Careful Planning and Expertise Are Crucial to a Sound Partnership
Home builder Ira Norris has raised millions of dollars from hundreds of limited partners he has never met. By combining his expertise and their cash, Norris has built more than 9,000 homes and is proud of his ability to please a business partner.
“It is important to really get to know each other’s expectations and talk about the downside of the deal,” said Norris, founder and president of Inco Homes in Upland, which employs about 70 people. “Then, when something bad is happening, let your partners know right away.”
By following his own advice and building affordable quality homes in Southern California, Norris was chosen local Builder of the Year by his construction industry peers in 1988. He has built a loyal following of investors who keep reinvesting because they are pleased with the results.
Every day, in coffee shops and conference rooms across the country, business owners and potential investors are scribbling deals on scratch pads and napkins. But turning those scribbles into viable, legal and satisfying partnerships takes careful planning and expertise.
Entering a partnership is very much like getting married. Unless you know the person well, communicate openly and develop trust, you may end up in court.
“Regardless of all the handshakes, no deal is a deal until the partners fully understand all the consequences of the arrangement,” said Scott Farb, a partner in the accounting firm of Kenneth Leventhal & Co. in Los Angeles. Farb, who reviews Norris’ construction partnerships, said a partnership agreement must be clearly written so each partner understands exactly what he or she is getting into.
“You should clearly define what each partner will contribute and the percentage of ownership,” Farb said. “It’s also important to make arrangements up front as to how the partnership will obtain additional cash if there are operating deficits.”
Every partnership agreement must also include a provision for buying out or terminating a partner in the event of disability, death, bankruptcy, criminal activity or irreconcilable differences. Farb said the agreement must be fair and “track properly” when it comes to profit-and-loss allocations among the partners. And, every partnership needs a detailed business plan, forecast and hypothetical financial projections.
Whether the actual agreement is 10 pages or 100, an attorney should be involved in its drafting. After the attorney writes the legal language, it should be reviewed by an accountant familiar with the tax laws affecting partnerships. By seeking counsel from both advisers in the beginning, the partnership has a much better chance of success.
“You should be as specific as you can be about the purpose of the partnership and very clear about who will run the business or enterprise,” advises Warren Kessler, a Beverly Hills attorney who specializes in drafting partnership agreements.
Kessler, who has drafted hundreds of partnership contracts, said the most traditional partnership involves one person who provides the product or management skills, while the other contributes the cash.
“One person should be responsible for creating a budget and a timetable,” Kessler said. “That person also needs to produce regular financial statements for the partners.”
Unlike a corporation, which operates under a standard set of bylaws, Kessler said, a partnership agreement can be tailored to spell out exactly how a particular business venture should operate.
Although most entrepreneurs need cash to pursue their dreams, many are wary of entering partnerships because they balk at having to give up control in exchange for capital, according to David King, a partner at the law firm of Morgan, Lewis & Bockius in Philadelphia.
King, who specializes in venture capital issues, said a key part of his job is to “educate entrepreneurs as to what an investor wants from the deal.”
Entrepreneurs need to know exactly how and when they will receive their share of the profits from a partnership, King said. And, he also stresses the importance of open and honest communication with the people putting up the money.
“If the business is successful,” King said, “you are going to have to go back to the same investors for more money to grow.”
Strong Managers Can Still Get Venture Funds
Despite the turmoil in the Middle East, which has raised recession fears, the outlook for finding venture capital is not as bleak as you might think. Bank-backed funds have become more conservative in their investments, but private money is still available to back strong managers interested in buying or starting their own firms.
This was the message from five venture capitalists appearing earlier this week at the Los Angeles Venture Assn.’s annual venture capital forum.
“This is a very good environment for spinoffs,” said Charles Fullerton, managing director of First Interstate Venture Capital Corp. in Newport Beach. “Subsidiaries of larger companies are retrenching, creating a lot of opportunities for management teams to buy divisions.”
Fullerton also said more sellers are willing to finance deals rather than reduce the selling price of their companies.
Allen Lay, general partner of Southern California Ventures in Los Angeles, said money is available, but fewer and fewer dollars are going to start-up companies.
“Two to four years ago, people looking for capital to start a company had lots of places to go--not so anymore,” Lay added.
All the venture capitalists emphasized the importance of having a respected intermediate present your business plan to them. A plan sent in cold to a venture capital firm tends to sit on a stack of other unsolicited business plans. A well-written plan handed to a venture capitalist by a banker, attorney or accountant is more likely to be seriously considered.
The venture capitalists also reminded entrepreneurs that venture money is expensive. Due to the risks involved in investing in new or growing firms, most venture capitalists expect at least a 25% return on their money and a controlling interest in the company.
CREATING A SUCCESSFUL PARTNERSHIP * Define who will contribute the cash, property or expertise. * Specify the percentage of ownership each person will have. * Prepare a business plan and financial forecast for the life of the partnership. * Figure out who will provide additional cash if it is needed. * Be sure the tax profit-and-loss allocations are consistent and fair for all the partners involved. * Provide a way to remove or buy out partners who fail to meet their obligations. * Define how, when and in what order the profits will be distributed to partners. * Communicate openly and honestly with your partners.
