The number one reason partnerships fail

Business partnerships can be just as tricky as personal relationships. John Knight explains the top reason business partnerships fail and what you can do to prevent it from happening to you.

Many businesses are owned by more than one principal.

Sometimes these multipleprincipal businesses are family businesses with one spouse looking after sales and the other looking after property management and back office.

Sometimes, they are successful businesses with unrelated principals working together.

However, not all partnerships are successful. Many of them fail. There can be a whole range of reasons why partnerships fail, but the number one reason I see is when they haven’t discussed and implemented a strategy to deal with any inequality in what each party contributes to the business.

To explain, I’ll use what I call the bucket analogy.

Think of it this way:
1. Every business has a bucket- this is where all the profits and equity of the business accumulates before being distributed.

2. Profits and equity are distributed in proportion to your ownership percentages. So if it is a 50:50 partnership, 50 per cent would come out to each partner.

3. Each partner is required to put something in the top of the bucket. This may be time and effort, money or referrals, and so on.

4. Sometimes a partner will take something, such as a wage or a commission, out of the bucket before the profits and equity are distributed in their ownership percentages.

5. If items of a different value go into the top of the bucket (point 3), then it is essential that something comes out of the bucket (point 4) before profits and equity are distributed.

6. If not, over time one partner will eventually feel like they have contributed more than the other. Over time their dissatisfaction builds to the point of frustration that prevents them from working effectively together.

Let me give you an example:
• Aaron and Amy decide to go into business together and buy their boss out.

• Aaron has been the top salesperson in the team for years and has taken on a leadership role with the rest of the team.

• Amy has been running the PM side of things and experienced significant organic growth in recent times.

• They decide to buy the business through a company with 50:50 ownership. The bulk of the purchase price is attributed to the rent roll and they each finance the business in equal proportions.

• Both partners are expected to devote 100 per cent of their work time to this business.

• The plan is for Amy to continue to run and grow the rent roll as well as the majority of the back-office responsibilities.

• Aaron is to run the sales team while still making his own sales to improve profitability and reduce risk.

Typically, the key arrangements that need to be agreed relate to remuneration:

• What commission, if any, does Aaron get for his personal sales?

• What remuneration does Amy get for managing the rent roll?

• Does Aaron get a salary for the sales manager role?

• Does Amy get any additional remuneration for the growth in the rent roll?

• Does Amy get any remuneration for managing the back-office?

It is tricky to compare the roles and remuneration in this scenario because one contributes sales and immediate cash flow while the other contributes stability and capital value.

Aaron and Amy may agree between themselves that they are contributing the same amount of value and not require any adjustment in remuneration, but if they do not have this discussion upfront and implement a strategy to deal with any real or perceived inequality, sooner or later someone will feel ripped-off and the partnership will fail.

That’s why it’s important to ask for help, discuss the drivers of any arrangement and document them in a partnership or shareholders’ agreement.

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John Knight

John Knight is the Managing Director of businessDEPOT, a team of energetic accountants and advisors.