121. Legal partnership red flags in business - explained by a lawyer

[00:00:00] In the last episode, we talked about business partnerships, but in this episode, let's look at the legal implications of that. Hi, I'm Katie McManus, business strategist and money mindset coach, and welcome to The Weeniecast. In last episode, I went through all the reasons why I don't recommend going into a business partnership and then I kind of alluded to some of the reasons why it actually could be good for you.

[00:00:24] So I've invited my trusted friend, David Fryman, who is a lawyer, onto the show to offer insights on setting up a legal partnership. David, thank you so much for making the time to be here today. Thanks for having me, Katie. I really appreciate it. So I know we have a lot of ground to cover today. I want to hear some horror stories of how this can go badly. I also want to hear some good stories about how it goes really well. And then if you don't mind at the end, sharing some tips and tricks with the audience

[00:00:52] around the red flags to look for and the green flags to look for and how they can set themselves up to have a really positive experience in a business partnership. Can you give us an example of a client that you've worked with? There is a law firm that I was very close with. I worked with them in various capacities and their structure was they had one partner that brought in the business.

[00:01:18] He was great at sales and rainmaking and another partner that did the work. And their deal was that you do the work, I bring in the business, we split it evenly. Right. And over time, the working partner started bringing in business too. Because he was working, he was networking, he did a good job for his clients. He got referrals because the clients that were brought in by the other guy, after they realized who their actual lawyer is, who was the one adding value, referred to him.

[00:01:48] And then at some point, that 50-50 split didn't make sense anymore. Right. Because now, one partner is doing all the work and bringing in some of the business, but still only splitting it 50-50. And they ended up having a falling out. And they had been very close friends. They are less close friends now. And, you know, they were able to negotiate somewhat of an amicable-ish separation. But I remember thinking about this and wondering just how avoidable it was. What do you mean?

[00:02:17] How could it have been avoided? They spent a little bit of time talking about what their compensation breakdown would be. There are many creative ways they could have come up with to make the numbers more equitable. But you can't do that once there's resentment. Once somebody resents the other person, to expect them to be the bigger person, it's impossible, but it's hard. Well, I mean, I think everyone, this is true for everyone.

[00:02:47] You don't have to have narcissism or anything going on in your personality to be true. But we never think that we're the one that deserves less. Right? Right. Which is like, once you've kind of like gone into a business agreement and you've been getting a certain amount of money or, you know, you've been able to kind of slide doing a certain level of work, that seems fair. And also, you know, I love that you're talking about the money split, you know, bringing in new business. But it also goes into, you know, who's managing the associates?

[00:03:15] Who's managing the assistants? Who is doing like the boots on the ground work? Because I think that's a lot of the stuff that doesn't get credit at the end of the day because it's stuff that's so easy to just not notice. It's very hard to see when you're on the inside, especially when you have a trusting relationship. After all, you're going into business with somebody you trust. And so there is a tendency to assume you will be able to work it out.

[00:03:46] Can you tell us about a partnership horror story that you've dealt with? A while ago, I had a client that was in a business partnership and there were three partners. And one partner was sort of the subject matter expert who was able to really provide a high-end service. Partner two had done a lot of the early business development that kind of put them on the map.

[00:04:11] And partner three was somebody hired as an employee and then was, you know, eventually granted equity over time as they become more valuable. And none of this was written down. This was just understood. And the equity started changing as they felt the need that like, well, you worked really hard this year. You added this value. And it became fluid. And there were some conversations about it, but they were not specific.

[00:04:41] And then somebody showed up one day and realized that there was a lot of money taken out of the account. Because one of the partners felt like that he had added a lot more value than everyone else and decided to take a large multi-six-figure bonus for himself. And he thought he deserved it. When that happens, I mean, the trust immediately breaks down. People start locking each other out. And this was a viable business, a successful business.

[00:05:10] Once the trust breaks down, so something I've seen it happen here and I've seen it happen elsewhere, is when you feel wronged, justified or not, you feel that your partner is doing something, smells wrong, something's different. You start doing things that you wouldn't do. Like you start protecting client information. You start maybe hoarding some things. You start maybe doing side deals with clients.

[00:05:37] And you justify it to yourself by, well, I think they're probably playing some games with the numbers. So I'm just being, I don't want to be a patsy. You know, I'm just trying to protect myself. But then now the other person picks up on this and it spirals very quickly and it gets very ugly. People don't think about money in a partnership. I know that sounds crazy, but they think about synergies and possibilities and all kinds of ways we can work together.

