If you are looking for information about creating business partnership agreements (operating agreements, founders agreements, partnership agreements, etc.), read Creating a Business Partnership (Founders) Agreement.
When two founders show up in my office to talk about how to structure their business partnership, they have often been told to avoid an equal partnership, a business arrangement where they are each 50% owners. I am not nearly as down on 50%-50% business relationships as some other attorneys are. In this article, I explore the pros and cons of equal partnerships and explore some ways to make them work if you are inclined to go that route. These considerations apply for cofounders in a technology startup, joint venture partners in an oilfield venture or any other business relationship where the participants are considering a completely equal ownership and control arrangement.
What are the Pros of a 50/50 Business Partnership?
In a 50/50 business partnership (two equal cofounders), the partners benefit from:
- diversification of ideas and talents
- greater stability in business vitality (partners feed off each other’s energy)
- operational flexibility afforded by another team player (complementary skills to round out the management/leadership team)
- shared start-up costs
- shared work responsibilities and risks, and
- mutual support and motivation
Granted, some of these pros exist in businesses where the cofounders aren’t exactly equal owners, although the sense of comradery and sharing the upside and burdens are all amplified in a business or other venture where the founders are entirely equal partners.
What are the Cons of 50%/50% Cofounder Relationships?
The reasons to not engage in a 50/50 business partnership include:
- having to share the profits (again, this applies whenever you have a cofounder regardless of the exact ownership split)
- confusion among employees and vendors about who is in charge (where the buck stops)
- deadlocks and disputes when the founders can’t agree on a decision, and
- constant work and talking things through are necessary to keep the equal balance working well
The Uniqueness of 50%/50% Business Ventures
A business with equal 50%/50% partners is a unique relationship. Neither partner can do anything without the approval of the other unless they establish clear, distinct areas of responsibility. Even then, a lot of people worry about the power struggles that will ensue with 50%/50% business relationships.
I talk to lots of business people and lawyers who adamantly believe that a 50-50 partnership is a bad idea. They think every startup or business partnership needs a boss, the person who is ultimately accountable and has control of decisions.
Sometimes when two very large companies merge they brand the deal a “merger of equals.” If neither CEO wants to step aside, they may decide to move forward with co-CEOs. In this scenario, where neither CEO wants to be second-in-command, a power struggle is almost certain. On the other hand, two long-time colleagues or friends who know each other well and aren’t worried about working through issues together can probably handle a 50%/50% partnership. In fact, it may be preferable in that case.
The main reason I support 50-50 business partnerships with the “right” partners is because it requires them to work and play well together. The partners must sort things out. They must communicate and stay on the same page. That’s good for partners. In the case where one partner is an 80% owner and the other is 20%, the majority owner may be inclined to do things without even consulting the minority owner. This imbalance of power can have a way of creating its own problems, including resentment from the minority owner. In other words, I think the 50-50 business partnership is the best of all worlds when it works well.
Plan Your Business Partnership Before You Start
No matter how well you know your partner, your venture will end at some point. If it ends when you sell your company for $100 million, it’s safe to say it will end well. In a lot of situations, though, the split among partners comes when the company is trudging along and one of the partners has a different vision or just wants to go do something different. Or, one of the business partners is not pulling their weight, not participating fully or not contributing or working at all. I can tell you from experience that it is very frustrating to be working as hard as you possibly can while your partner doesn’t contribute much at all. These situations can become toxic very quickly.
If you split under anything but the best terms, having a clear, thorough founders agreement is critical. You want to decide upfront how you will buy out your partner or vice versa – how your partner will buy you out. This is important in any partnership, although it’s especially important to think through disputes and deadlocks in 50-50 businesses because the deadlock situation is a distinct possibility.
Options for Breaking Up Business Partnerships
Think through dispute resolution processes upfront, especially if you go with a 50%-50% setup. Focus on ones that are quick and easy. Litigation and arbitration are time-consuming and expensive. Actually, arbitration isn’t always super expensive, although it easily can be. I was Chief Legal Counsel for a company once and we were involved in one arbitration where the two parties (us and the company on the other side) spent $6 million in legal fees! Non-binding mediation is quicker. It can happen fast and inexpensively. Even better is to find a neutral third party you and your partner/cofounder respect and trust to serve as the referee and to break deadlocks.
If all else fails, you should have a mechanism in your founders agreement to both walk away. You can do this through a buy-sell mechanism, which involves one partner selling their shares or LLC membership interests or other equity to the other partner. Buy-sell agreements keep the partners honest. If they can’t work things out, they may find themselves on the outside – this is an incentive to work through things together.
There are lots of versions of how to accomplish a buyout, including Russian Roulette and the Texas Shootout. In a Russian Roulette buy-sell agreement, the party triggering the provision makes an offer to either buy the shares of the other partner or sell their shares to the other partner, in either case at the same price. In other words, Party A may offer to pay $1,000,000 to buyout Party B or to accept $1,000,000 to be bought out. The party making the offer has an incentive to get the price right and not pay too much or sell on the cheap.
In a Texas Shootout, each partner submits a sealed bid, which contains the price at which they’d be willing to buy the other’s shares or other equity interest. The higher offer gets to purchase the other’s equity.
Provisions like Russian Roulette and the Texas Shootout work best when both parties have the resources to follow through on the purchase. If one party has a lot more money than the other, they may be able to leverage that into a better deal because the party without resources can’t make a great offer if they lack the ability to pay for, or finance, the purchase.
