Partners for profit: from limited partnerships to corporations, forming a successful business alliance, takes time planning and research.

From limited partnerships to corporations, forming a successful business alliance takes time, planning and research

STARTING A BUSINESS CAN MEAN TRAVELING some rugged terrain Whether you're planning to run an aggressive race in a high-stakes market or just turn a hobby into a profitable home-based venture, your basic business survival kit should be equipped with capital, customers, common business sense and a competitive edge. In many cases, it's smart to travel with a partner or two who can help shoulder the load or add whatever you're missing.

Plainly put, a partnership is a business where two or more people agree to share the profits. When partners click, the results can be spectacular; when a partnership goes sour, it can be a real kick in the assets.

There's only one way to go about partnering, say those who know, and that's very carefully.

Picking the right person or people to go into business with is just part of the process. You must also choose the legal form of partnership that will work best for you and your company, set up criteria that will enable you to work productively together and establish protective measures that will help you part peacefully when and if the time comes.

KNOW THY PARTNER

Eric Dawson, an art director at Prentice Hall in Ramsey, New Jersey, has been thinking about going into business on the side with childhood friend Bruce Jackson. Their plan is to purchase commercial real estate and rent it out. "Whatever venture we ultimately decide on, we will probably structure our partnership so that I put up most of the money for the down payment," says Dawson, who has known Jackson for 30 years. "Bruce, who came up with the idea to partner, could pay me back from his share of the profits over time, or agree to handle most of the management of the property."

Dawson feels that his friend's trustworthiness and willingness to work make him a good bet as a partner.

Maybe. But to be on the safe sided Dawson should do a little more homework, according to business experts.

Partnering with friends or relatives can work well if you remember one thing: know who you're going into business with. "No matter who the person is, check out the background thoroughly before you take him or her on as a partner," says corporate and business attorney Robert Taylor of East Orange, New Jersey. "That goes for your brother-in-law, your best friend, even your spouse."

He advises running background checks on a potential partner's credit history, arrest record, marital or other personal relationships, tax history and past business relationships, if any.

For instance, find out how the person manages personal assets and how they're set up. Is the person a responsible money manager? Does she or he owe any back taxes? Has the person ever filed for bankruptcy? Are there liens on his property? A partner's poor credit can prevent your company from obtaining loans and lines of credit. Ask the prospective partner for permission to check into his or her financial past, including obtaining a credit report from Experian, Equifax or any of the other major credit reporting companies. Be wary if the person says no.

If you plan to have your prospective partner actively involved in the running of your business, you'll need to know his or her professional strengths to determine if they complement your own. For example, if you're an introverted person who prefers working behind the scenes, you may need an extroverted partner who can schmooze with clients, make presentations and bring in business. If you're poor with figures and details, it would help if your partner were a financial whiz or at least could understand the books.

In addition to skills, you should also look at personal factors, such as the person's marital situation. How stable is it? If married, how supportive of the business will the spouse be? Spouses can greatly influence the amount of time and money a person gives to the business.

If your partner is going through a divorce, you may find your own assets under scrutiny during discovery proceedings to determine the spouse's true value, says Taylor. Also, your partner's shares may be switched to the spouse's ownership during a settlement, making the spouse an unwanted partner in your business.

Also take into account the person's health history. A chronic problem may prevent someone from fulfilling the bargain or could cost your company thousands in medical expenses down the road.

Ask other people what they know about your potential partner. Check with relatives, former co-workers, clients or other associates to determine how the person operates in social or professional circles or manages people, projects, time or money. Does the person have integrity? Are there habits that might prove embarrassing in front of clients?

Also, ask yourself if you can get along and if you share a common sense of values, which are two factors many partners consider critical to their success.

Nearly four years ago, BE published a story by Charles Jamison, who shared the reasons his New York advertising agency, Jamison & Associates Advertising Inc., went belly up in 1992 (see "Why My Business Failed," June 1994). Among the problems was a partnership that soured, leaving Jamison several steps behind even as he transitioned his business from Jamison & Leary Advertising to a solo act. According to Jamison, he and his partner, Kathryn Leary (now president and CEO of Leary Group Inc., in West New York, New Jersey) had the same goals but two radically different approaches to running an agency. For instance, the two had different philosophies about landing new business. "My partner believed one had to socialize and make contacts," says Jamison. "I believed you had to create a legitimate reason for the company to need your services." The clashes led to Leary leaving.

