Rich Christiansen - Parallel Entrepreneur, Entrepreneurial Expert

Today we learn a very concrete rule to live by when starting a business: three is not your lucky number.

My home seems to attract neighborhood children. All of our sons bring friends home regularly and we have always welcomed them, making our home a safe place to play. However, a few years back my wife established a wise rule: you can have one friend over, or three, but not two. Three has always been a dangerous number. Whether you’re nine years old making up a game in the backyard, 16 and going out to a movie, or 40 and starting a new venture, three is a tricky number.

When you’re dealing with children, the storm will usually blow over after a day or two, forgiven and forgotten. However, it’s harder for adults to play nice the next day. More often than not, we tend to hold grudges and attempt to exact revenge.

I once cofounded a business developing niche content web sites. My partner and I were enjoying rapid success. A close friend of my partner’s—a former boss of mine—stopped by for a visit. He had lost his job and was looking for an opportunity. I was reluctant, but my partner felt very strongly about bringing this friend into our business. Not wanting to rock the boat, I went along with the plan, despite my reservations and the deep concerns of my wife.

After extensive discussions, my partner and I agreed to bring this fellow on as the general manager under three conditions:

1) He would not have ownership in the company: no equity involvement.
2) We would pay him a very good salary.
3) We would not follow a path that would raise capital (which was his background and natural path).

Somewhere deep inside, I could hear a voice telling me that this relationship structure was perilous, but logically I couldn’t find fault with it. To complicate the situation, our new hire had also been the chairman of a company where I had been the CEO. In this new arrangement, he would be required to report to me rather than me reporting to him. I know, I know—this screams train wreck, doesn’t it?

A number of months later, as we were developing our next business concept, the new general manager laid down the gauntlet and demanded equity to remain involved. My partner supported his position and pressed hard to grant him ownership. I caved. Rule #1 violated. Several months later, I woke up realizing we were on the path of raising funds “to quickly bring the new concept to market.” Rule #3 disregarded.

Now I want to be very clear here. I hold myself accountable for the violation of these rules, as much if not more than my partner.

In most of our interactions, I felt displaced and stupid. I felt awkward. I was the odd man out. My communication and interaction became guarded and I became hesitant to verbalize my thoughts, feelings, or ideas. Much of the direction of the company was now being decided independent of me.

I was the little kid left out on the playground—the third wheel that just didn’t fit. And just as the little kid on the playground gets mad and runs home pouting, I made a stupid mistake. This mistake was over-dramatized, which, when combined with the communication breakdowns, led to the total destruction of the business relationship and the friendship. For me, the loss of the relationship was far worse than the loss of the business, but the decisions we made left us no other option than to messily and bitterly part ways.

Porter’s Points—Three Is a Dangerous Number

• 1+1+1 does not equal three - it equals trouble.
• If you know the train is bound to wreck, why buy a ticket to that destination? Get off the train and find another ride—there are hundreds of trains!
• If you find yourself in a hostile partnership give plenty of consideration about the price of terminating it. Pride is not your friend!

Stick to the rules you made when you started your business and watch for warning signs that you’ve drifted off course. Next time we’ll talk about family businesses.

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Today I’m posting the next two sections from Chapter 7: Fish & Partners since the first section is so short. Remember that last time we talked about the difference between ownership and upside.

Are Your Goals Aligned?

As you start your business and it begins to grow, it is critical that you and your partners align your goals. Make sure you set both joint and individual goals and share them with each other so that you understand the other person’s point of view. Your ultimate goal should be success.

Sometimes, success can mean separation. Do your goals reflect that? Selling one successful business does not mean that you cannot start another business with the same partner, but having a good exit plan from one business will often preserve the partnership and allow your business relationship to live to undertake another venture.

Before striking out into the entrepreneurial world, I was working as an executive for a startup tech company. There was another executive who was my colleague and ally in the company. He was a level-headed, clear-thinking executive who always exercised sound judgment. Suddenly, out of nowhere, this associate started making simply crazy decisions. I could not figure it out. Then I discovered the reason.