Usually buyouts of this type happen with one to two months after the price is determined. They are documented in partnership buyout agreements, which may be called a stock purchase agreement or membership purchase agreement.
A third possible option to build into partnership and founder agreements to break deadlocks is to force the sale of the company. If you and your partner can’t come to agreement about something, you agree ahead of time to sell the business as a way of resolving the dispute. It’s a bit draconian, although it’s an option and, as I mentioned, it helps keep the partners honest.
Slight Tweaks on the 50%/50% Business Partnership
One way to avoid the dreaded deadlock is to make the partnership 51%/49% and let the 51% partner make the decisions. You can still set it up so that some decisions are made unanimously (which is essentially what every decision needs to be in a 50%/50% relationship), although you don’t have to do that and you can make it so that most decisions are decided by majority vote. In other words, the 51% owner makes the decisions. In a majority voting situation where one partner owns 51%, there can’t be a deadlock. This raises the concern I touched on earlier where the minority partner could feel like they aren’t involved or starts to resent not having any true say in the business.
A way to keep power equal among partners, but avoid deadlocks is to bring in a third party and grant that person a small piece of equity. Think of this as a 49%/49%/2% setup. In this scenario, the partners agree to have equal say, but to have a third party that can break the deadlocks. This way, there is always an easy way to find a decision – you just need two of the three equity owners to vote in favor of something.
Other Tips to Ensure High-Functioning Business Partnerships
Partnerships require work, although great partnerships are great for business. There is nothing better than sharing the joys and sorrows with someone who is just as committed to making the business successful as you are. Here are a few tips for making your partnership, 50%/50% or otherwise, work well:
1) Talk through all the important considerations upfront. These include your respective goals and expectations about the partnership. Take time to understand more about your partner. This investment in knowledge about who they are and what motivates and matters to them will help you understand and work well together.
2) If the partners are relatively equal (not just 50-50 but even if they’re 60-40), this one applies. Give both partners full access to the books and bank accounts. It doesn’t matter if you oversee sales and operations and your partner handles finance and accounting, you should have access to the bank account. And, if your role is accounting, you want to give you partner access to the books and bank account. Transparency is a good thing and helps avoid misunderstandings. Businesses need cash to grow and expenses pile up. If one of you isn’t looking at the financials occasionally, you may be surprised that the bottom line is not as high as you thought it should be. That happens and it’s best if you can understand why, rather than jumping to the conclusion that your business partner is cooking the books (I know, partners steal money, it’s just that sometimes there are misunderstandings and not improprieties).
3) Set realistic expectations about your compensation. What do each of you need to make? You want to be brutally honest with each other and understand your respective needs. You want to address this in your founder documents in some manner. Otherwise, one partner may just be looking for more and more compensation from the company while the other is perfectly content to plow the profits back in to growth. Disconnects here can be a big source of angst. If times are tight, you want to know how much pressure that’s putting on your partner and to understand their stresses. You may be able to help address them in some way.
4) Vest your equity. Each founder or partner should agree to earn their equity over time or according to other metrics if there are ones that make sense (e.g., if one of the partners is responsible for sales, a metric may be revenue produced). Most equity vests according to time. What this means is that if one of you decides to go do something else, you leave any unvested equity on the table. This is good for the company because companies need their equity to grow – to sell to investors or grant to employees to help the business reach its goals. If a partner leaves early on with half of the equity, the other partner may be forced to shut things down and that’s not great for anyone. A four-year vesting schedule is fairly standard. Silicon Valley vesting schedules are typically four years with a one-year cliff, which means that the person has no equity until the one year mark and, at that point, they earn 25% of the equity. The rest vests equally over the course of the next 36 months.
5) Be sure each founder has access to company property. You should each know the passwords for your website hosting company. If you store source code in a cloud service, all partners should know how to get to it. You should each be on the bank accounts (see tip #2 above). If only one partner has this type of access and that partner dies or becomes difficult to deal with, it can be very taxing on the remaining partners to not be able to control key company assets.
What If You Don’t Have a Founder or Partnership Agreement?
I see this a lot. It happens, and I get it. Founders are excited and anxious to get working and don’t see the value in spending time and money on a startup lawyer to create a strong, custom operating agreement or other founder agreement. Then, when things go badly the parties don’t have any guide for what to do next.
If you don’t have a strong, custom partnership agreement and things are going well, take the time to make one. You can do this after you’ve started (there’s an old Chinese proverb that says that the best time to plant a tree is 20 years ago, but the second-best time is today).
If you don’t have a founders agreement and your partnership is imploding, my short answer is to sit down over a beer or take a weekend trip together – find any semi-social environment to talk things through. If that ship has sailed, mediate. It’s inexpensive and it’s quick.
Author: Brett Cenkus
Brett Cenkus is a business attorney with 18+ years experience based in Austin, Texas. He has worked with a variety of businesses and has clients throughout Texas as well as many technology clients throughout the United States. Brett is a Harvard Law graduate with a sharply seasoned mind and an entrepreneurial heart. As a founder of 6 companies himself, he is especially passionate about helping startups succeed. In 2016 Brett was named the winner in the Individual category for RecognizeGood’s Ethics in Business & Community Award. He offers businesses solutions that are in sync with their culture, goals and values. You can learn more about Brett by visiting the About page on this website.