A business partnership can be as productive as marriage—and sometimes, just as devastating. Marian Edmunds looks at protecting yourself in the boardroom.
When business partnerships break down, the clean-up effort can be messy. Everything is thrown into the aftermath—from homes
to relationships, personal savings and even the very business itself.
In his 21 years in hospitality management, Tony Eldred has seen many hundreds of people lose everything—including their marriages.
“Often, if one of the marriage partners doesn’t do their bit properly, not only does the business sour, but the marriage sours at the same time. That’s not at all uncommon,” he says.
But sometimes, business can survive soured personal relationships. Eldred consults to a boutique hotel operation where the partnership soured 30 years ago and the partners haven’t spoken a civil word to each other since—other than what’s needed to run the business.
“They’ve stayed in business for pragmatic reasons,” says Eldred. “It’s a good business, but they don’t talk to each other. That can happen,” he says. Presumably they have a clearly laid out partnership agreement that enables them to survive running the business day to day.
Partnerships are most commonly between the chef and front-of-house, and the relationship will start to break down when either party is dysfunctional. They start to go to war with each other as they see their savings disappearing before their eyes.
Other partners go into business with mates, but Michael Conrad is quick to point out he’s not one of them. He and David Pugh have a successful partnership in their eateries, Restaurant TWO and Three Bistro in Brisbane; but their relationship started as a purely professional pairing, Conrad tactfully explains.
“We knew each other, but were by no means close personal friends.” Then Pugh came to work for Conrad and Conrad made him a partner three years afterwards. The pair has since opened Restaurant TWO and Three Bistro together.
“It’s a working partnership,” Conrad says. The kitchen provides a solid dividing line, with him looking after everything in front of the kitchen door and Pugh running the kitchen.
“We sit down and we talk quite a lot, but not in a formal sense,” says Conrad.
The high cost of a business break-up usually comes down to one or two things: the structure of the business and the lack of planning of an exit strategy should the venture not work out.
Eldred recommends a proprietary limited company rather than a partnership, which leaves you personally liable. In a partnership, debts are recoverable against all partners and your creditors are likely to file for bankruptcy or to sue you for the debt, which may result in you having to sell your house to clear your debt, or declare yourself bankrupt.
If the business fails, it can cost you your house, whereas with a proprietary limited company, you’re only limited to the assets of the company and it doesn’t affect your personal assets. “To me, that’s a fairly serious implication given the percentage of hospitality businesses that go belly up,” says Eldred.
Jonathan Kaplan of Meerkin and Apel Lawyers in Melbourne specialialises in most aspects of law touching the hospitality industry. For the past 15 years and until recently, Kaplan also owned cafes in Melbourne. “The important thing to remember about a partnership is that the liability of the partners is unlimited,” says Kaplan. This means that when partners go into an arrangement and one of them incurs a debt, then the other partners are liable, even when the debt is incurred without their consent or even knowledge. “It’s joint and several liability, and that’s the risk no matter what the internal arrangement is between the partners, because to the outside world it still exists as a partnership, with all its disadvantages,” he says.
Kaplan agrees with Eldred that it’s best to set up a proprietary limited company structure. But for not much more money, he says, a trust structure provides greater flexibility for tax purposes. These structures protect individual wealth, says Kaplan.
The requirement, though, for personal guarantees for the debts of the business becomes a problem when you’re dealing with a supplier, says Kaplan. A meat or grocery supplier is not interested in the internal structure of the business and is only concerned about getting paid. Most credit applications for any of the grocery suppliers require personal guarantees from the directors. “If you’re setting up a joint venture arrangement and you have a nominee company, which is often the way it’s done, the joint venturers nominate a company to transact on behalf of the joint venture. The nominee company, generally, will have as directors the operators of the business. That company really has no assets, so the directors would generally have to guarantee the obligations of the company in relation to any credit application that they are making with any supplier,” says Kaplan. “So personal liability cannot always be fully protected.”
