The Shotgun Fund


Breaking-up (with a business partner) is hard to do

Breaking-up (with a business partner) is hard to do

By Camilla Cornell
PROFIT Magazine, November 2004

At the most strained point in Lenny DeRoche's six-year business partnership, he recalls arriving at work after the weekend to find "love letters from hell" from his partner slipped under the door. "There were accusations that I was psychologically unstable, that my wife was divorcing me, that my wife — who had previously worked at the company — had stolen things from the company," he says ruefully. "It really was just like a ridiculous divorce."

The worst thing was, although DeRoche and his now-former partner, Jeffrey Wolcroft (names and some details have been changed), had never hung out socially, they had been friends. But they haven't said a word to each other since their partnership in an Oshawa , Ont.-based manufacturer broke up.

That doesn't surprise Jim Ambrose a bit. As a partner with The Shotgun Fund, owned by private investment firm Argosy Partners Ltd. of Toronto, he has provided financing for many shareholders faced with buying out their partners or being bought out. Ambrose has seen first-hand the bitterness that can grow between partners, who are in a kind of marriage, one often even more intense than the real thing. "You're so financially entangled," he says, "and you spend far more than eight hours a day with or around your partner."

That's why it's crucial to choose your partner carefully, then establish firm ground rules and a structure that encourages communication and consultation. You also need to agree on how you'll resolve disputes. But even that may not be enough. If breaking up is the only alternative, it pays to keep the proceedings civilized. Unrestrained battles between husband and wife can leave a child with lasting scars; similarly, quarrels between business partners can damage a firm badly, sometimes fatally.

No one knows this better than DeRoche and other entrepreneurs who have suffered through a business divorce. PROFIT asked them and other business experts to share their best advice on how partners can stay together — and how to minimize the trauma if a split-up proves unavoidable.

The courtship

Occasionally, a quickie Las Vegas wedding leads to years of wedded bliss, but more often such relationships end almost as fast as they start. Just as it pays to put some effort into finding the right mate, your partnership is far more likely to succeed if the two of you have compatible management styles and personalities.

Vincent Dequoy found that out after becoming a partner in Avant-Garde Engineering (1994) Inc. of L'Assomption, Que. with an entrepreneur, Jean Robillard, a generation older than him. Dequoy had been a consultant for Avant-Garde, which makes work platforms used in construction, when Robillard (who died last January) persuaded him in 1996 to invest personal and family money to buy 25% of the company. This rose to 34%, compared to Robillard's 66%, when they bought out a third partner. But, as time went on, the younger man began to realize he was Robillard's partner in name only. "Jean was a one-man show," says Dequoy.

The two men's management styles could not have been more different. Robillard's leadership was intuitive, and he was involved in every aspect of the company. Dequoy's attitude: "When you're busy running day-to-day operations, you're not making good decisions. You're too busy." Dequoy takes a more measured, consultative approach, expecting staff to grab hold of responsibilities and run with them, and he tends to make decisions based on facts, not his gut. Robillard, he says, "was a real entrepreneur — great at marketing and startup. But sometimes when a company is growing, the entrepreneur can be the one who will be the obstacle to growth."

Adding to their differences, Robillard, who was in his 50s, liked to live large. He drew a big salary, took expensive trips that had little to do with business and ate at fancy restaurants on the company dime. Dequoy, still in his early 30s, wanted to reinvest Avant-Garde's profits in the business, but his hands were tied. Fed up after just three years, he began to negotiate for Robillard to buy him out.

How could this have been avoided? Don Olson, a lawyer at Giffen Lee LLP in Kitchener, Ont. who has many family-business clients and has seen his share of messy splits, believes partners have a better chance of success if they frankly discuss up front the organization's structure and each partner's role. "Before we sit down to put together a shareholders' agreement, I often advise clients to separately write down what they expect from themselves, their partners and the business, and then compare lists," he says. "If the lists don't mesh, you probably aren't a good fit."