ASKING THE TOUGH QUESTIONS

After deciding in 1990 to formalize her freelance graphics design business, Cynthia R. Jones invited professional buddy Barry K. Worley to join the venture. She felt that Worley's strong background in signage and way-finding design would help strengthen the firm's competitiveness. Although Jones had used Worley, a former co-worker, on assignments and was comfortable with his work style and personality, the two native Georgians still asked each other a lot of personal questions before setting up their Atlanta-based company, Jones-Worley Inc. For instance, Jones, who was banking on there being plenty of business for a woman- and minority-owned design firm, anticipated that this might be a sensitive area for Worley, who is white. She probed to find out whether he would be uncomfortable with his "minority" role in a traditionally white, male-dominated field.

Satisfied there would be no problem, the two agreed up front that to enhance the firm's image of uniqueness, Jones, who owns 65% of the business, would be the more visibly prominent partner. Two years ago, Jones-Worley garnered recognition for being the only woman- and black-owned graphics firm on the design team responsible for creating the overall "look" of the 1996 Summer Olympics, the "Quilt of Leaves" theme. The firm's work designing signs, clocks, a poster and the look of specific venues helped push the company's revenues well into the seven figures. Other clients include AT&T, Delta Air Lines, Coca-Cola and Turner Broadcasting. Since forming their partnership, the two have experienced a steady revenue growth of 25% annually.

Jones and Worley are both single, have no kids and can devote as much time as needed to the business, which was another factor Jones considered when taking Worley on as a partner. The two have different work styles but feel they complement one another. "Cynthia is impatient to see results and I'm more laissez faire," says Worley. As vice president of Jones-Worley, he oversees signage work projects while Jones, who is president, brings in business and manages finance. "If we were both the same, I think our employees would have a difficult time with us, which might have a negative effect on our ability to satisfy clients," Worley says.

By resolving potentially sticky issues beforehand, Jones and Worley have paved the way for a smooth-running partnership. Asking the tough questions can give you enough information to make the right decision about your choice of partners. What you find out may not discourage you from partnering, but it can help you decide how to set up the business to protect your assets or structure responsibilities around the person's liabilities or weaknesses.

PICK THE PERFECT SETUP

There are several ways to form a partnership, ranging from a general partnership to a corporation (see sidebar, "How to Legally Set Up"). The structure you choose should be the best possible fit for your liability, capitalization and taxation requirements. To help you determine what will work best, be sure to pull financial and legal advisors in before you start making decisions that might limit your options.

In addition to setting up the business, you may also need to look at additional ways to protect your own assets from possible attachments or liens generated by your partner down the line. If, for instance, your potential partner is planning a divorce in the near future, you can minimize impact on your own assets by setting up a limited liability company that protects partners from corporate problems (and each other). You also might establish a trust to double protect your assets from discovery and other negative legal procedures. Your accountant and/or attorney may advise you to hold off on establishing a partnership until after your prospective partner has gotten through any legal or financial difficulty that could hurt the business.

AVOID THE PARITY BATTLE

Although Jones has brought most of the clients into the business and considers herself its driving force, she sees Worley's inspiration and talent as intangible contributions that make their business picture complete.

While not the case for Jones and Worley, weighing each person's contributions to the partnership commonly leads to feuds. Except when measuring dollars and cents, the day you start running the business with a partner, all parity ends. "There is no mathematical formula to establish parity in terms of who's contributing more time and effort to the business. At any given point in time, the person who owns 51% could deliver as little as 10% or as much as 100%," says attorney Taylor. "If there are expectations among partners of absolute parity, the business is doomed to fail."

Of course, some evaluation must take place to justify the continuation of the partnership. But too much time spent on this issue probably means you're not paying enough attention to what counts, the profitability of your products or services. If, however, your partner is failing to hold up one end of the financial bargain, you have a better chance of winning the parity battle if you've established written criteria that both parties agreed to when the partnership agreement was first inked.