Family businesses don’t tend to be set up as partnerships. They are usually owned by an individual or a couple, and the relatives and children work in the business and are paid a salary as normal employees, often with the understanding that one day the business will be handed down. This sometimes doesn’t happen and family business structures can be all over the place, says Eldred. ‘Family’ partnerships can offer tax advantages when splitting income, but people should take the same care in setting up these business ventures as any, Kaplan says.
Partnerships or shareholding companies are the two common structures and, if you set up a proper company, you automatically become partners, whether you have a proper partnership or shareholder agreement or not. But this is inadequate without a proper partnership or shareholders agreement, says Eldred. Sometimes people just have a handshake, which is dangerous. He recommends setting up a proper partnership or shareholders agreement spelling out the rights and responsibilities of both partners. This is extremely important if you have a so-called ‘silent partner’, who’s usually the financier. The person who puts up the money is anything but silent, says Eldred. “They often enter these relationships with the expectation of a normal financial return on investment and when it doesn’t come, they become quite vocal and will often then start to dictate what happens to the business,” he says. “There’s no quick way out of a business in trouble and you can’t sell them.” Usually the only thing left is to walk away.
Conrad and Pugh’s partnership has made provision for worse case scenarios. The partners carry very large insurance policies on each other’s lives, so if something was to happen to one of them, there would be a large injection of cash to cover the downtime and cost for anything that needs to be changed over. There is a second policy that enables the sale of the restaurant to surviving partner. The share must be sold automatically to the surviving partner rather than family taking over.
The more detail in the written agreement between business partners, the better, says Kaplan. They need to document the terms of the relationship between them, their rights and the obligations that they have towards each other. “There needs to be a properly documented process to deal with any disputes that may arise between them, including an obligation to mediate a dispute before resorting to litigation,” he says. There also needs to be a detailed termination clause so that if a partner wants to extricate himself from the business he can, says Kaplan.
Sometimes business structures and succession provisions are foolish and ill-planned, if, say, a partner can sell their partnership to a third party that the other original partner doesn’t have the right to veto, says Eldred. “You could end up selling your partnership to a complete idiot who had a pocketful of money—but it could destroy your business. Normally, when a partner jumps out, it forces the business either to fold or to be placed up for sale.”
Partnerships without written agreements in place skate on thin ice, says Kaplan. Many people end up in costly litigation and even when they are successful in court, they usually end up with little to show for it.
As your best negotiating position with your partner is before you make any formal commitments or spend any money, you should engage a lawyer (preferably with hospitality industry experience) to document your agreement at that early stage to avoid any potential disputes later on. An investment of $3000 to $5000 in legal fees to do so could end up being money well spent, says Kaplan.
Such an agreement should set out the rights and obligations of each of the parties, their remuneration, their financing obligations for the venture, the frequency of distribution of profits, who’s going to maintain the accounts of the business, the sale or termination provisions of the business and dispute resolution procedures.
Conrad says that he and Pugh are good at working out any difficulties or differences. “It doesn’t matter how you feel or what you think, if there are 100 customers here and they’re expecting to be fed a very nice meal and have a wonderful night, we just have to get over it and get on with it,” he says.
The partnership works because Pugh and Conrad have similar aspirations and motivations and they communicate. Eighteen months ago they took on a smaller partnership with Peter Marchant, who runs Three Bistro. “Peter’s probably the only person that’s ever worked for me, or with me, who does everything pretty much exactly the way I do it, which is why things have been passed on to him in terms of equity and everything else in the business,” says Conrad.
Partnerships are usually best if both parties are on equal footing, says Conrad. “Partnership is, in its own horrible way, like a marriage. You’ve got to work to make it work and there’s got to be a lot of respect going in both directions,” he says.
“You do have to sit down and write it on paper, but there’s got to be a knowledge and an understanding between all the parties as to what is going on.”