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By Karen E. Klein

Avoid the Pitfalls of Partnering
Analyzing your motives — and getting a good lawyer — are keys to a smooth deal

Q: My wife has owned a hair salon for 10 years, and we recently had our first child. She has been approached about taking on a partner. What are some concerns with this issue, and how can she protect herself from major financial disaster?
--C.M., Mich.

A: Your wife should start by asking herself why she might want or need a partner in her salon and what a potential partner's interest would be in joining her. For example, if she's desperate for an infusion of cash, bringing in a partner to alleviate the situation may trade a short-term capital fix for a bad long-term solution. After all, a poorly run business or one with little economic potential is unlikely to be more satisfying or lucrative for two partners than for one. If she would like someone to share the burden of the business to spend more time with the baby, she needs to make sure that her potential partner wants to run the day-to-day operations and is competent to do so. Also, in a business such as a hair salon, the owner needs to be keenly attuned to clients and share the existing partner's tastes and vision -- or risk alienating the business' following.

Then there's the independence issue. When someone owns a business for a number of years, it's hard to suddenly share control with another person. The change can be a relief -- or a threat. It's usually easier to start a business with a partner than to bring one into an ongoing concern.

That's not to say your wife and her business couldn't benefit from the right partner and a well-structured deal. You're right to investigate first: Too many partnerships are struck over a drink or after a couple of conversations, leaving neither party ready for the reality of working together long term. Your wife should take her time thinking about this. There's rarely a good reason to rush into something so important.

Once your wife has studied her motives, run a thorough background check on her potential partner. Look into references, finances, personal credit history, business reputation -- and consider it a cross between the investigation you would do on a potential employee and one you would do on someone to whom you're lending money. A few questions to ask about this potential partner: How well does your wife know this person? If they know each other, can they work together? What assets -- money, experience, or contacts -- would this person bring to the salon?

Next, be sure your wife retains an attorney who specializes in small-business partnerships to look over any deal. And put the partnership agreement in writing. An expert will foresee many potential pitfalls that she won't and will be able to build safeguards into the contract.

Peter Cowen, a Westwood (Calif.) investment banker, says a bad partnership can jeopardize a business: "Make sure that the expectations of both potential partners are drawn up on paper ahead of time." Adds Cowen, who runs his own consultancy, Peter Cowen & Associates: "In fact, it's very helpful if the two people put together a mini-business plan that lays out how they will work together and clarifies their mutual vision and commitment to the business." The experience is an early test of how people get along. It also gives the new partner a fast education about the company.

Cowen recommends making new partners wait and prove themselves before they can take a stake in the company. "Have them earn it or have it vest over time," he says. "If there are going to be major problems in the partnership, they are likely to emerge in the first three to six months. That's why you should not give equity for a minimum of a year. If things don't work out, you can part ways much more smoothly, without long-term implications for the business."

If a partner brings cash into the business, Cowen suggests that the contribution be structured as a loan that's convertible to equity at some point. He also tells his clients to build into the deal a payback period for the loan and interest, in case the partnership dissolves: "Many times, the money goes straight into working capital. If one partner wants out, it can bring the company's operations to a halt if the remaining partner has to pay back the loan in a big chunk."

Remember, too, that partnerships aren't necessarily 50-50 deals. As Cowen points out, "One partner can have more ownership, and there can be equal voting rights or nonequal voting rights. It is not uncommon to give a one-quarter or one-third ownership to a new partner. That way, the new person doesn't immediately get voting control and veto power."

One final piece of advice: If your wife decides to make this new partner an equal, designate from the start a third-party mediator, whom they both respect, just in case there's a deadlock on important decisions.

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