Recent statistics for the divorce rate in America show that 50 percent of marriages end in divorce. I would venture to say that 75 percent of partnerships end in “business divorce.” I don’t have hard facts for that number, just years and years of experience. Think about it: If people who fall in love can’t even stay together, what makes us think that people who aren’t in love can?
Over the years, I’ve experienced plenty of crying sessions in my conference room, all of them dealing with a business divorce. Here’s the most common scenario: You, the entrepreneur, have a fantastic idea, great vision and are hardworking. But you’re strapped for cash (sound familiar already?). You approach a wealthy friend, Mr. Deep Pockets, for an investment. The friend agrees to invest some money for 50 percent ownership interest in the company.
Your eyes get big at the sight of the check as you begin to imagine all you can do with the money. You and Mr. Deep Pockets have been friends for years; it seems like a beautiful partnership. You take the check and shake hands. Then, two years down the line, you’re in my office screaming that you’re tired of doing all the hard work while your lazy partner sits around and reaps all the rewards. “It’s not fair,” you cry.
Well, no, it’s not fair. Life’s not fair, and when you make a bad business decision, you’re often stuck with it.
So what do you do? You need the money.
Have your cake and eat it, too
Even though you’ve been best friends with Mr. Deep Pockets for years, try not to give away the farm. Your equity is precious. Consider these options:
1. Unsecured loan
Why not take the check and treat it as a loan? Be creative with the terms. For example, consider a higher interest rate in exchange for no payments for six months or a year.
2. Profit sharing
Okay, it’s true, Mr. Deep Pockets is not likely to hand over a big wad of cash and take a lot of risk for some measly interest payment. If you can talk him into it, great. But let’s get real. If he believes in your vision, he will want a piece of the action. Give it to him, but in the form of a short-term profit sharing agreement. Lay out exactly the definition of “profit;” how profits will be divided; when profits will be divided; and, most importantly, when the arrangement will terminate. With a profit sharing arrangement, you get to keep your cake (your equity) and eat it, too (the cash).
3. Secured loan
If you’re friend is really worried about repayment, and you desperately need the funds, consider securing the loan with a business or personal asset. The asset may not be one acceptable to a financial institution, but good enough to give your friend some confidence in the likelihood of repayment.
4. Convertible loan
Consider a convertible loan structure. For example, consider your loan agreement above whereby you agree to commence payments six months after receiving the check. You could structure the loan so that if you do not make the payment as agreed, the loan automatically converts into a certain percentage of profit sharing or equity in the company. Of course, be sure that it does not convert into too much ownership. Even though Mr. Deep Pockets is your friend, negotiate the smallest conversion possible.
A partner can be beneficial – but only in rare situations
With the above warnings in mind, there are narrow situations where a partner will be extremely beneficial. Consider partnering with an existing company, but not just any company. Partner with a company that provides significant cost savings or intelligent expansion, such as a company that can help mainstream processes at a considerable savings, expand your product or service offerings, or significantly expand your customer base. Due diligence is key in these cases. You don’t want to let a Trojan horse into your well-designed company. Know exactly what you’re getting into before you sign on the dotted line.
Due diligence is the key to any arrangement, partnership or otherwise. Know what Mr. Deep Pockets needs to feel secure and what would make him comfortable parting with the big money.
At the same time, keep your goals in sight. Don’t give away your precious equity! Find a creative alternative.
Salmeh K. Fodor, Esq. is a Partner with KF Law, LLC with 18 years of financial and legal experience. Her practice focuses on corporate, business and securities law, and her clients have ranged from start-ups and emerging growth companies to publicly held corporations. For a full resume, see the firm’s site at www.kflawllc.com.
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