The prenup

Your second step should be to formalize your understanding in writing. To save on legal fees, many entrepreneurs opt for bare-bones partnership or shareholders' agreements that don't reflect their individual circumstances, or dispense with an agreement altogether. That can lead to turmoil and expense down the road.

Mississauga , Ont. entrepreneur Steve Taylor agrees. He and his ex-partner (whom he refuses to name) started working on a shareholders' agreement almost immediately upon launching Nova Staffing Inc. in 2000. Unfortunately, when the business grew fast, "we put it on the back burner." The only detail they had really ironed out was that Taylor — who had taken on all the financial risk, using his own money and personal guarantees to raise all the startup capital — would be 75% owner, and his partner, who contributed no cash, would own 25%. Both took a small salary.

They hadn't agreed on a decision-making structure or performance expectations for the partners. Those omissions became glaringly obvious just a year later, when Taylor 's partner started a family. That decision came as a surprise to Taylor, who felt his partner's primary commitment should be to the business, at least for the first few years. Instead, the partner worked fewer hours after the birth of his first child. Taylor says that would have been acceptable as long as revenue had met targets. Instead, it fell, missing targets by more than 20%. What's more, although Taylor 's partner was in charge of sales, he often left work before lower-ranking sales staff, causing resentment.

Taylor , having hired staff to fill projected orders that never came, was worried. But when he tried delicately to raise the subject, his partner refused to discuss it. His attitude: as one of the partners, "he didn't owe me an explanation." Taylor argued that he could set performance criteria because he was the majority shareholder. Regardless, he says, partners must answer to each other if their performance isn't up to snuff. Relations between the two became increasingly hostile. By the time they split up, they were speaking only through their lawyers.

In retrospect, Taylor says, he should have hammered out the details of the partnership agreement in advance, even if it meant delaying the startup. "We wrote nothing down in terms of each individual's responsibilities, performance agreements and the official reporting structure," he says. "A lot of these things were just assumed, or were verbal agreements."

The family meeting

Even if you sign a raft of agreements, you can't anticipate every problem that may arise. Just as families need a forum to air grievances and forge agreements, partners should meet at least once a year — preferably twice — to compare notes, plan strategy and discuss issues, advises Elspeth Murray, an associate professor at Queen's School of Business . "This is where an advisory board helps," she says. "Get together with a group of trusted outsiders every quarter who can identify trigger points or indicators that all is not well. They can force you to sit down and have that chat."

Dequoy and Robillard met regularly with advisers, but Dequoy says two things interfered with their effectiveness. First, Robillard was not one to revel in the consultative process; his attitude was "just follow me!" Second, the advisory board included consultants doing projects for the company, who were unlikely to go against the major shareholder.

Since buying out Robillard in 2000, Dequoy has added three new partners: a venture capitalist, silent partner and active partner. He talks to the active partner "about 10 times a day," mainly because "like a husband or wife, if you communicate day to day it makes for a much stronger relationship." As well, he reports to a board of directors that includes all his partners and challenges him regularly. And twice a year he holds four-day retreats with his management team (including the active partner) to discuss strategy.

That opportunity to touch base can be crucial. While you may feel your personal life has no bearing on your business relationship, stresses Murray , it's often the "human-nature, personal-relationship issues that derail the good intentions in a partnership. You have to have an ongoing discussion of how things are going."

Having trouble keeping that discussion on track? Hire a facilitator, suggests Jim Hatch, a business professor at the University of Western Ontario . "Sometimes they can stand above the fray and ensure that you cover the pertinent issues."

Marriage counselling

Just as even the tightest couples hit rough patches, partners are bound to disagree at some point. If there's no mechanism for resolving the dispute, a good partnership may be scuttled.

That's a lesson Mike Desnoyers learned the hard way. He and his ex-partner, John Polkinghorne, worked well together for eight years, taking their electronics design and manufacturing business from a two-person operation with no sales in 1989 to an $18-million business by 1997. But the wheels of Kitchener , Ont.-based Etratech Inc. fell off that year, when it acquired a company across the street. The new business consisted of an electronics division that meshed perfectly with Etratech, plus a circuit-board manufacturer. "Circuit boards are an integral part of what we do, but we had always acquired them from other companies," says Desnoyers. "We really knew nothing about the business."

