Making It Legal:

. . . but you can’t pick your partner’s nose. (Or can you?)

I received an inquiry from someone who, I’m sorry to say, is going at this bass-ackwards. She’s chosen a business partner, but not the kind of business she wants to set up. She wants to control all the decisions, but seems more concerned with the type of partnership agreement she needs. She wants to know “What type of business with a partner is best for me?”

A.: Wrong question. You could have a business partner who’s great for a consulting firm and lousy for a baby clothing manufacturer. You need to start with what kind of business you want to have, then look at whom you need to help you get that business off the ground. If you want to control the roost, you may not be suited for partnership . . . and may be better served by delegating to employees (or outsourced staff).

In addition, choosing a business partner is a decision of paramount importance, as I discuss in my BusinessPartnershipCentral.com blog. How you come to that decision (and whom you choose) should be the result of careful planning and consideration–not the fulcrum around which all else spins.

With two brothers, I was raised that I had to share. “Share and share alike,” I was told, even though at age 10, I really wanted to hoard the last few Ring-Dings for myself. When entrepreneurs get involved in business partnerships, they tend to be sharers, wanting the good for all. But when a giver meets a taker, you have a personality conflict . . . and a potentially serious tax problem on your hands. Here’s how the unpleasant scenario can play out (I’ve seen it happen.):

Anna and Barb went into business together as 50/50 partners. When business was tight, Barb often needed more than her 50 percent share. Anna had more personal financial resources and, out of friendship, she let Barb have what she needed–after all, how could Anna say, “No, Barb, you may not have the money you need to make your mortgage/car/insurance payment this month”? What kind of person would I be if I let a friend lose her house in foreclosure?”

Anna had a rude awakening when time came to file their taxes. As 50/50 partners, Anna and Barb received equal credit for the income that the business earned. However, they were also equally responsible for paying taxes on their 50 percent share of the business income–even though Barb took more cash out of the business. The net result for Anna was that she had to pay taxes on money she never actually received.

Luckily, these two entrepreneurs didn’t need to learn that lesson twice. Anna and Barb got squared away and made Anna “whole.” Barb got professional help to get a handle on her personal budget. The company hired a bookkeeper to play money gatekeeper and write the checks to the owners for their draw. Both owners agreed not to use company bankcards to withdraw cash for their personal use.

Other owners I’ve encountered had a hard time letting that lesson sink in. Partly, this is why:

• Financial illiteracy. They didn’t truly understand the impact their actions had on the financial and tax situation for the business (and, ultimately, themselves).
• No referee. It can be tough to tell a close associate no, especially when the need is dire and you don’t want to face having to shut down the business or kick someone out. Agreeing to abide by what a third party decrees can be an easier way to ensure that fairness prevails.
• No proactive planning. By addressing the previous year’s taxes after the first of the year (e.g., 2008 taxes after January 1, 2009), they have left themselves no time to rectify any mistakes or problems for tax year 2008. The time to keep an eye on potential tax problems for 2008 is in 2008. With the right accountants, they could have monitored their tax situation proactively to see if any shifts in their planning were necessary.

Check in with me later this month when I discuss how to find the accountant who’s right for your business.

This week’s training is what I call “partner training” (sometimes not unlike potty training). What can we expect from our business partners (Reasonably, that is)?

Q.: Are there time and performance standards for entrepreneurs starting a business? How much of a time commitment would be expected for partners starting a business together?

A.: For many entrepreneurs, the answer is “whatever it takes.” If you intend to start a business and clock in and out like you’re the mailroom clerk, don’t go into business for yourself. You need to have a very open and candid conversation with your partner-to-be to discuss your expectations of each other. Are you both planning to work at the business full-time? Have you clearly determined what roles each of you plays for the business and how much time each day that takes? Do you have obligations outside of the business that you cannot change (e.g., child or family care responsibilities)? Can you work from home?There are no set standards, but if you’re both planning to work at the business full-time, you need to decide what “full-time” really means for each of you.

Q.: What would be the best thing we can do when our partners ignore us in the middle of business falling down? I am currently in the advertising business. We are eight partners but unfortunately two of them left us at a time that our business was in the survival stage. The president got 90 percent of her share without us knowing that she would take it; the other was not able to complete her share until now. We have survived and these two people are claiming that they are still part of us knowing that the business is operating again. Do they still have the right as members? Please enlighten me with legal actions about this.