[00:06:05] Very few prospective partners sit down with each other at the beginning and say, I plan to make $300,000 a year from this business. Like that is my goal. That's the money I need for this to be worth my while. Right. What about you? What do you need out of this business? You also, okay, great. You also want to make $300,000. So now we know we need this. We need to now work backwards. Now, I know Katie, you work on this with a lot of your clients to do that. Right.

[00:06:36] But it's important for your own psychology, your own money mindset. But it's really important in a partnership because a lot of times those numbers aren't the same. Right. And one partner is perfectly fine making $100,000 a year. And the other partner is going to start resenting that really quickly because I was thinking this would grow on a different level and you're not pulling your weight. And the other partner is saying, what are you talking about? This is going great. What are you talking about? Like we're doing well.

[00:07:04] Neither of them said to each other, this is what I want to do. Right. Do you want to sell the company one day? Do you want to keep putting profits into the company to grow quickly? Right. So you've got a company that's doing $2 million a year and not making profit because they keep taking that money as they make their millions of dollars. And then they hire more staff and put more money into marketing and keep growing. And the goal, their goal might be to exit.

[00:07:34] They don't need profit. We want to sell this company for $10, $30, $50 million. Or they're okay with making profit in five years, but they want to build like a real big company. The other partner is like, okay, but like I have bills to pay. I like, I wasn't planning on not making, like there's money here. We're making millions of dollars. Why don't I have a paycheck? The situation with these three partners, one person had taken money out. What happened? They retained me on the verge of litigation.

[00:08:04] Which partner retained you? One partner was squeezed out, was basically locked out of the business and retained me, basically get him the most he can get him. Right? It's one of those situations where a client comes to me and their goal is like, it's their best case scenario. They don't even know what they're entitled to yet. He wanted money.

[00:08:28] There was not, the time he came to me, there was not a reasonable expectation of him, you know, continuing as a ongoing partner in this business. And we negotiated over about eight months. And at a few points, we were sort of on the verge of litigation. All the documents were prepared. We were ready to go. And eventually, with a lot of hemming and hawing and a lot of conversations with the lawyers.

[00:08:57] And I mean, because at that point, the partners themselves could not be in the same room or even on the same call. It just, it didn't go well. We're able to negotiate a structured buyout over time. And they were able to part ways. It was not admirable in any way, but it was admirable in the sense that they didn't actually have to litigate. Right?

[00:09:22] And the danger there with business divorce litigation is that this was a service business. Right? So in a service business, everyone on some level is playing a game of chicken because if you pull the trigger and litigate, there's a good chance the business is gone. Right. So it's in everyone's interest to get a deal done because it's in everyone's interest to keep the business going. But there's also no trust.

[00:09:49] And they couldn't even agree on a way to run their bank accounts because no one wanted anyone else to have access. No one was trusting anyone. So it got to the point where, like I said, we're on the verge of litigation. Thankfully, we were able to get a deal done, which honestly, as a litigator, I still always prefer. Hey, quick question. Did you follow this podcast on your favorite podcast app yet? It takes just a few seconds. I personally love Apple Podcasts, but you can find us anywhere, even on YouTube.

[00:10:17] So as the kids say, smash that button and make sure you never miss an episode. Do you have any other horror stories? The most ridiculous litigation I've ever had was a massive decade plus dispute between two partners that had various real estate related ventures together. I did not represent either of them.

[00:10:43] I represented a couple of minority partners in one of their ventures that got stuck in the crosshairs of these two partners that had gone from being extremely successful together to being so acrimonious with each other that this happened.

[00:11:07] When I was taking a deposition of one of them, the other one showed up midway through the deposition and decided he was going to start asking questions. And because he was technically in that particular proceeding representing himself without a lawyer, he was allowed to do that. But he came in late and was disruptive and just kind of insisted on asking questions.

[00:11:30] And then I was sitting there, not really wanting to take a side because I represent the other players here. And the one being deposed said to me, well, are you finished? I mean, if you're going to let this guy go, I'm leaving. And I tried very hard to avoid taking a position. And so I said, why don't we break for 10 minutes? I got on the phone with the arbitrator.

[00:11:58] I called because in court too, but in arbitration, it's, you can just, you know, there's an issue in a deposition. They need an emergency ruling. And I was waiting on hold and I'm sitting there while the other two went outside. It turns out they followed each other. A few minutes later, I heard screaming outside. One of them was on the floor clutching his chest. The other had stomped on his chest, but also had bite marks all along his legs.