At first, both men agreed they would try to make a success of the circuit-board business. But as more and more money flowed into it, Desnoyers began to question the wisdom of this move. "We came to a strategic fork in the road," he says. "John felt he could make it a success, but I wasn't so sure. In the meantime, we became distracted from our core competency, and our business was suffering. That became quite a dispute between the two of us."

By 2000, Etratech was $3 million in debt, and the circuit-board maker was still losing $80,000 a month. Even worse, sales — which had grown by 30% to 35% annually in the first eight years — had essentially flatlined. As far as Desnoyers was concerned, "We were on the verge of bankruptcy." Yet he couldn't persuade Polkinghorne to give up on the circuit-board business. "He literally built that business with his own hands," says Desnoyers. "He was over there soldering pipes and building machines. He was convinced he could make a go of it. I have no doubt John thought he was doing the right thing, and I know I did. We just couldn't agree."

Unfortunately, the partners had no procedure in place to deal with the dispute. Although they had an advisory board, it had no teeth. "We had one person on the board other than my partner and I," says Desnoyers. "He was our corporate lawyer, and he was there in an advisory capacity only." The partners became so estranged they could no longer work as a team. Eventually, they relied on a "shotgun clause" — in which one partner sets the price, and the other decides whether to be the buyer or seller — to determine who would run the business. Polkinghorne pulled the trigger, and Desnoyers ended up buying out his partner.

"I thought John and I had a pretty good view of where we wanted to go," says Desnoyers, "but in the end that was clearly not the case. The failure on our part was that we didn't put any kind of dispute resolution process in place."

Olson favours a multi-stage process to deal with disputes. In the first, the shareholders agree to meet within a certain number of days to discuss a disagreement. If they can't resolve it, they might turn to mediation, having an objective outsider listen to both and make non-binding recommendations. If they still don't see eye to eye, binding arbitration might be the answer. Desnoyers suggests asking auditors or lawyers for the names of organizations or individuals who can help resolve thorny issues. "If you do get into a dispute, don't let it fester," he advises. "There are organizations that will help get a resolution for you. Seek out help — don't just destroy your company."

The good divorce

Sooner or later, all partnerships end, whether a partner dies, moves to Hawaii or gets into a different line of business. Apart from the usual buy-sell provisions that deal with the death or disablement of a partner, you should consider including a last-ditch exit clause that would allow one or more partners to sell their shares. The most common are the right of first refusal and the shotgun clause.
In its simplest form, the right of first refusal states that if you want to sell your shares, you must notify the other shareholders, who get first dibs. If they opt not to buy your shares, you can sell them to a third party. Some require a third-party offer first ("Match it and buy me out, or I'll sell to them"). Others allow the seller to set the price ("If you don't want to buy under the terms of the deal, I'll find another buyer").

The downside? "There's the assumption that there really is a potential buyer out there for what may be a minority shareholding in a business in which the partners may not be getting along," says Olson. "It's not easy to find somebody who's willing to take that on." Meanwhile, the non-selling shareholders are faced with buying out their disgruntled partner or accepting that he'll sell to whomever he likes. Says Olson: "They could have Attila the Hun coming in as their new partner."

The alternative, the shotgun clause, also has pros and cons. The partner who pulls the trigger notifies the others of his intention to buy their shares at a set price. If they don't want to sell, they must buy his or her shares at the same price. Olson recommends a shotgun clause only for two-shareholder companies in which both parties own an equal share, have similar involvement in the business and are on a roughly equal footing in financial assets.

Consider the case of Dequoy and Robillard. In the midst of Dequoy's negotiations to be bought out, Robillard called a showdown. His lowball offer reflected the assumption that, at age 34, Dequoy couldn't raise enough money to buy 66% of the company within 30 days. Robillard, on the other hand, needed only half as much to buy out Dequoy.