Unknown to the rest of us, my friend had decided to invest his entire IRA in the high-risk company we were involved with. Instead of making decisions that were best for the long–term strength of the company, he started making decisions he thought were best for his investment. Our goals were no longer aligned. The company failed shortly thereafter.

Porter’s Points—Are Your Goals Aligned?

• Write you goals down and share them openly before entering a partnership.
• If you ever have a situation where you can’t understand the logic behind a partner’s action, explore her or his goals. Odds are you have a misalignment.

Best Friends No More

On numerous occasions I have watched as good buddies who really enjoyed playing golf together concluded they would make great business partners. The ability to enjoy someone’s company for an afternoon of golf, even over the course of years, is not the criteria to use when choosing a business partner. Social relationships are completely different than business relationships. They are created for different reasons and are subject to different kinds of stress.

I am aware of a partnership that melted down—or, more accurately, blew up—that exemplifies this point very well. These two individuals were actually best friends from high school. Both were charismatic, highly successful individuals who loved to be the winner and the center of attention. They decided to form a partnership and initially found success.

I noted with great interest that much of their interaction and communication revolved around competition with each other. Although at times that dynamic proved successful, more frequently it became destructive. One of the partners achieved some limelight outside the partnership. He used this notoriety to whip his partner around. He then began an inappropriate (and supposedly secret) relationship with his partner’s wife. Needless to say, they are no longer friends or partners.

It is easy to become competitive with friends. I have oftentimes seen friends get into a business together and then waste their talents on a spitting contest. Instead of getting down to business and allocating tasks with regard to skill set and focus, they try to outdo each other, becoming more like little boys on a playground than a partnership. Not surprisingly, most of these partnerships last about as long as recess.

There is a way to work with friends. In fact, it’s quite possible that your partner, because of your sheer amount of time spent together on your common interest, will become your friend. What is vital, however, is that at the outset, you openly establish the expectations and clearly define your roles.

The most important aspect of any partnership is that you each bring a unique and irreplaceable asset to the table. That asset could be knowledge, skill, contacts, or financial resources. Whatever it is, find someone who complements it.

I tend to be really task-oriented and get a lot done very quickly. I don’t engage on lengthy projects very well. Details drag me down and kill my efficiency. However, I know that ignoring the details can result in—well, a sinkful of smelly fish the next morning. Knowing my tendencies, I look for a partner who is detail-oriented and loves to streamline the work and sweat the small stuff.

I have had one partner and dear friend, Roger Seegmiller, with whom I have owned several small businesses through the years. Roger and I graduated from MBA school together. Some of our businesses have been profitable, and others have been just plain stupid. None of our businesses have hit the million-dollar mark. However, more important to me, we are still dear friends.

Perhaps we are still friends because there has never been enough money involved in the companies to strain our relationship. Perhaps we are more mature than other friend-based partnerships I’ve seen. But I doubt either is the case. I think we are still friends because we have clearly and consistently established and delineated our roles and then drawn on our different contributions.

Porter’s Points—Best Friends No More

• Just because you are “best friends” does not mean you will be “best partners.”
• Be precise with who brings what skills to the table.
• Make up for your weaknesses with your partner’s strengths. This is the foundation of a solid, durable partnership.

I hope that as we continue with Chapter 7: Fish and Partners, you are getting a clear idea of who your ideal partner will be as you start a business.

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As we continue in Chapter 7: Fish and Partners, I now share the important difference between ownership and upside and the necessity of finding partners willing to share ownership.

I have a good friend and business associate named Clint Argyle who is also a very successful entrepreneur. Recently, he shared with me how he handles that awkward and inevitable moment when a key employee comes to him and asks for ownership in the company. Invariably, these employees feel like they have put a lot into making the company successful, and they want to have a piece of it.