[00:12:28] Somebody shoved somebody down. Somebody bit someone else's leg. And in response was stomped on. And they ended up in handcuffs in the hospital. I'm not usually speechless. This was just like, what? What? I just like literally stare at it. What? What did you? Are you kidding me? Sitting there in the corner, like, what just happened? Meanwhile, the arbitrator's on the line, like, hi, what ruling would you need? This is a particularly crazy case for a lot of reasons.

[00:12:56] But two things were noteworthy about this. One, both of these guys had at least eight, if not nine digit net worths and were in their 50s and 60s. And we're fighting over less than a million dollars. And these guys had been partners for decades. When people feel betrayed and taken advantage of, it cuts different. It hits you.

[00:13:22] And it's very hard to maintain any kind of rationality. What's the potential cost of setting up a partnership without a lawyer? My guess is probably between $150,000 and $200,000. So here's a question for you. If they were to come to you when they started this business to ask you to create contracts, help them create that agreement of how they're going to split everything up,

[00:13:50] how much would that have cost? And of course, I'm saying this and the audience has to know that, like, you know, this would be for this one client. If you go to David and ask for a quote, depending on the type of business, your quote may be different based on what kind of business you have. It would have cost less than $10,000. That's 15 to 20 times more. In summary, it makes sense to really invest the money in the beginning to avoid that cost. Yeah.

[00:14:18] And by the way, at no point did anyone refuse to put it in writing. It was always something we'll get to. So every business owner that's considering a partnership needs to spend a good chunk of that time considering legal coverage. The analogy I like to give is that legal is like the lower back of your business, right? Like it's not sexy. People aren't like, you know, influencers aren't taking locker room selfies of their killer lower backs, right? Like that's not... That would be a really weird TikTok trend.

[00:14:49] But also, if you check out David's TikTok, it actually is a whole lot of selfies in the mirror of his lower back. Yeah. That's it. You know me so well, Katie. Yeah. And nobody goes to a personal trainer and when they ask what your goals are, it's like, I want a really toned lower back. If you know anything about fitness, if you start putting on muscle without working on your core and lower back,

[00:15:15] the really dangerous thing is that you're going to be fine for a bit, right? Because like in the short term, you'll like, you know, you'll build muscle, you'll feel better. The muscles that are visible that you want people to see will look better. And then you're just going to hit a point that you have no idea when. And you're going to hit that scourge of lower back pain. That is the max and you've just hurt yourself. And it's something that you like may be able to come back from, but also might not be able to. Correct. A business divorce is devastating.

[00:15:45] It's psychologically devastating. It's financially devastating. And the bigger the business, the bigger the fall. So we've heard all the horror stories. Now, can a business partnership actually go well? It can go well when partners allow you to scale on a level that you simply can't do as a solo. That is why despite all of the drawbacks and despite the pitfalls,

[00:16:13] there's a real value in finding the right co-founders. There's a reason why many VCs and investors want co-founders. They don't want solo founders. They want somebody that knows how to work with a team and can build that. You can't have all the relationships out there. It's very daunting. And Katie, I'm sure you've worked with solo business owners that are trying to do all the things. And it's just impossible to keep track of it.

[00:16:42] And they end up kind of on a treadmill where they just are, okay, I'll do some marketing. And then my operations takes a backseat. And then I try to hire some people and it doesn't work. I go back to square one. And it's hard. And having somebody, so for example, somebody whose job it is to kind of supervise the admin team and the operations team, and another partner who's doing business development. This is very common in, for example, the healthcare field.

[00:17:09] You have somebody with a professional license or with just expertise in healthcare. And then you have a partner who knows how to run a business, knows how to hire and operationalize at scale. And they can work together and really build something that would just be impossible for either one of them to do. We have a mutual friend who's doing just that with Heinz Family Health and LB Health, Lauren Howard. You know, she does all the background stuff,

[00:17:39] the business development, the operational stuff, but she's not a doctor. And so she's partnered with Dr. Heinz, who obviously does the doctor-y bit. Yeah. So that's a great example of a complimentary, successful partnership venture. Obviously, people listening to this are entrepreneurs or aspiring entrepreneurs or no entrepreneurs. Some of our best friends are entrepreneurs. You get the idea. But we're dreamers. We dream big. We want big things.

[00:18:07] This is why I love working with founders and business owners because I just, I get off on that energy. It's a phenomenal energy to be in. To dream big, it's very hard to be the type of person that have the type of skill set that dreams big and sees the big vision. And also can, like, you know, do your bookkeeping and hire your staff and come up with a ad placement strategy.

[00:18:35] And so a lot of times, the best thing is to be aware of your own skillset and your limitations and say, I don't have the head for marketing. I just see this massive business opportunity and I want to partner with someone who can figure out a way to turn that into a concrete marketing strategy and run with it. It can be successful. It could grow your business into something you physically couldn't do before.

