Buying A Business With Partners Or Family Members: Pros And Cons

I have sold many businesses to buyers who were family or friends, and I have sold just as many when the reason for selling was "dispute between partners." Owning a business is extremely time consuming, and so it helps to have someone there when you are not who you can trust. Internal theft is a major problem in many business operations, and so just having a "manager" on site is not enough to deter theft. There are some things anyone who is interesting in becoming business partners should consider.

1. Identify Roles

I suggest anyone who wants to become partners to analyze and decide which roles each person will do. If you are buying a restaurant decide what person will be responsible for bookkeeping, working in the kitchen, handling staff issues, etc. Many times, people will by a business and become frustrated, because one person feels they are there all the time while the other person comes in infrequently.

2. Define Your Goals

Identify what your ultimate endgame is. Are you buying a business that you will eventually sell in 2-3 years or are you planning to expand in the future? It's important to ask yourself what your plans are and what you will do if one of the partners decides they want to leave. I have seen people become successful by buying a business and working it together and then eventually opening up another location that one of the partners runs.

3. Visit An Attorney

Possibly visit an attorney and have them draft up a business partnership agreement. Is one person bringing in more of the money, while another will be sweat equity? It's important to decide if it s going to be a 50/50 or 60/40 split or another percentage of the business' net profit.

4. Separation of Private and Personal Lives

If you are a husband and wife buying a business make sure that you make it a point to separate your business with your marriage. On a personal level, I have seen many people who lose their personal relationships because they become consumed with the business and ultimately through conflict both their business and relationship suffer.

Following up on Mark's comments, I can't think of any good reason not to form an LLC or sub-S corporation rather than purchasing a business as a partnership. In a partnership, each partner becomes the effective agent of every other partner and can create unlimited liability for the other partner(s); the risks are enormous.

The decision to form a limited liability company (LLC) or a "C" corporation or a "sub-S" corporation is almost exclusively a tax issue. When I practiced law in New Jersey, I would advise clients to discuss that decision with a CPA; then I would form the preferred entity for them. That's the easy part. The intricate and essential part is discussing, negotiating, and drafting the in-depth shareholders' agreement that covers all the possible "what ifs" that could arise and how they will be resolved if they occur. The concerns are myriad, including: death, disability, or mental incapacity of a partner; incompetence, dishonesty, malfeasance, insolvency, or bankruptcy of a partner; personal judgments against a partner; divorce of a partner; sale, gift, or other transfer of a partner's interest; inheritance of a partner's interest and other succession issues; sale of the entire business to a third party; employment of partners and/or their relatives; conflicts of interest; competition by a partner with the company; confidential and proprietary information; transactions between the company and one or more of the partners; day-to-day and long-term decision-making control and management authority; authority for capital purchases and real estate transactions; authority and control over finances; distribution or reinvestment of profits; taxation; directors and officers (D&O) insurance; protection of minority partners from the majority; mediation and/or arbitration of disputes; and many more.

Obviously, this requires the advice and counsel of a seasoned business attorney ... preferably before purchasing a business. Failure to plan thoroughly in advance can lead to losing everything, and not just what was invested in the business. I have seen it happen before, and I can guarantee it will happen again if partners fail to plan and provide the proper agreements to protect themselves and their families.

To expand on Joe's point 3, in California, if you act as a partnership when you buy and operate a business, you create a legal partnership automatically. If you don't have a written partnership agreement (or form the business as an LLC or Corporation) then you are going to be stuck with California's parntership laws if you ever have a dispute or one of the partners is incapable of running the business. I don't know about you, but most entrepreneurs and business owners I know would rather not have the State of California making crucial business decisions for them.

Even if there's not a dispute you can still run into issues. For example, what happens if one of the business owners becomes incapacitated or declares personal bankruptcy? If you have a partnership agreement (or, even better a corporation or LLC) those issues can be worked out ahead of time, the way you and your partner(s) decide, not the way the State of California decides.

If there's a dispute things can get even more difficult if you don't have a written partnership agreement or corporate entity. If you plan ahead you can work out reasonable provisions which allow one partner to buy the other out if you can't resolve a dispute or if there are other unresolvable issues. If you don't plan ahead you can be stuck taking your dispute through a costly and lengthy court procedure where a court-appointed receiver makes the decisions that you can't because your partner(s) refuse to cooperate.

Additionally, if you start or purchase a business as a partnership you may be exposing yourself to substantial liability that you wouldn't be exposed to as a shareholder of a Corporation or member of an LLC. Before you purchase a business with partners make sure that you're considering all of the legal implications and whether a partnership (as opposed to an LLC or Corporation) is truly the best fit for you.