Clint tells them, “You do not want ownership. What you want is ‘upside.’” They look at him funny and ask what he means. He asks, “If our company has it rough next month, are you willing to go off salary?” The employee invariably says, “No, I want to get paid for my work.” He then asks, “Are you willing to mortgage your house if we need help to cover the rent on the building? If things go bad, are you going to help do the layoffs? Are you willing to only be paid on the good months so that we can make sure our employees are taken care of?” The employee usually responds, “No!” Then Clint explains, “What you really want is upside. You don’t want ownership.”

Ownership involves ultimate responsibility. This responsibility is there through thick and thin. And as Clint went on to point out, there’s a vast difference between upside and ownership. Most people want rewards, not responsibilities. That’s why companies set plans up that give upside bonuses as they achieve success. Profit-sharing plans and goal-oriented rewards are great upside plans. However, those who are willing to sign the personal guarantees and put the money in up front are the ones who should own the business.

I’ve been in several situations where I have shared the ownership of the company, but my partners were not willing to help on the downside. Had I heard these wise words of Clint Argyle back then, I would have been saved a lot of grief and frustration. I made the mistake of carrying all of the downside risks; however, I put myself in a position where I was expected to share the upside benefits.

Porter’s Points—Ownership or Upside?

• You must have an honest (and documented) conversation with all potential partners about ownership vs. upside. Who is willing to risk what? How will the tough decisions be resolved?
• Do not put yourself in a position to be responsible for one hundred percent of the downside and a smaller percent of the upside. Partners share upside and downside equally.

I hope you’re getting a good idea for what kind of person you want as a partner. Next time we’ll focus on aligning you and your partner’s goals.

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The first step in a new partnership is to set expectations. Expectations about who will do what, how compensation will be decided, and the duration of the partnership, for example. We learn about setting those expectations today.

There are a few basic choices that need to be made before launching any venture. First, you and your partners need to set the expectations. A partnership is not a life-long commitment. Rather, it is a merger of convenience based on skill, resources, present life situations, and the opportunity at hand. Forming a partnership with this understanding will allow you to be logical in your business dealings and be able to let go when the time is right.

When you decide to take on a business partner, it is absolutely crucial that you sit down and talk through your long-term goals. Partnerships are all about expectations. Skills need to be aligned and expectations set.

Your goal may be to build the company to a certain level and then sell—at which point you intend to split the profits and begin another venture. Your partner’s goal may be to have a life-long career in this business, with you as his sidekick. It really doesn’t matter what the goal is as long as you are both heading toward the same destination.

Sit down and talk about your expectations, skills, and areas of expertise. Maybe one partner will handle finding new customers and securing contracts, while the other will solidify the processes, make the deadlines, and collect the accounts receivable. You cannot simply assume that you will each “settle” into your roles. You must discuss them and decide them! If you need to adjust down the road, at least you’ll be moving from one decided process to another.

You also need to decide at the outset what to do if you encounter a failure. In Chapter 5, “The Rules,” I explain the importance of knowing when to pull the plug.

I now want to focus on something else that can kill a partnership as easily as anything: Success!

Part of being an entrepreneur is taking whatever resources are around you and using them to create a company. The problem arises, ironically, when the company starts to make money.

How do you put a value on the initial resources? If you start a business in your home and you partner comes over and uses your paper and desks, not to mention your air conditioner, heater, and indoor plumbing, when the company is successful, do you get reimbursed for your costs? If you are incubating several companies in the same office where you use the same secretary, copier, desks, and contacts, when the companies go independent of each other, how do you divide these resources? What if these resources are technologies? How do you divide these?

This is the biggest mistake that I have made. I have learned the importance of defining all of these details up front and not as you go along. Accountants tell us, “Don’t co-mingle funds.” It is just as important not to co-mingle ideas, assets, personal property, or technology.

Regrettably, like Ron and his fish, I have stunk up a few partnerships. The main thing that I have learned from these experiences is to set expectations at the beginning. Have the hard conversations before you even start a new venture.