PARTNER WITH A PURPOSE

Some entrepreneurs move easily in and out of partnerships to achieve specific growth objectives, ranging from joint venturing to exploit short-term opportunities to taking on or becoming a subcontractor to increase coverage of a market or audience. Bob Adams, president of Adams-McClure Inc., a promotional printing company based in Denver, has partnered in a variety of ways to provide a full-service offering that takes a client's job from pre-press through finishing and delivery, all under one corporate umbrella.

When an opportunity arose in 1994 to purchase a small printing company whose assets were about to be liquidated after the owner's death, Adams moved quickly. He already had a client lined up--his former employer, Coors Brewing Co. All he needed to get the presses up and running were partners--that is, expertise and capital--to help pull the down payment together. "I needed partners who knew the printing business, could think fast and keep up," says Adams. He turned to three people he knew and felt comfortable with, Randy McClure, Bob Knappe Sr. and Joe Frink, former business associates with printer's ink in their blood. "Frink's experience in pre-press, plus Knappe's and McClure's knowledge of sales, production and finishing, covered the business from A to Z," says Adams.

In addition, Knappe had successfully run his own finishing company for five years, which brought even more credibility to the mix. Added to this arsenal of expertise were Adams' considerable dealmaking skills, all of which he used to leverage a new client's (Pepsi-Cola) stated need for work into a promissory note for $1.1 million to purchase a six-color press that would handle their first big job.

The complexity of this start-up required the four men to huddle for countless hours over strategy, roles and expectations and the best way to set up. In less than three weeks, Adams-McClure was in business. Adams' investment of $25,000 placed him at the helm with 51% of the ownership, with the other three partners investing the remaining $25,000 and splitting 49% of the shares.

The promotional printing company, run by Adams, earned $2.2 million its first year on the strength of its Coors and Pepsi contracts. In 1996, additional clients such as Miller Brewing Co. and Coca-Cola pushed revenues to $7.5 million. In another strategic alliance, Adams has subcontracted with Denver-based Optical Securities Group to do all of the promotional company's three-dimensional/lenticular (motion) printing. Adams' portfolio now features jobs like the Batman and Robin movie poster and Bugs Bunny posing for his new postage stamp, in vivid color and appealing motion.

To continue building a reputation for full service, Adams-McClure recently bought out Knappe's partners and folded the $8 million finishing company into their operation as a subsidiary. In yet another strategic move, Adams-McClure partnered with a former production manager from American Color, Tom Fernandez, to form a pre-press company called Magic Color Graphics 2000. Fernandez, who bought 20% of the stock as his capital contribution, also brought 20 years of pre-press experience to the bargain, plus a $500,000 start-up client.

In September, Adams' company purchased 51% of an advertising agency in Southfield, Michigan, which is co-owned with his new partners, Calvin O'Neal and Steve Mason. This newest acquisition added another $4 million to Adams' bottom line, bringing total revenues to $20 million, and meeting his objective to have a full-service operation under one umbrella.

PROTECT WITH A PRENUP

Of the diversity of his partners, Adams says, "Race and gender don't matter if the parties involved can bring money or experience to the enterprise and are hardworking and honest." He and his partners think alike, says Adams, share the same conservative values, and get along well. "The chemistry is there," he asserts.

The right chemistry notwithstanding, Adams and his partners still prepared for the eventuality that one or more of them might want out someday. They built in an "escape" clause that allows the other partners--shareholders--to buy out a departing shareholder at market value and in proportion to his equity stake.

In attorney Taylor's experience, most disputes are caused by unexpected circumstances such as a partner's illness or divorce. "Unless someone comes into the partnership with an ulterior motive and wishes to be adversarial, partners will have a sincere desire to work out the problems," he says.

All the same, nearly 90% of the breakups Taylor sees do reach the "draconian stage" and drag out in court for years, often ending in the destruction of the business itself. To protect against this scenario, partners should draw up a "prenuptial" agreement before wedding their resources. This document would outline each person's obligations, plus establish conditions of performance. To the extent possible, partners should quantify expected contributions and establish measurements--almost like a performance plan. It should also address how partners will leave the business or new partners will enter.