[00:19:01] The pitfalls, I think, are very often worth the risk reward, but you still have to be careful. What are the three red flags you would recommend an entrepreneur would look for in a potential partner as a warning they shouldn't partner with them? If you're enjoying this episode, would you do me a small favor? Will you please leave me a review? Don't worry, it's super easy to do and it only takes a few minutes.

[00:19:28] You can leave your comments in Apple Podcasts, CastBox, Spotify, and Podchaser. Just go to weeniecast.com forward slash reviews and scroll till you find the chosen app. That's weeniecast.com forward slash reviews. They are not all that different from other type of relationship red flags. Somebody that is resistant to the conversation

[00:19:52] avoids talking about money, avoids talking about roles, discourages, sitting down with a lawyer, procrastinates beyond normal entrepreneurial procrastination, but somebody that is obviously avoiding having this conversation. It's a red flag in any kind of relationship, particularly in business.

[00:20:14] Another major red flag is somebody that is very quick to throw prior business partners under the bus and who only has worst case scenario war stories. I was in partnership with this person, this person's an ass. I was in partnership with this person. They stole. There was too much drama here, right? Somebody that they're going to talk that way about you.

[00:20:39] Even in partnerships or other kind of business relationships that did not end well, I would never throw someone under the bus that way. Because one, it's a nasty thing to do. Two, it reflects badly on me. It's one thing to tell a particular story about who you were taking advantage of. But no, sometimes it doesn't work out and you move on and you keep your mouth shut and you don't just start bashing your prior partners to your new one. And again, you're going to notice, right?

[00:21:07] Not limited to business red flags, but it is a business red flag. And I see that come up time and again. So what's the third red flag? The third red flag is somebody that their value is couched in excessively vague promises that can't be pinned down. I'm going to blow it. I have so many connections. I'm telling you, I'm going to get in front of investors. Look at all these investors I know. I'm connected with this guy and this guy and this guy can get you meetings.

[00:21:36] They sound like they're on Shark Tank, but they're not actually billionaires. The thing to notice there is if they're making you a promise and they're careful to promise something that you can't hold them to, to promise you meetings, think about that for a minute. Right. Not promise you money or investment, think of your meetings. It's not worth equity in your company. It is very, very tempting.

[00:22:03] And if you give me 2.5% of your startup, I'll put you in the room with these people, investors. It's very hard to hold them to that. They now have equity in your company. And that 2.5% felt like nothing until either you make a ton of money or you bring in a serious investor down the line and this investor is doing diligence and they're like, who is this person on your cap table and what do they bring to the table? Right.

[00:22:32] And now you're in a situation where now you kind of have to buy them out at a price that you can't really impose on them. A lot of the situations doesn't have to be someone wants equity for general consulting and so you have to run in the other direction. There are solutions here. There are ways to narrow down the scope of the work. There are ways to allow for future buyouts based on an agreed upon algorithm.

[00:23:00] You know, you find you get 2.5% of my company. You have to hit these metrics. And at some point, I have the discretion to buy you out. And at that point, this is the formula we're going to bring to up front that would be fair in that situation. And so if people are willing to roll up their sleeves and are serious about helping your company, that's a sign that they're the real deal. These people who actually want to work with you do think they're going to provide value.

[00:23:29] Otherwise, they wouldn't agree to get bought out for some small amount. And somebody that refuses to have that conversation can't pin down in numbers what value they bring. Either the worst case scenario, this is a scam or just somebody that's going to be hell on earth for you. Even if they're well-meaning, it's going to lead to resentment. And a lot of these cases are, right, like, you know, some of the sexy horror stories about, like, the crazy people beating each other up in an elevator.

[00:23:58] The really sad ones are the preventable friends that went into business and just never got on the same page and leave with real damage done to their relationship, to their own sense of integrity, to their future business prospects. So those are the red flags. What are the green flags that you should look for in a potential partner?

[00:24:23] There's certain things that you can do, certain signs that, like, this is a really good deal, right? So somebody that, you know, has, like, specific concrete help for you. So, for example, if I have a service business in the healthcare space and you have the ability to, you know, formulate that or organize it or show me a business model that I couldn't do otherwise, you have a specific value add, right?

[00:24:53] I have done X, Y, and Z for these seven businesses in my career. I see a synergy here. I can do something for you in this. Now, I brought up Shark Tank. Many of your viewers have seen Shark Tank or Dragon's Den or some of the other versions in different countries. But one of the things you'll notice is that the sharks or the dragons will often try to sell themselves with that type of pitch. Look what I've done with this company.