Porter’s Points—Set the Expectations

• While partnerships may not be life-long commitments, all partners must be committed to a clear understanding of expectations – always.
• Aligning your goals from the outset is paramount. Divergent goals will result in opposing paths that may never merge again.
• Make an exit plan. (For more detailed instruction, see Chapter 19, “No Exit Strategy?”) Determine what you will do in case of success or failure, and stipulate the amount of compensation either partner will receive in proportion to the resources he or she used in starting the company.

Next time we’ll discuss ownership v. upside and how to distinguish between the two.

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Today we begin Chapter 7: Fish & Partners. We open with Ron’s intro to the chapter.

I love to eat fish. One time, my family and I caught a bunch of fish. When we arrived home, it was late and we were really tired. In fact, I was so eager to jump in the shower that I left the fish in the trunk of the car. The next morning, when I climbed into the car to go to work, it smelled terrible! It took several days and a lot of air freshener to get the stench out. Obviously, we didn’t eat the fish, and we didn’t go fishing again for several years.

We’ve all heard the saying, “Fish and company both stink after a week.” Rich and I would like to extend this advice to business partners as well. I’m familiar with a business that illustrates this issue.

It started in a garage. The two guys enjoyed working together. Their business became profitable and they leased a warehouse. They obtained some assets. More money came in, and they found themselves “living the high life.” Then, without warning, the market conditions changed, and they found they were treading water.

That’s when it came to light that one partner had set aside resources for a rainy day. The other had not been so responsible. He had accrued a high level of personal debt. Understandably, he did not want to downsize.

All of a sudden, contention arose. There were questions about what belonged to whom. The debt-ridden partner got a day job in the construction industry to make ends meet, but his heart was still set on the entrepreneurial upside. To his chagrin, his partner moved on to something new and let their venture stall. Fingers were pointed and the friendship was strained. The bootstrap garage utopia was lost because these partners’ ultimate goals were misaligned.

Obviously, not all fish stink; when attended to, fish can be delicious. I recently had some fresh salmon from Alaska. It makes my mouth water just thinking about it. Just as fish can be delicious, business partnerships can have a very important and useful place in starting and maintaining a business. But it is important to note that if you are going to bootstrap a business, all the partners must really be willing and able to pull themselves up by their bootstraps. If one partner is using the income from the business as his rice bowl and the other is just placing a bet on the business, then goals are misaligned and trouble is sure to follow.

This chapter is designed to preserve your partnership and prevent it from stinking up your venture and your valued relationships.

We’ll start the chapter next time where any good partnership starts: with setting expectations.

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Beyond sole proprietorships, entrepreneurs can also choose to operate their businesses as general partnership, limited liability partnerships, limited liability companies, or corporations.

It is common for a person to start her or his business as a sole proprietor and at some achieved objective transition it into another business vehicle. Some of those other vehicles are described below.

General Partnership

Definition
This structure has a lot in common with a sole proprietorship, except that it allows for more than one person to share profits and liabilities. General partnerships accommodate individuals, corporations, trusts, other partnerships, or any combination of the above to unite.

Advantages
General partnerships are easy to establish, and to exploit (in a positive way) the skills, knowledge, and talents of all the partners. Additionally, profits are not directly taxed.

Disadvantages
Unlimited personal liability exists for all partners for all of the partnership’s debts and liabilities, not just for that partner’s “share.” As with a sole proprietorship, a general partnership terminates upon the death of a partner, so make sure you think this one through and do some advanced planning! Additionally, any partner can commit the firm to obligations. General partnerships do not protect participating partners against personal liability with regard to claims against the partnership.

Don’t make the mistake of failing to enter into a written agreement as you put in place this business vehicle. Ensure that all parties understand the terms and conditions and that all parties execute the agreement. Do not rely on an informal verbal agreement. Witnessed signatures are highly advisable in a general partnership.

Limited Liability Partnership (LLP)

Definition
LLPs are legal entities formed with your State’s secretary of state. These arrangements provide liability protection for all partners. In addition, all partners get management rights in the partnership. This entity is popular among professional practices and offers, for the most part, the same limited liability as does a corporation.

