Franchise Business Partnerships - Evil King or Hand-Cuffed President?
The Evil King vs. the Hand-Cuffed President - who do you want to be? Our experience has demonstrated that the best way to position yourself and your successor is somewhere in the middle, between these two opposing operating organizations.
No one wants to run a business without the autonomy to make critical operational decisions. No one wants to invest their assets in something they can't control or get away from when things go bad. Whether other family members are involved or not, every thriving business needs a clear structure which will protect both the business and the family. To accomplish these goals, documents need to clearly define which issues will require more than 51% of the vote (often 67%), which we refer to as 'issues of major importance.'
Creating a lasting business structure with the flexibility to evolve will require a discussion of "what ifs" specific to your business. Where do you go to learn what are the most important issues to consider? The items listed in boiler plate legal documents can be a good start but need to be closely reviewed and massaged because they are rarely specific to your particular operation. Our experience suggests there are some key discussions that must take place around issues such as selling the business, acceptable debt limits, adding/removing partners, amending executive pay plans, circumstances surrounding issuing additional shares of the company, amending shareholder agreement/operating agreement, and entering into lease agreements, to name a few. Sole owners during their lifetime often are not as concerned about these issues since they are the person wearing all the hats and making all decisions (The King). However, sole owners who at some point begin seeking succession and/or taking on partners will find themselves in unchartered waters, with no experience in wading through issues they have never been made aware of. Suddenly, they find themselves considering new dynamics pretty early in this new planning process. However, this is a critical point in time for the development of a long-term successful business. There is no better time to plan for the governance and/or potential dissolution of a partnership than when you begin one.
Some business owners avoid this critical component in developing a long term, sustainable business because they have no idea how to begin without causing more harm than good to their operation. This can be like discussing a prenuptial agreement before the wedding day. It seems so unpleasant that many would rather ignore the need for discussion and hope for the best than try to navigate a difficult conversation and risk everything before the deal is consummated. When considering what's at stake however, it could be business suicide to go into a partnership without protections for all involved.
Some partners prefer to be investors only. "I trust you to make the decisions critical to profitability." A partnership with one partner holding all of the voting control can be desired by those only seeking a return on investment and no ambition of working in the business. This deference to "The King" works...until it doesn't. When profitability dips (for any reason), The King's throne is often challenged. It is natural for anyone with a vested interest to develop an opinion on how things should be done. Predictably, trust will be hard to come by and an "escape hatch" in the partnership agreement becomes necessary to allow partners to go their separate ways without incident, if such is the necessary solution. Often, simply knowing that an "escape hatch" exists reaffirms the trust between partners because they are choosing to be together, not forced to be together. Some consistent real-life issues needing resolution we have seen:
- What if the partner-operator needs to take on debt requiring personal guarantees by all shareholders?
- Should a partner have to meet some criteria to have the right to get out of the partnership?
- Should it be accepted that a partner can get out anytime he/she feels like it?
- If so, what are the terms?
- Is cash realistic?
- How long should the amortization be?
- How is the value to be determined? By appraiser? Whose appraiser?
These are just a few common considerations - there are any number of ways two partners can make an argument when trying to separate.
Apply these dynamics to a family business and you quickly realize there is more at stake than just the business. Succession through the family quickly becomes a nightmare when siblings are forced to enter a negotiation which results in a perceived winner and loser. Irreparable damage can occur (personal and family dynamics) through the process resulting in losses far greater than money.
In some cases, partners may have expectations of formal voting protocols and a Board of Directors. In family businesses, I have heard, "Mom and Dad gave me an interest in the business, therefore I have a say in how you do things!...And guess what, I vote that we make a distribution this year!" Without formally identifying the protocol, we have seen CEO's with voting control award themselves a raise in salary that precluded the ability to make distributions to their sibling shareholders. Should the "investor only" siblings have the right to govern the salary? To what extent should the successor operator be forced to consult with other shareholders before making decisions? In other words, how do you avoid becoming the "Evil King" without creating a "Hand Cuffed President"?
Whether you're developing a partnership with a friend or other third party, rewarding a key manager with stock ownership, or transferring shares to family members, it is worth the effort to define how you would like to resolve issues of major importance before any appear.
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