[00:25:22] I have a relationship with this brand that we can use as a platform. But in those cases, those are really meaningful pitches. And that's why they land and that's why they pitch them. Because that's not, I'm really smart. I have a lot of money. I know people. Give me a good chunk of your company and I'll like take you to the moon. That's nonsense. It's garbage. But saying I can introduce you to these two companies and it turns out like that's actually a lot of synergy.

[00:25:52] They were looking for this kind of opportunity or rather have a specific plan. That is a meeting you take. That is something you seriously consider. And it's also something that can either work out or not and you can create contractual terms to protect you. Somebody's saying I will get you this type of relationship. Well, okay, great. So if you do that, we can put triggers in.

[00:26:17] You could put a vesting schedule for it, which is that you have equity in the company now, but you would lose it if you're no longer actively working in the company and the founder has some way to fire you if it doesn't work out. And then when your shares or your equity vests, that means that it's yours, right? Because you now own it outright. But you put a schedule there. It's not all at once.

[00:26:43] You can put various metrics there and it has to be done properly and in compliance with SEC and other legal restrictions. But yeah, that's where having a good lawyer early on, even just to know what to ask for would be a huge help. To others, a green flag is somebody that has a relationship with your target client that you don't have. So for example, if I have this great idea for a farming technology, I'm an engineer. I just have this insight, but I know nothing about farming.

[00:27:13] I have no connections to the farming industry and I don't know anything about my ideal client. So for me to seek out somebody that was a farmer, is a service provider for farmers, has some relationship with the farming industry, right? That is a really strong synergy. That's a matter of being honest and straightforward with yourself about what your skill set is. Look, it's a balance because you also don't want to sell yourself short.

[00:27:40] And a lot of things that you can learn, but you want to be realistic with yourself. And that's where there can be really meaningful synergies. The third green flag that I'll point to is somebody that like, even without you suggesting it, offers to put things in writing and make guarantees and really put forward in a transparent, reasonable way. It's like, really want to talk about these things openly with you.

[00:28:09] Another analogy to relationships, because it really is about relationships. There's a tendency for some types of founders that are insecure to be put off by that conversation. This investor or potential co-founder, they're talking about contracts already in terms and making offers. And it's like, I don't know. But the truth is, they're doing that because they know what they're doing. And they've been down this road before.

[00:28:35] And so I don't think it's ever too early to sit down and form companies and put contracts together. As long as it's done respectfully and openly and honestly, it really is a green flag. Give us one piece of advice for everyone who is considering going into a partnership. If you are in the process, whether you're working with a lawyer or you're thinking about it, and you have even the slightest doubt, get a second opinion from your own lawyer.

[00:29:04] In other words, two partners go to a lawyer and they're going along, they're doing a thing. And you have like any just, there's something that like, probably nothing, but I'm just feeling a little bit uneasy. Have your own lawyers, your own business with your own money, and have them review the agreement in your best interest. Because your lawyer represents the group. If I'm hired by three partners to represent their company, I represent the company.

[00:29:29] I'm not looking out for the individual partners and focusing on their specific concerns. If somebody is getting screwed, I have an ethical obligation to not be part of it. And I would generally, if I see a reason, I would tell one of the partners, you know, I would recommend you seek your own counsel. But that's one thing you can do that at a minimum, it'll make you feel more comfortable.

[00:29:56] Because you should never go into any kind of business partnership or any relationship where like there is like something buzzing in the back of your mind that something's not right. And it's a way to bring up a legitimate issue, you know, because you've now had another lawyer kind of suggest, yeah, I can see how this particular term could be used to kind of push you into a corner down the line. What if you do it this way?

[00:30:22] And now armed with this new thing, you can now stop a potential train wreck early on for, again, a few thousand dollars, maybe. There are a lot of messy, complicated litigations that would have been prevented by somebody trusting their red flag sensors a lot earlier. David, thank you so much for being here today. This has been so helpful. I know a lot of folks in the audience who are starting their businesses and want to do partnerships

[00:30:51] will take away so much from this. If they want to get in touch with you, what's the best way to do that? My website, FreymanPC.com. Connect with me on LinkedIn, which is the one social media that I use at least mostly consistently these days. Or email, email at attorneys at FreymanPC.com. And we're going to link that website, his email and his link to his LinkedIn in the show notes.

[00:31:20] David, thank you so much for being here. Thank you so much for having me. This is a real notch in my head. I got to be a guest on the WeedyCast. Thank you. Thank you.