A.: Not sure I understand all of the details, but in short, there’s a big mess. Which usually arises when there’s no partnership agreement among the owners to clearly indicate who has what share of the pie. Problem is, once someone’s an owner, you can’t fire her as if she were an employee. You have to buy her out (or push her out, depending on whether she’s harmed the business). Do so before the business starts to take off. If the other partners were merely passive investors, whose only expectation is that they would provide money (and not active involvement in the business), you can offer to buy them out, but they haven’t done anything wrong as long as they provided the money they promised. Sometimes it’s better to walk away and start all over again. If there’s no real money in the business and no agreement among the owners about the right to solicit clients and use the company’s intellectual property, you may want to dissolve the company and create a new one with the business partners you can truly rely on.

From the department of “Oh, why not just put a stake through my heart?” came an inquiry from a reader who’s working with her boyfriend in his business.

Ugh. Need I say more?

It goes on: He’s having cash-flow problems.

[Something tells me she isn't getting paid for her efforts]

He’s run the business for 15 years by himself [Nu? After all these years, he can't hire staff?] and is not prepared to take on a partner [Hmmph].

She’s been helping him with marketing materials, communications with alliance partners and clients, creating e-courses and organizing the website revamp [In other words, helping create valuable intellectual property for his company].

She’s confident in her talents and abilities . . . and that he’ll compensate her fairly [Double hmmph].

The $64,000 question: Should she ask him to “put something in writing”?

What do you think?

[You've probably guessed what I think!]

There’s more to doing business with your nonprofit organization than just the disclosure required for “interested transactions” and avoiding a conflict of interest when making decisions on the organization’s behalf.

As a board member, your status is similar to a trustee. The organization’s money is not yours to spend as you please. You are a “steward” for the organization. You must make prudent financial decisions. And generally, you must use a higher level of care and caution than you do with your own business. Your board will also want to make sure that the membership doesn’t feel excluded from any paying contract opportunities that arise (remember, they’re not illegal; you just have to handle them carefully).

These issues are referred to as “arm’s length transactions” and “procedures.” Hopefully these scenarios will illuminate them:

1. Board member “A” submits a proposal to draft a strategic plan for organization XYZ. She prices the proposal at $500,000. (Most people with her experience level in the industry would charge $50,000.) “A” discloses that her firm would receive the funds. She recuses herself from the room for voting. The board votes in favor.

There’s no violation of the conflict of interest (some would say) because of the disclosure. However, XYZ was not given a reasonable, fair price for the project, such as would be given by an outside third party. So this was not handled as an “arm’s length transaction.” In addition, given the enormously inflated price tag, the board members might (if anyone got wind of the full story) be accused by membership (or donors) as squandering XYZ’s money and could find themselves on the wrong end of a lawsuit for mismanagement of organization funds.

2. Same as above, but “A” prices her proposal at $50,000. It’s a fair price for the industry. She discloses the financial gain. She recuses herself from voting. The board votes in favor. They’ve avoided the conflict of interest and the transaction is arm’s length–no better and no worse than working with an outsider. Membership gets wind of this. Every member who’s in the same industry as “A” goes bananas because he or she wasn’t given an opportunity to be considered, and there was no open/transparent RFP process. The board is accused of cronyism and favoritism, and membership falls precipitously.

A common suggestion for effective networking is “Get involved.” So we join organizations and nonprofit groups with the hope that, as we serve in a leadership capacity, we are also piquing the interest of others who might want to use our services–or be willing to refer us to others who do. When the opportunity does come to deliver our services on a paying (rather than volunteer basis), it can seem like we’ve hit “pay dirt.”

But these kinds of opportunities are not as straightforward as they look. Board members in particular need to make sure that, if hired, they have followed the laws of their state concerning the conduct of nonprofit organizations.

Let’s say your business provides web design services. You serve on the board of your local chamber of commerce. The chamber happens to need a new website, and hires you to design and host it–for a fee.

Those kinds of transactions are known (not surprisingly) as “interested transactions” because the board member (you) has a financial interest in the outcome. Under many state laws, if a board or committee member has any financial interest in a business opportunity being presented to the organization, that financial interest should be disclosed to the board. This is different (although related) to having a “conflict of interest.”

Ideally, when you serve on a board, you put the interests of the organization ahead of your own. It’s in the organization’s interest to get the highest quality web design services at the lowest possible price. It’s in your interest to get paid as much as possible for providing the web design services. Therein lies the conflict.

The “conflict” doesn’t arise in performing the services; it arises when the opportunity is presented to the board. If you receive a financial gain but your proposal has been vetted fairly, there’s been full disclosure of the financial interest and the proposal has been deemed in the objective best interests of the organization to pursue (with other members having had the fair opportunity to participate and offer proposals of their own), it’s not a conflict. However, you will have to recuse yourself from the voting when the proposal comes to the board for a vote.

To protect yourself (and the organization), make sure there are minutes of the meeting where your proposal is discussed and a record of the vote taken.