The only kind of ship that won’t float is a partnership… Dave Ramsay
Roughly half of my corporate clients are structured in some form of partnership. Running a business can be lonely and stressful and depending on your personality it can be helpful to have people around you that you can lean on and keep you moving in the right direction. It’s also helpful to have an equity partner when raising capital or creating a division of labor especially in organizations that require many and varied skill sets to operate. Granted that does not need to be in the form of a formal partnership but being a lone wolf is not any better or worse, structurally speaking, that having a formal partnership structure of some sort.
I’ve seen it a number of times though, two friends meet in college or on the job and decide that it would be fun to be in business together. They develop a concept, raise some capital and set out into the brave world of entrepreneurship. But not too far down the road they run into some form of conflict, they have difficulty getting a product to market, lose their funding or one party just loses interest and before long the company in mired in conflict and infighting worthy of a daily soap opera. That is what radio personality and author Dave Ramsay is referring to in the quote above. When conflict inevitably strikes, partnerships sink.
That’s why I work with all of my corporate clients that are structured as partnerships to make sure they have a well planned and iron clad partnership agreement. I am not a lawyer but I consult regularly with businesses on structural and managerial issues. In my experience the partnership agreement needs to clearly spell out what to do when the partners experience one of the four Ds.
The first two are the most dramatic, the least common and the easiest to deal with using some simple insurance type products. The last two are far more common and take a lot more planning and forethought to deal with upfront but believe me, if you make the effort now it will save you a ton of heartache later. Dissolving a business partnership is not unlike a divorce and your partnership agreement is kind of like your pre-nup so take the time to get it right, you’ll thank me later.
I’ll tackle the first two Ds today and come back to the last two in my next post.
Contrary to what many people believe, under family law when a partner in a business dies his shares in that business do not automatically transfer to the surviving partners. They instead transfer to his surviving spouse, children or other next of kin. What the means is that if you are in a partnership with someone and they die, you are automatically in business with the heirs of their estate. Those people may have absolutely no interest or ability in being in business with you or they may be simply incompetent or just plain crazy. If losing your partner wasn’t enough to sink the business, being in business with his distraught widow could be exponentially worse.
In most cases the easiest way to combat that eventuality is with a criss-cross Life Insurance ownership. Each partner buys life insurance equivalent to the value of their shares naming the other partner as the beneficiary. When one partner dies, they use the proceeds of the life insurance to buy the shares from the deceased partner’s estate. If the company is structured as a corporation we can have the company purchase the policies and pay the premiums with corporate pre-tax dollars but then actually getting the money into the hands of the deceased partner’s estate is a bit more complicated. That’s a specific discussion that I would have with an individual client but the concept here is pretty straight forward and there is no reason why any partnership would exist without some form of life insurance on the partners.
Similar to the situation with death, if one partner is unable to work the value of the company is likely going to go down. But partnership owned disability insurance is a lot more complicated than life insurance because we are trying to accomplish multiple results. Not only are we trying to preserve the value of the disabled partner’s shares, we are also trying to replace his income and perhaps hire a replacement to do his job. This is often accomplished through the purchase of three different disability insurance products.
First we look at business overhead insurance. This is a disability policy designed to help pay the day to day expenses of running the business in the absence of a key person. Second we look at an income replacement plan, coverage to pay the salary of a disabled person while they are unable to do the regular activities of their job. And thirdly we would look at Key Person insurance, designed to provide start up capital to hire a replacement for a key employee or business owner in order to keep the business afloat. All three policies can be owned either individually or corporately. The ownership structure of the policies is dependent on the structure and type of business you are running and would again be a specific discussion I would have directly with the partners.
For more information on the process of structuring theses policies inside a well crafted partnership agreement write to: email@example.com and stay tuned Wednesday for part 2 of this discussion when I tackle the remaining Ds, Disinterest and Distraction…