Painted Into A Corner - Business With Friends

“I want to open a business with a good friend.”

Maybe a remodeling business for those summer rentals by Narragansett Beach?

GREAT! And how you structure it is of vital importance – both to the business and to your friendships. If you want both to prosper it’s critical to think forward – how could things go wrong, even if they go right?

A critical component of any partnership or LLC is an operating agreement. Forgo this and you may save some bucks early on and suffer down the road. Sure, you know and trust each other – but if things go south, who takes the hit? Or if things go great and one of you wants to get going? Or she dies, what happens to her investment?

Horror stories abound – I have clients who have gone in with the best of intentions but just did not plan properly. The following is a fictional situation, but one that is replayed time and time again – just change the names, numbers and details.

Stu and Mel open a painting and renovation business together – “Rental ReModeling.” Neighbors and friends, Mel has the dough and Stu the know-how. Mel pitches in $50,000, Stu hires the crew and provides some equipment.

Business is slow to start, but has it potential. Stu draws a modest salary. After two years their account stands at $15,000 when Mel becomes engaged and wants to move overseas, or at least to Woonsocket – and needs to cash out his investment. Nothing is in writing, and Stu needs the funds to continue.

Mel thinks he is automatically entitled to his investment back – he wants $5,000 cash and the rest paid over two years, with interest. Stu protests that this will bankrupt his business and cancel his livelihood. Mel says Stu is living off his investment. Stu says the equipment he contributed should count too – it’s not worth nearly as much as when they started. They were the best of friends.

What are their options? Is there a way to keep them both happy, keep the business solvent and satisfy Mel’s concerns? There well might be – but with no prior agreement they have no legal framework to even start a discussion. It can be worse than divorce, where – as ugly as it gets – there are some established government guidelines for issues such as child support and alimony.

What should Stu and Mel have included in their agreement? At the very least these items needed to be addressed:

• How will the start-up funds – Mel’s $50,000 – be treated? Is it a permanent investment – “capital” – or a loan? They may have different expectations. If it is loan, does it need to repaid by a certain date?
• What is the value of any “non-cash contributions” – e.g. the equipment Stu contributed?
• How are profits distributed – what's the formula – who gave the most? 50-50? How is Stu’s time included in that equation?
• How does a partner exit?
• Why would anyone want to leave Narragansett?

Depending on the nature of the business there are many more such issues to be included. As with all relationships, the clearer the communication is the greater possibility of success. A business enterprise is no different.

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Rich Streitfeld is a CPA with Aaronson Lavoie Streitfeld Diaz and Co. in Cranston. He loves working with start-ups and can be reached at rich@alscpa.com or (401) 223-0205. He authors a blog, “Peace Love and Business Planning – Prosperity for the Rest of Us.” –www.peaceloveandbusinessplanning.com.