I discuss this as well as what I've learned about partnerships.
Enjoy. Watch it here: https://youtu.be/UNZavOxgg74
Hi everyone, it’s David Barnett from InvestLocalBook.com. This week I’ve got a question from Kurt who asks about partnerships and I’ll read it here: I have recently approached a local business owner for a partnership. Me being able to buy in. I think he may actually be considering it. How would I evaluate this opportunity and what would be some sources of financing?
Well Kurt let me tell you. If a business is already up and running and established then probably, unless it’s a very mature business that’s paid off all of its debts, it probably already has financing built into it, so if it’s a business let’s say that’s worth $400,000 and there’s $300 000 of debt the financing is already there. You would be buying and/or be becoming a shareholder by purchasing some of the shares and you’d only be buying what is represented by the equity.
So say there’s $100,000 worth of equity there. As far as you getting your hands on money to buy those shares, you’re not going to find any outside sources of financing for that aside from maybe your relatives, parents, you know great aunt that kind of thing. If a banker is willing to lend to you personally, it will be personal lines of credit for example.
Now personal debt at the bank is usually associated with your level of earnings and your job, so if you wanted to get a lot of credit in order to have money to buy into this business then you would you need to arrange that debt facility before you left your job.
Now here is the big danger of doing what you’re proposing. Getting into business with someone, especially as a minority partner is a risky affair and the closest thing that I can think of to this type of relationship would be a marriage. You’re going to be getting involved with someone who is still going to own the majority the business, could still outvote you, when it comes to important decisions. The only way to get around that is to have a partnership agreement that specifically spells out that maybe even if you don’t own the majority of the shares or even half of them, that you still get an equal proportion of decision-making power.
Now the problem with that is if you have to regulate your relationship with this person through contract then in order to go back and visit the contract means there must be some kind of conflict between the two of you. In my experience conflict between the two people usually stems from people not having a well-defined job description or series of responsibilities. If you’re going to get into a partnership with someone, you have to know them and trust them and know that you’re going to be able to get along with them. Also, you have to have a well defined structure as to who is responsible for what. You need to formalize the roles within the business just like a big company does. Different managers of different things. Different people have different responsibilities.
I recently did business with a partnership and it was a man and a woman. They were not a married couple, they are business partners and I met the gentleman only once because I needed his signature on something. Other than that I just dealt with the woman. That’s because the woman was CFO and in their partnership agreement they had clearly defined roles, she was the CFO and the president and he was head of operations and so he managed everything to do with the plant and the factory floor and receiving the shipping, the transformations of the goods and she never went there.
Her domain was the financial aspects: payables, receivables, making sure customers paid, etc. They both had a very clearly defined set of responsibilities and roles and then every once in a while, they met together as shareholders to discuss the direction of the company and big picture things.
The problem that often happens in small companies that are partnerships, especially in your situation where you’re thinking about buying into a business that already exists, is the owner that’s already there. He’s already accustomed to being the person in charge of all decision making, so everything goes to that person right now. They make all the decisions. Are they open? Is their mind open to a change in how the business functions? Are they open to having another owner there? Are they willing to define roles and not have the both of you stepping on each other’s feet all the time? It’s a very big decision and it has to do with a lot of things. It has to do with business sophistication and also emotional maturity and that’s why I say that in a lot of ways this is like a marriage because you’re going to be joining yourself up financially with this person and you have to be able to get along with them.
There’s another client of mine that I’m working with right now, who has found someone that wants to buy his business and they’re actually considering a multi-year transition. The buyer will buy in 20% then the following year, they’ll do a dividend of any extra cash and then the buyer will buy another 20%. Eventually the dividends will allow the buyer to buy out the seller in that five-year transition period. They’re going to go through a period where both of them are going to have an ownership interest and in the beginning, the buyer will be minority and towards the end, the buyer will be the majority.
What they have realized, with my help, is that what they actually have to create policy and procedures manual. They have to create job descriptions for all the different roles, they have to create a formalized hierarchy or organizational chart showing who does what, so that when they operate with two owners, each of them is going to know you know; when I am wearing the hat of the service manager then that’s what I do and these are my responsibilities. “I’m not going to go and stick my nose in the business of the marketing manager because that’s his domain,” for example.
These two guys are wearing multiple hats so it’s always going to be a challenge to make sure that people are just doing their roles and then to reconcile that later when they come together as shareholders to have that shareholder meeting to make sure they’re both on the same page.
So it can be a very difficult and complex thing. Kurt, you’re not going to get somebody to lend you money to buy into a small business. In my book Invest Local, I explain clearly why it does not make sense to be a minority shareholder and the one exception I do give it in the case where shareholders are active in the business. This is what you’re proposing.
So I hope that answers your question and if anyone has any other questions or comments feel free to send them along and don’t forget to sign up for my email list at www.InvestLocalBook.com
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