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A Cautionary Tale About Partnership

Richard Fox, Cofounder and Business Development Manager, SulfaTreat

For any of my fellow entrepreneurs who are thinking about taking on a partner in business, I offer the following personal experience, which I hope will make you either reconsider or seek good legal advice.

With a background in corporate law, I thought I was well protected when I gave up my legal career to start an oil and gas production chemicals company with my father in 1989. I created all the necessary legal documents and agreements to ensure that I would always run the day-to-day business as president. Specifically, I created shareholder agreements, voting trusts, buy/sell agreements, and special bylaws and articles of incorporation.

It wasn't my father that I felt I had to protect myself against. Rather, it was his previous business partner who had never shared my father's more conservative business philosophy. Although my father and his partner had a serious rift in their relationship before I came on board, by operation of law, the partner was allowed to carry over his earlier 50 percent interest into the new venture.

Despite all my planning, I never anticipated what transpired immediately after my father tragically died in an automobile accident in 1993.

On the day of my father's funeral, the partner had a secret meeting with our number one competitor to try to sell the company out from under me. When I found out about the meeting and refused to cooperate in the sale discussions, the partner tried to force the sale through the courts.

But luckily courts don't like dissolving successful businesses, so his initial efforts failed. Undeterred, the partner continued to batter me with several more lawsuits, arguing everything including mismanagement, shareholder oppression, wasting of assets, conspiracy, and abuse of power.

I won every lawsuit over an eight-year period, but it turned out that that was only the beginning.

In 1999, the final and devastating blow was delivered in the form of a newly enacted Missouri state statute. The statute gave the partner the absolute right to sell the company "at will." Given the statute's deliberately word-smithed language, not even a judge could stop him.

Upon investigation, we discovered that the passage of this legislation was no coincidence. The statute was sponsored by a state senator who was also an attorney employed by the business partner's law firm. The bill went unnoticed through the legislative docket because of "unusual circumstances" and only became known to our lawyers after it was signed by the governor.

Although I fought the statute and filed an appeal with the Missouri Supreme Court, when I lost in the trial court I complied in good faith with the court order to sell the company. By then the business was generating more than $5 million in annual profits and was still growing strong. It was my plan that if we did not receive a fair offer, I could use the pending appeal as a "poison pill" to kill an actual sale.

Ironically, this unique situation gave the investment bankers a story to tell that was irresistible to buyers. In the end, eight companies made firm purchase offers, and in 2001 the company was sold to the highest bidder for $35 million in cash, a very nice offer in both my opinion as well as my partner's. After eleven years, it was the first thing we agreed on.

In retrospect, I did a lot of things right then, and there are a few things I would do differently today. What follows are lessons learned:

  • Know Your Existing Shareholders' Rights. Shareholders of private companies—even minority shareholders—hold the same legal rights as shareholders of public companies. When you accept shareholders, you accept the same scrutiny that comes with being a public company without the benefits. Understand that you can never be adequately prepared for a shareholder who wants to maliciously assert their shareholder rights to cause you problems.
  • Avoid Taking on New "Legal" Shareholders. Entrepreneurs sometimes give ownership interests to key employees to allow them to share in the equity growth of the business. For the reason stated immediately above, you might consider offering "phantom stock," which carries all the economic benefits of common stock ownership without the potentially abusive rights of legal ownership. Your lawyer should be able to advise you on the details.
  • Take the high road. Rather than counter-suing the partner, I chose to put my energy into building the business. Not only was it good for the business, but it kept from muddying the waters any further and made a much needed ally out of the company's other corporate director.
  • Be prepared for anything. Pushed to the edge, some people will fight back with extreme measures. Although secretly passing legislation is extreme, be prepared for the unexpected.
  • Sell on your way up. Entrepreneurs are "hard-wired" to grow businesses. The idea of selling is usually a far-away concept that is considered, but knowing the best time to sell is not intuitive. Don't wait until you can see the peak because chances are your buyers can see it too and will discount the price accordingly. Plan on a full year for the sale process to be completed; if you pull the trigger too late, you may miss.

Let's face it, I got lucky. Two months after we sold the company, business was devastated in the wake of the September 11 attacks. It took more than three years to recover. So despite all the planning, there are some things we just can't control.

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