Most of us would agree that equality is a virtuous concept. Like beauty, however, it lives in the eyes of the beholder, which makes it highly subjective — and, in the business world, ripe for disagreement.
In the restructuring field, you often see this contradiction play out in disputes involving 50/50, or so-called “equal,” partnerships. Typically, these are scenarios where one partner or managing member brings the money and the other provides the sweat equity or operational expertise by doing the work.
On the surface, the arrangement seems fair. Here is the problem: In practice, it doesn’t work.
Ask any business attorney or corporate receiver who has had to deal with individual partners accusing the other of not meeting their obligations, as the accuser perceives them to be. What starts out as the perfect union ends up in the corporate equivalent of divorce court and the costs, both financially and emotionally, are draining.
Roads to Receivership
We had a recent case where continuing operational and philosophical disputes between a healthcare clinic’s former principals created significant financial pressures on the business and threatened its ability to keep its doors open. Declining revenues, deficiencies in billing/collection procedures, and high staff turnover only added to the problems we faced as the court-appointed receiver.
In another case that involved a brewery, we faced a very different scenario. From a profitability standpoint, the business was successful and cash flow-positive. Unfortunately, the two equal partners disagreed on virtually everything, which led to the company being placed into receivership.
The fact that we were able to step in as agents of the court and, eventually, through operational improvements and forensic evaluation of assets, sell each set of business assets for a price in excess of their auction value was a good outcome. However, that is not the key takeaway. Both cases could have been preempted or more easily resolved had a clear decision-making process been set up initially.
Planning
For things to get done and decisions to be made, there needs to be an allocation of responsibility within a business in which a partner has controlling decision-making authority. So, which partner? In most cases it comes down to which one invested the most cash. By creating a 51/49 relationship based on cash invested, the money partner can vote their extra 2% in critical situations.
It is important to note that there is a difference in an LLC or Partnership between profit participation and decision making. It is quite easy to have an agreement that provides for 51/49 decision making and 50/50 profit participation.
When entering into a new LLC or Partnership, the operating agreement is the controlling document. In addition to the legal aspects of the agreement, the business terms are important. It is key for each party to make certain that both legal and business terms are exactly what each desires from the agreement. Do not assume that anything is “understood.”
The Value of Good Counsel
On the legal side, it is probable that each party has an attorney. Those attorneys should pick a third party to draft the agreement. The drafting attorney represents neither side and the resulting agreement should favor neither party.
On the business side, if one or both parties do not have extensive experience with business contracts, they should get an advisor. The important thing here is to make certain that the terms pertaining to the business are what the parties want. And every agreement should specify what constitutes a violation of the agreement and what happens as a result, both from an operating, financial and equity standpoint.
Not only is transparency between the owners important, it is also important that neither party has sole control of accounting or disbursing funds. Checks larger than a certain amount should require two signatures; any debt assumed by the company should require both owners to agree.
If money is handled by a person inside the company, such as a controller, that person should not be related in any way to either of the partners. Financial reviews involving both partners and an independent third party also should be frequent.
Finally, in any Partnership or LLC, there should be no such thing as a “silent” or inactive partner or member. To quote an often-used statement: “It’s not personal, it’s only business.” Or as a past U.S. president said: “Trust, but verify.”
Al Davis serves as Principal at Revitalization Partners LLC, a corporate and board advisory firm that specializes in restructuring and receiverships. He is a Court Appointed General Receiver in the State of Washington as well as an interim CEO and advisor to middle market companies. He can be reached at adavis@revitalizationpartners.com or 206-903-1855.
