Haimo Law - Wills, Trusts, Probate, Business Planning and Asset Protection

A Partnership Gone Bad – Start-Up Sand Castle

A Partnership Gone Bad – Start-Up Sand Castle

 

By: Barry E. Haimo, Esq.

May 21, 2014

Ben and Dan were friends for years. They had adjacent offices at their current systems firm. Throughout most days at work, they’d brainstorm about their dream business, Trust Consulting, a boutique consulting company (a partnership) for tech startups. They would constantly exchange notes and images of their service, fantasizing about what their thriving entrepreneurial future would be like; their nontraditional office, team culture and impressive benefit packages and perks. Hoping to emulate Facebook’s approach, they’d always talked about working part-time until the business took off. Then, they would quit and work full-time to grow and scale it.

Ben and Dan were smart, and knew that they had to have their ducks in a row before pulling the trigger. After all, they wanted to build something substantial, not a castle made of sand. After a few mini-meetings, Ben and Dan met for drinks to discuss how to realize their vision. They closed the bar with their 8 hour meeting, during which they agreed to form a company rather than a partnership, Trust Consulting, Inc., an s-corporation, as equal partners. They each dipped into their savings and contributed $18,000 to the company. Ben promised to contribute his excess free time to lead the software development of their web-app prototype, create administrative infrastructure and leverage his personable nature to start developing strategic relationships to begin customer development. Ben also agreed to be responsible for legal issues because his brother, Aron, is a business attorney, specializing in wills, trusts, business planning and asset protection. Dan agreed to help develop the prototype and be responsible for accounting, branding, web design and development and sales.

Enthusiastic and overflowing with optimism, Ben and Dan shook hands, funded the company and started getting to work. Over the next 6 months, they worked hard at their respective second jobs and things were coming along nicely. They rented shared workspace and had their systems in order. As expected in a startup, they hit a curve ball in month 10 when customers overwhelmingly demanded a different feature set on their prototype. Ben remained optimistic and continued chugging along, working with their developers to make the necessary changes to the prototype. Dan began to develop doubts and started refocusing on his day job.

By the 18th month, there was a glaringly disproportionate contribution between the partners. Ben had begun managing most of Dan’s responsibilities, primarily because Dan received a promotion at work. He had also doubled his financial contribution, increasing his contribution from 1/2 to 2/3. Nevertheless, the allocation of equity and control remained vested equally between Ben and Dan, which posed a serious problem for the future viability of Trust Consulting, Inc.

By this time, it wasn’t Facebook, but Trust Consulting, Inc. was earning a handsome income from key evangelist clients. Their runway was extended to give them time and resources to refine the business model. After a lot of thought during the weekend, Ben approached Dan and informed him of his concerns and intentions to take control of the company and continue contributing his time and money. He’d pay Dan back his investment and Dan could retain a 10% voting interest in the company moving forward.

Dan’s response was unsurprising. He exploded at the prospect of losing his interest in a company he funded, formed, and built with his hard earned savings and blood, sweat and tears. Ben immediately called his brother, Aron, the business attorney, seeking advice. Without hesitation, Aron blankly looked at his baby brother and asked, “what do your operating agreement, partnership agreement and employment agreements say?”

“Um.. ” Feeling like he had the wind knocked out of him, Ben’s jaw dropped. He knew he had made a tremendous mistake. “Sit down,” Aron said to his baby brother. “Here’s what’s going to happen. You’re in a special marriage to each other because there’s a viable business and it’s growing. That’s your child. The King Solomon approach doesn’t work here. Every second you can’t agree on a resolution hurts the business. Litigation will eat up tens of thousands of dollars that you can’t afford and take a year or two that you don’t have to wait. Most importantly, you can’t execute your business model and litigate simultaneously. So, you have to find a way to work it out now or this business is as good as dead. I’ve seen it countless times. You need the right team, documentation, and vision or you’re building a sand castle. Why didn’t you talk to me first? We needed to engage in appropriate business planning. I could have told you a few stories of very promising ventures that failed because of similar issues that could have been easily avoided.” For example, this one exciting new venture called–never mind. I think you get the point.

“What do I do now?”, asked Dan.

Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose
Email: barry@haimolaw.com
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