49/2 partnership. Here you add a trusted 2 % partner, who, while not sharing as much in your profit and loss, still has an interest in the company’s success and most importantly can act as the swing voter should a deadlock arise. It is important that you do not select an arbitrary 2% shareholder. Instead the partners should really think about a person who has the interest of the company at heart and also understands the business, so they can make informed decisions when it comes down to their vote.
4. Ultimately, the easiest option in addition to a well crafter operating agreement or set of By Laws, is to create a 50/50 profit split and hold a 51/49 decision making split. So here, while you share the same amounts in profits and losses, the 51% share owner will have the controlling vote in decision making and can choose to use it in a deadlock.
Most of these steps are best taken before you start your business. If you have started your business, you can make room for an amendment or change in organizational design. If you are already dealing with a deadlock, it might be too late to change these, but it would be advisable to think about the end goal of your business, which is that both parties obviously want the best for the company hence why both feel strongly about their positions. If you are able to remember this, it would be much easier to come to an amicable solution that doesn’t include liquidation of your business because both parties have all to lose here. If you are not able to get past this, consider your other options before you chose litigation. Litigation is often expensive, emotionally draining and time consuming, so when possible, mediation is a good option to determine if both parties can come to an unbinding resolution and if that fails, consider arbitration. Note that with arbitration the decision by the arbitrators will be binding. Nonetheless, both these options would often save both partners’ money and be resolved quicker.
Finally, a lot of these can be avoided by contacting a trusted legal advisor to advise you on organizational setup and agreements before you enter them.
Ayesha Chidolue is the Managing Attorney at The Chidolue Law Firm. We are a boutique law firm that acts as a trusted legal advisor to small business owners. Attorney Chidolue is licensed to practice law in the states of Florida and New York. At The Chidolue Law Firm, we can guide you through organizational design and set up as well as with a proper operating agreement and/or bylaws for your business from the onset of the partnership. If you need legal assistance with your business, we will be happy to assist you. Please contact us at firstname.lastname@example.org or call us at 407-995-6567.