Similarly, if one shareholder can't run the business on his own, his partner can take advantage of that by naming an artificially low price per share. But at least a shotgun clause provides a last resort for partners who simply can't work together anymore. "Think of a world without divorce," says Ambrose. "There would be a lot of unhappy people around."

What's more, the existence of companies that can help entrepreneurs react quickly to an executed shotgun clause, such as Argosy and some venture-capital firms, makes the outcome less certain.

In Dequoy and Robillard's case, the older man lost the gamble. He was forced to sell when Dequoy managed to cobble together the financing he needed with help from one of his customers, a distributor of Avant-Garde's work platforms. "I was quite prepared to be bought out," says Dequoy. "But he didn't play fair."

Partnership Prep 101

Want to make sure you're on the same page before you tie the knot? Here's what you must agree on:

Contribution of startup capital: How much cash will each partner contribute, and under what terms?

Decision-making: Articulate the hierarchy of decision-making and the difference between "ownership" and "management."

Decisions that require unanimity: Typically, you'd want all the partners onside for a major strategic shift, such as entering a new sector or making an acquisition. With more than two shareholders, you might use another formula, specifying, for example, that certain decisions require two-thirds or three-quarters approval.

Performance and salary expectations: Will salaries and expenses be reviewed against a benchmark in your industry? Must all partners agree on changes to compensation? Or will it rise as a percentage of profits? Spell it out.

Distribution of profits: You may want to specify in advance what proportion of the profits you'll take out of the business and how much you'll reinvest. Or you could specify that no dividends will be paid out without majority approval.

A need for additional capital: What if the business needs more cash? Will each shareholder contribute equally? Will one be the "banker" who's willing to contribute more if necessary? Will the company seek a bank line of credit, and if so, are the shareholders willing to make personal guarantees?

Provisions for a partner's death or disablement: What if a partner suffers an accident tomorrow and can't work for six months — or, worse, is permanently disabled or dies? Where does that leave the business? Does that trigger certain rights of purchase? On what terms?

Top 5 causes of business breakups

"I work harder than you do"

Partners tend to overvalue their own contribution and undervalue their partner's. Typical thinking: "Man, I'm breaking my back here, and one of my partners is taking it easy — taking four weeks vacation in the summer and not contributing nearly as much as I am."

Expert advice: Don't sweat the small stuff. Recognize that you and your partner may have different work patterns. He may take four weeks in the summer, but work more hours through the week; she may take work home rather than toiling at the office. Employment contracts specifying each partner's role and performance expectations can help.

"We can't talk anymore"

Partners may be so caught up in day-to-day work they lose touch with each other's goals and plans. After a few years of this, you find you've grown irreparably apart.

Expert advice: Schedule some kind of meeting at least twice a year in which you talk broadly about your relationship with the business and each other. "If one partner wants to retire in five years, it shouldn't come as a surprise to the other," says Jim Hatch, a professor at the University of Western Ontario 's Richard Ivey School of Business.

"You want your son to take over?"

A partnership may go along swimmingly for years, but bring family into the equation and you could be in for stormy weather.

Expert advice: Make succession planning an ongoing process. As the business grows, you may want to bring in professional managers to decide whether family members are qualified for leadership roles. And whether you want your daughter to be a principal in the company or just to have a summer job, discuss it with your partner.

"We make toilets. What do you mean you want to get into sinks?"

Entrepreneurs can sometimes have widely diverging visions of where the business is headed.

Expert advice: Strategic planning should be ongoing. Questions to keep top of mind include: How will we finance the business? How quickly will we grow? What steps will we take to penetrate markets or develop products? "These things are not unique to a multi-owner business," says Don Olson, a lawyer at Giffen Lee LLP in Kitchener , Ont. with many family-business clients. "But having more than one owner complicates things further because you have more than one point of view."

"I just don't want to do this anymore"

Your partner may want to pursue new avenues or quit work altogether.

Expert advice: Don't take it personally, and ensure an exit mechanism is in place.






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