How to Avoid Losing a Friend when You Become Business Partners

Many of life’s burdens – big and small – are lightened with a friend for support and this lesson has not been lost in business. If you’re thinking of starting a business with a friend or family member, you’re not alone. Some of the most enduring and positive American companies were founded by a couple of friends who had an idea. They didn’t always have a lot of start-up cash, but they had each other.

• UPS was started in 1907 by two teenagers with a single bicycle and a hundred dollars borrowed from a friend. Back then the U.S. Parcel Post wasn’t around and there was plenty of opportunity for the American Messenger Company of Seattle, Washington.
• Ben and Jerry met in seventh-grade gym class in 1963. A decade later, they took a five-dollar correspondence course in making ice cream.
• In 1978 two 20-something friends, John and Rene pulled together $45,000 to open what started as SaferWay and later became Whole Foods Market. Times were so hard on the friends they lived in the store and reportedly bathed using the hose disconnected from the dishwasher.

In fact, about half of all start-up businesses today are organized around a friendship and there are good reasons for this. Underlying a strong friendship is the expectation of a higher level of loyalty, sharing, and understanding that’s uncommon in many work environments.

The spreading of responsibility can alleviate the stress of starting a business and having a trusted partner to rely on in times of change can be a great help. Often, friends who create business partnerships share complementary skills and the business can thrive off the healthy working dynamic that would not be possible with a single business owner attempting to do everything alone.

If the friends have known each other for many years and perhaps even worked together in the past, their friendship may have already experienced its own share of problems, which can give the friends a perhaps unfair level of trust that the business partnership will be a success. Unfortunately, business owners who started as friends don’t always end up friends and the friendship can be decimated in the aftermath of the business partnership.

1. Should you form a legal business partnership?

The decision to create a business partnership with a friend is tempting, but there are many legal considerations to address before shaking on the deal.

A legal business partnership is – very simply – an unincorporated business relationship that is subject to regulations, taxes, and even government review (depending on the industry). It’s also a less complicated way of getting a business on the ground quickly and so many partners opt to go this route.

The benefits of forming a legal business partnership include:

• No complicated incorporation paperwork or fees (a huge benefit for start-ups on a tight budget).
• Each partner contributes to all aspects of the business from making decisions, to profit sharing, to the burden of taxes (spreading the responsibilities and sharing the stress).
• Inclusion can be used as a powerful incentive to motivate exceptional contributors (what better reward for dedication than the ability to become a founding member?).

While a partnership agreement can be as loose or as detailed as the partners like, it’s always a good idea to have it reviewed by an experienced, professional small business attorney to ensure that it doesn’t have gaps and that it will stand up in court should it need to.

2. The Types of Business Partnerships

Essentially, there are three types of business partnership agreements:

1. A general partnership which divides the profits, liabilities, and management duties equally across the partners or unequally using a defined percentage.
2. A limited partnership which allows partners to minimize their liability and input. An example of this types of partnership is a silent partnership – where one partner is the money behind the business and the other assumes the responsibility of developing the business.
3. A joint venture partnership, which is essentially a general partnership that expires at a defined time limit or when a certain phase of development is completed.

3. Forming a Legal Business Partnership

Once the decision has been made to start a business together, and before you register the business with state and local governments, as well as with the Internal Revenue Service (IRS), you’ll want to create a legally binding partnership contract to address six critical areas:

1. What are each partner’s roles and responsibilities?
2. Where is the start-up money coming from?
3. How and when will each partner be paid?
4. How much of the business does each partner own?
5. How will you solve conflicts between the partners?
6. What are the rules for exiting the business?

Typically, partners will set up equal ownership with each contributing half of the initial investment, but terms can vary greatly depending on a number of factors.

4. How to Know When it’s Time to Call it Quits

While a business partnership may make perfect sense for a start-up, there may come a time when business growth necessitates the dissolution of the partnership. Knowing when it’s time to call it quits is tricky but it’s a necessary step to address if the business is to continue to grow. The following are signs that it might be time for the partnership to end:

• When the liability risk becomes too much for the partners to bear.
• When the number of partners gets unmanageable and the business is being run ‘by committee’.
• When it’s time to woo venture capitalist investment in order to take the business to the next level.

In any of these situations, it may be time to incorporate the business instead and set aside the looser business partnership agreement.

In the end, a partnership should be between two people with common goals and of similar minds and a friendship should be a close relationship between two people who like doing things together. A well-defined business partnership is essential to keeping the partnership as well as the friendship running smoothly. If things in the partnership get cloudy or hostile, you can turn to the partnership agreement for guidance and keep your friendship solid.

Matt Faustman is the co-founder of UpCounsel, the fastest growing online workplace for businesses to easily hire trusted business lawyers, corporate lawyers, patent lawyers and many other types of legal professionals. He frequently posts on the UpCounsel blog on business legal issues, efficiency, and the future of labor. You can get more great business insights by following him on Twitter at @upcounsel.