Just like a partnership, an LLP acts as a flow-through entity for federal and state tax purposes. Note that this entity type is different from a Limited Partnership (LP) which has one or more general partners who bear the operational and financial risks of the company and one or more limited partners who do not have operational or financial risks.

Advantages
Limited partners are liable only for the amount of their capital invested. In turn, each partner’s respective share of the partnership income and losses is reported on the partners’ personal income tax returns.

A required element of any partnership is the agreement itself. This agreement governs the operations of the business. Ensure the terms and conditions of this agreement are understood by all parties. We are huge advocates of clear and honest communication between partners, and the signed agreement is a cardinal element in keeping with this philosophy.

A nice advantage of the LLP is that there is not a requirement to include a termination date for the partnership in the agreement in some states. Also, LLPs are an independent legal entity and as such may own property, sue, or be sued.

Disadvantages
Because an LLP is an independent legal entity, its formation requires a bit more paperwork (legal documentation) than do general partnerships.

Note that in some states, if one of the partners in this type of entity leaves for whatever reason, the LLP automatically dissolves.

Limited Liability Company (LLC)

Definition
LLCs are a cross between partnerships and corporations. They unite the limited liability advantages of corporations with the tax status of a sole proprietor or partnership. (As a note, LLC owners are referred to as members.)

Advantages
Like partnership entities, LLCs are guided by an “operating agreement.” If such an agreement does not exist, the LLC is governed by the applicable State Limited Liability Company Act. LLCs may be formed by one or more owners or members but may own property, sue, and be sued in the LLC’s name.

LLC managers are elected by the members of the LLC and may be individuals or other entities. Managers do not have to be members of the LLC.

In some states, if the LLC’s Articles of Organization do not specify otherwise, the LLC are perpetual—similar to corporations.

Disadvantages
While not a big deal here, legal documentation figures in more prominently in an LLC than in a proprietorship or partnership, given that LLCs are legal entities. But like those business models, taxes flow directly to the individual members’ tax returns. This can be either an advantage or disadvantage. Note that the IRS does allow LLCs to elect to be taxed as corporations, but a discussion of the impact of that election is beyond the scope of this chapter.

Corporation

Definition
These are state-chartered organizations and are considered and act as separate legal entities. Corporations are the most structured of the business entities.

The corporate charter—a sort of operating agreement for the corporation—specifies business activities, and the business of a corporation must be in keeping with that specification.

Corporations may elect for tax purposes to file as a C-Corporation or an S-Corporation. The differences are defined by the tax filing status as determined by the chapters in the Internal Revenue Service Code.

C-corporations:
These pay federal and state income taxes on earnings.
Earnings are distributed to the shareholders as dividends, and earnings are thus taxed again. This double taxation is a huge drawback to this type of entity.

S-corporations:
These entities have the same legal attributes as C-corporations; however, S-corporations do not pay income taxes on earnings. Rather, the shareholders pay income tax on dividends, using their personal income tax return.

Advantages
Corporations continue to exist unaffected by the death or transfer of shares by any of the owners; also, owners’ liability is limited to the amount they have paid into their share of stock.

The Certificate of Incorporation may specify the corporation’s continuity; otherwise, they exist in perpetuity. As a separate legal entity, corporations may own property, sue, and be sued in the corporation’s name.

Disadvantages
These entities are closely regulated, including the double taxation for the C-Corporation.

In order for a corporation to maintain the liability protection, certain formalities must be followed to avoid “having the corporate veil pierced.” These formalities include holding annual shareholder and director meetings and having minutes of those meetings.

Porters Points—Boring!

• Carefully review your rules, your gas, your market analysis, and every other step you have taken so far. Where does you idea stand in relation to these legal frameworks? Decide and get to work. But to be sure—
• Talk to your attorney. If you don’t have one, get one.
• Talk to your accountant. If you don’t have one, get one.

That does it for Chapter 6: Boring! I told you I would be brief and to the point in this section of the book!

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