This document is called a partnership agreement in a general partnership, an operating agreement in a limited liability company or limited partnership, and a shareholders' agreement in a corporation. The shareholders' agreement should be done in conjunction with an employment agreement, which spells out what happens when employees leave the company.

Taylor also notes a "disturbing trend" in which mainstream companies that partnered with black-owned companies during the 8(a) affirmative action heyday are now dissolving those partnerships to pursue the same contracts on their own. When forming such joint ventures, protect yourself with an agreement (i.e., a noncompete clause) that restricts departing partners from doing business with current clients after the partnership ends. Often the departing company will take key executives or staffers with them, a problem that can be redressed with an employment agreement (or noncompete clause) that determines how companies will deal with defecting employees.

You may not prevent the actual loss of business, but with the proper agreements in place, you can sue the former partner for what's known as tortuous interference in your ability to do business, or wrongful conduct.

If a problem can't be resolved amicably, outside arbitration may be a less costly solution than taking your battle to court. This will work only if you already have a mechanism, or an agreement, in place that will help the third party decide how to settle the dispute. Each partner should retain his or her own attorney, and all must agree to the process and to abide by the decision. An alternative dispute resolution firm may charge anywhere from $500 to $1,000 to review the situation and render an objective decision in less than 30 days.

On the other hand, litigating through the courts can take from two to three years and cost anywhere from $10,000 to $100,000 or more in attorney fees and court costs, not to mention time lost from the business.

Remember too, that while you're in litigation, it's nearly impossible to obtain loans or credit from banks.

Horror stories about bitterly feuding partners and lost dreams should not scare you from partnering, but they do impart a warning: It takes work to ensure that a partnership will be both profitable and personally satisfying. Says Cynthia Jones of her partnership, which she likens to a marriage: "Keeping our relationship peaceful and productive requires that we communicate candidly with each other, appreciate each other's strengths and accept and compensate for weaknesses. Most importantly, we trust one another completely."

Never forget, however, that in business, trust goes a lot further when you put everything in writing first.

RELATED ARTICLE: How to Legally Set Up

You can still start your partnership the old-fashioned way, with a simple handshake. However, there are a variety of options that address a range of tax, capitalization and liability requirements. Your attorney and/or accountant will help you select the business formation that best fits your situation.

The easiest form of partnering is the traditional one--the general partnership--which literally can be started with a handshake. In this situation, all parties have a direct interest in the business and are personally liable for its debts and any claims clients/customers may have should the business default on a contract. Unless there is a formal partnership agreement spelling out how assets and debts will be divided upon dissolution of the partnership, most states will dictate a 50-50 split, regardless of who originally put up the most money or time. At tax time, profits and losses "pass through" to your personal income and are taxed at your personal rate. A general partnership is good for those not concerned about personal debt or other liabilities.

One of the newest ways to partner is the limited liability company (L.L.C.), which protects the partners--called members--from liability for the wrongful or negligent acts of the business, in much the same way shareholders are protected from a corporation's problems. An L.L.C. offers the same pass-through tax benefits found in a general partnership where partners pay personal taxes on their profits or losses. Professionals, such as doctors, lawyers and accountants, can set up a limited liability partnership (L.L.P.).

Another option is the limited partnership, in which a general partner (which can be an individual, several people, an L.L.C. or a corporation) teams up with a passive partner (same range applies) whose interest is limited to the investment in the business. The limited partner, also called a silent partner, is shielded from liability as long as he or she (or they) doesn't participate in the day-to-day running of the business or decision making. The general partner, however, is personally liable for debts and claims. This format is typically found in the entertainment industry, where the limited partner puts up the cash and the producer runs the show, and in deals involving foreign investors.

The fourth format is, of course, incorporation. The C, or regular corporation, is a stand-alone entity owned by shareholders and managed by a board of directors. Its profits are taxed directly by the federal government. Shareholders are taxed only on their dividends. In a subchapter S-corporation, a tax status the owner(s) must elect through the IRS, profits (including dividends) and losses from the business pass directly to the individual shareholders in proportion to their percentage of ownership and are taxed at the personal rate. Both types of corporations protect shareholders from liability for the company's wrongdoing or errors.