When a Business Partnership Goes Wrong

If the business is failing and your working relationship sours, there are steps you can take to either mend fences with your partners or dissolve the partnership

My fiancé decided two years ago to go into business with his sister and her boyfriend. The business is a entertainment venue and restaurant, but because they jumped into the business without a business plan or clear vision, it is failing. My fiancé knows this and wants out, but because of the emotional and verbal abuse he has endured from his sister's boyfriend, he feels trapped and doesn't know how to exit the business. What can he do? —S.D., Elk Grove, Calif.

Your fiancé's situation is a good illustration of why it is so important to plan thoroughly before starting a business. If these three had prepared a business plan (BusinessWeek.com, 1/7/08) and drawn up a formal partnership agreement (BusinessWeek SmallBiz, June/July, 2007), there would be a clear exit strategy laid out that any of them could follow. But without valid legal documents, there can be ugly financial and legal repercussions when a business goes sour.

That said, there are steps your fiancé can take to either mend fences with his partners or dissolve the partnership. "Approach your partners in a nonthreatening way and ask to discuss the situation. Plan a meeting at a neutral location so that neither party has an advantage and everyone feels free to express their concerns," says Dane Fox, vice-president of PartnerUp.com, an online partnership site. At the meeting, talk about why the business is failing, trying not to point fingers but to identify specific problems, he says. If your fiancé and his partners can list their main trouble spots, they can work up a plan to solve those issues, attaching clear responsibilities and deadlines to the remedies involved.

If that attempt fails, your fiancé has several options, Fox notes, including asking his partners to buy out his interest in the company, arranging to buy out their interests and assuming full ownership of the company, and selling the business outright to a third party. If the business is going under, he's likely to have a tough time recouping his investment and may have to be content walking away, hoping not to lose money repaying creditors.

Legal Counsel Necessary

His first step in extricating himself from this venture should be contacting an attorney, says David Margulies, whose Margulies Communications Group does crisis management (BusinessWeek SmallBiz, 12/14/07) and recently counseled two gym owners in a similar situation. "This isn't any different from getting a divorce; the individual needs legal counsel. A good attorney can also act as an intermediary to handle negotiations in an impartial manner. Whatever it costs, it will save money in the long run," Margulies says.

Your fiancé should present his attorney with any documents he signed in conjunction with the business, such as leases, contracts, and loan guarantees. He should also bring in any information about the entity that was formed to conduct this business, whether it is a partnership, LLC, or corporation (BusinessWeek SmallBiz, August/September, 2007). And he should draw up a history of his involvement, including how much money he invested initially and subsequently, what his duties were, and how many hours he put into working at the restaurant.

Next, he should determine if the business recordkeeping is up to date. "Are the books and records properly maintained? Have all tax returns due been prepared and filed? Has he reviewed the current financial statements and checking accounts, or at least a list of the unpaid creditors?" asks William Weintraub, an attorney at Jeffer, Mangels, Butler & Marmaro in Los Angeles. Getting the company books in order will help him determine what his potential liabilities are before he leaves the company.

Exit Strategies

In terms of an exit strategy, he can formally dissociate himself as a partner or resign from the corporation if he is an officer or director. "These acts can protect him from liabilities incurred afterward; however, he should be concerned about his potential liability as an owner, officer, or director during the period that he was active, particularly if the business is now failing," Weintraub says. That liability might include unpaid employment taxes, sales taxes, and unpaid business debts, depending on how the company was organized.

If there was no partnership agreement and the company was never incorporated, your fiancé can withdraw from the business by sending written notice to each of his partners. He should also notify in writing any individuals or businesses with which he or his partners have entered into contracts, says Cliff Ennico, a Fairfield (Conn.)-based small business attorney and author of Small Business Survival Guide. "He violated the first rule of small business, which is that you have to treat friends and family with the same formality that you would a complete stranger if you go into business with them," Ennico says.

Both you and your fiancé will be smart if you can remain cordial—or at least civil—toward his partners, Fox notes. "Getting angry and becoming hostile, particularly where family is concerned, can potentially make things worse and end with a bitter family feud. Running a business is always tough, so try to work it out if possible. If all else fails, then you need to bail, no matter how trapped you may feel," he says.

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