Here’s a sobering rule of thumb. The easier it is to enter into a business partnership the harder and more messy it will be to get out. And since failure rates for design firm partnerships are very high (statistics vary, but a greater than 50% failure rate is conservative), when you enter into one you may be signing up for a complicated and unpleasant experience.
On the other hand, the harder you work in setting up your partnership agreement, the easier it can be if you ever need to dissolve the partnership.
Since basic partnerships are the easiest type of business entity to set up, many design firms go the partnership or 50-50% LLCs route by default. But business partnerships are also among the most difficult models to pull off. And design firm partnerships are even harder–in part because designers often entered into them for personal, emotional, or moral support reasons more than for carefully thought out business reasons. It’s a familiar story, two friends or colleagues contemplate forming their own firm and with their mutual willingness to try it together boosting their confidence–it’s off to the races. All that necessary but complicated start up paperwork is the last thing on their minds, so they dash off a basic 50-50 LLC, or simple partnership so they can get on to all the fun stuff like designing the firm’s identity and website.
If you’re contemplating forming a design firm partnership, allow me to throw a few speed bumps in your way–to help you evaluate if this is indeed the right decision for you before you sign an agreement. And if you’ve already formed a partnership, and things aren’t quite working out the way you thought, well you might want to give me a call. Often you might need to go back to the drawing board and reform your agreement–undoing the mistakes that were made when you started.
This post is not going to cover the basic legal and business technicalities you should include in a business partnership agreement. There are plenty of books and articles (here and here) on those kinds of things (such as defining ownership percentages, how transitions will be handled, contingencies in the event of a partner’s death or a divorce, managerial roles, and so forth). Instead I want you to consider three big picture issues that are often overlooked when you start out.
But first let me urge you to soberly consider the fail rate of partnerships and seriously consider not forming one. There are other alternatives for two or more parties to go into business together without forming a partnership. For example, one party can employ the other and offer profit sharing. Or you could form an LLC and give a small amount of ownership and restricted voting rights to one party based on their role and long term contribution. There are other approaches too, but you should think through these three major considerations first, and if after considering them you still want to form a partnership, at least you will have given thought to these matters and planned for them.
#1 – Ownership Does Not Equal Employment
First of all partners should understand that unless your agreement specifies otherwise (as it should!), having a partnership only entitles you to share in the profits (or liabilities!) corresponding to your ownership percentage. That’s all. A basic partnership agreement means you have a right to your percentage of the worth and profits of that entity. It does not require you to work for the business, nor does it entitle you to a job or a salary from the business. This is an extremely important concept. If you form a partnership without adding clear specific language that ties ownership to employment, or work, you neither have a right to a job or salary, nor do you need to lift a finger to maintain your right to your share of the profits, and your right to make decisions on behalf of the business.
Now in most cases, at least initially, both parties have an implicit understanding that they will work for the firm. But rarely are those implicit expectations made explicit in the agreement. So owning a percentage of a partnership or LLC, if not specified otherwise, is not contingent on your efforts. This is the biggest, most basic misunderstanding that most people who enter into design firm partnerships fail to realize. And it often becomes the source of many tensions, when down the road one party feels like the other is not contributing equally to the business. And technically they don’t need to. They own their percentage by legally defined property rights, not by what they’ve put into it or failed to put into it.
That’s why every design firm business partnership agreement should essentially include a detailed employment agreement of the founding partners. Transition plans, buyout terms, non-competes, should all be specified in the event that one partner wants out, or has not performed their duties per the agreement and how such a failure will such trigger ownership transitions.
#2 – Long Term Roles
The second big picture consideration in forming a partnership is future role definition. Early on it is assumed that both parties will be active in building the business. Usually one party will wear the “business person” hat, focusing on marketing and business development and the other will be more of the “doer,” executing the projects. This is fine early on. Both roles are necessary and make sense. But when the firm grows and begins to employ more “doers” is the role of the original “doer” partner expected to change? If not, then at that future point what began as an equitable balance of roles will no longer be in balance. Then the doer partner continues to contribute the same as the new, less expensive, design employees do. Both parties might still be working 9-5, but when the firm grows the “business person” role may become much more crucial to the success of the firm and what seemed equitable at the start no longer feels so fair.
Before entering into a partnership ask yourselves, “If we’re successful, what roles will we fill when we have six, twelve, or twenty employees?” Do both parties have scaleable managerial capacities so that their roles, while distinct, will still reflect the 50-50% partnership when you grow? If not it might be better for one party to own the business and hire the other–and perhaps offer profit sharing in view of their import role in the early stages of the businesses development. There are plenty of incentive structures that can be designed to reward the risk the other is taking by joining a startup, short of full blown equal ownership.
#3 – Shared Decisionmaking
Finally, consider that when you form a simple partnership or a 50-50 LLC without specifying defining voting parameters all decisions will require agreement between all partners. This is where things can get very problematic if the partnership does not end up working out. No matter how much one party worked or contributed over the other, without defining ahead of time how decisions will be made, all partners must agree to any particular decision – including changing the original partnership agreement. You really don’t want to have to rethink your partnership agreement after you’ve have a falling out, or disappointing experience. This is one big reason why many partnerships fail–when it gets in trouble and the parties can’t agree–the entire business is paralyzed.
Before signing a partnership agreement both parties should address this important factor, and soberly assess themselves and each other with regard to their business decision making capacities. Do both parties have the same confidence levels? Are they compatible in comfort with risk taking? Is one party more decisive than the other? Any disparities here will be magnified when the business grows and the stakes get higher. Temperament disparities when it comes to matters of hiring and firing can seriously impinge the smooth operation of a business.
Because of the many complicated issues in business partnerships, in general, this kind of business entity is not a great choice–even though it is the easiest choice. At the very least make sure that these important issues have been thought through before shaking hands and becoming partners. Doing some hard work upfront, wrestling through some business decisions upfront will be time well spent. And if, in the process, or in light of the matters to be worked through, you find that one party or both is not comfortable or inclined to work through them–that’s a really good sign that you should not form it in the first place.
If you are considering a partnership, or are having trouble managing an existing one, or see potential trouble down the road, give me a call and I’d be happy to help you work these matters out.