Many Small Business Partnerships Will Fail Due To This One Fatal Flaw

Many Small Business Partnerships Will Fail Due To This One Fatal Flaw
Amy Fontinelle
on October 25, 2017
Read in 4 min

People form small business partnerships when they share a passion for an idea but lack the resources to carry it out on their own.

One business partner might have more money or property to put into the company while the other has more ideas or time.

One business partner might have expertise in product execution while the other has expertise in running a startup and getting funding.

Or maybe both business partners can contribute equally in finances, intellect, expertise, and effort, but need all that both can supply to make the business work.

In situations like these, forming a business partnership might seem like the obvious path forward.

Each partner can contribute in their areas of strength and share equally in the profits — or divide things 60-40, 70-30, or whatever make sense.

But be wary: as personal finance guru Dave Ramsey likes to say, “The only ship that won’t sail is a partnership.”

Ramsey suggests that instead of starting a business partnership, one person own the company and the other person work for it, or each person establish a separate company and the two work together in a joint venture.

This way, one individual’s personal or financial difficulties will be less likely to harm the other’s, and the two can easily part ways if necessary without ruining the entire enterprise and the relationships that helped to create it.

Why Small Business Partnerships Fail

What’s the one biggest flaw that sinks small business partnerships?

Human nature.

Here are some of the different ways your individualistic nature can break down business partnerships in real-life:

  1. Either the relationship gets in the way of the business, or the business gets in the way of the relationship.

Without a clear separation of ownership, what happens if one business partner dies, becomes disabled, experiences a major financial hardship, or wants to move on to a different opportunity?

That partner’s circumstances will have a tremendous, possibly business-ending impact on the company.

Could the business partner not experiencing problems buy out the one who is?

In theory, yes.

But in practice, buying out a partner is often cost prohibitive, and the business must shut down.

Then both partners have to divide up their assets and liabilities.

It’s a lot like settling a divorce.

And the circumstances that cause the business to dissolve might also destroy the once-strong personal relationship the partners shared.

  1. It’s natural to prioritize the individual over the team.

In a small business partnership, it’s essential to make the decision that’s best for the company as a whole.

But that decision might not be the one that’s best for the individual partners.

For example, it might be best for you, personally, to make sure you’re out of the office by 6:00 every evening and that you don’t take any work home with you so you can focus on your family.

But it might be best for the business – and for your business partner – if you work until 9:00 every night.

When there’s someone else who can theoretically pick up the slack for you, it’s easy to prioritize yourself over your team.

But if your business is entirely yours, there’s a greater incentive for you to find a compromise between doing what’s best for your business and what’s best for your family, such as working late two or three days a week and coming home on time the other days.

  1. It’s easy to feel jilted when things don’t seem fair.

Small business partnerships lend themselves to a sense of inequality.

One partner may feel like they are contributing more than their fair share in terms of finances or workload — more than they expected to or agreed to originally.

The division of labor or contribution of resources might be equal when the partnership first forms, but changes in the business or in one partner’s personal circumstances, such as a shift in the company’s direction or the birth of a business partner’s child, can affect what each partner is able to contribute.

It might also be the case that one partner ends up bringing in significantly more business than the other, or that each partner has a different work ethic or a different concept of the ideal work-life balance.

Difficulties in resolving these fairness issues, which are almost certain to crop up, can create partnership-destroying conflicts.

  1. Joint and individual liability creates too much stress.

If you’re considering starting a business partnership, one of the most important things to be aware of is that each member of a partnership is responsible for the entire partnership’s liabilities and debts.

And that responsibility comes at both the business level and the personal level.

If the business takes out a $100,000 term loan and can’t repay it, then it falls on the individuals in the partnership to repay it.

So this must mean that each partner, in a two-person partnership, is obligated to repay $50,000 of the loan, right?

Unfortunately, the lender may not see it that way.

If one partner can’t pay their share, the other has to pay it, or both partners will face consequences from the lender.

Or, suppose one partner takes out a personal loan for business and pledges their personal residence as loan collateral.

They could wind up in foreclosure.

You’re not going to like your partner anymore if he causes you to lose your home.

To make matters worse, everyone has a different risk tolerance.

Maybe one partner is comfortable with owner financing and the other would prefer an SBA loan.

Do you and your potential business partner have the exact same feelings about how much money you’re comfortable borrowing, how long you’re willing to operate without a profit, how much profit you want to reinvest in the business, and so on?

And even if you share risk tolerance today, can you guarantee that things won’t change?

You can’t.

And one business partner’s desire to be more risky or more conservative can have ramifications that the other partner isn’t okay with.

What if the less risk-averse partner does something that causes the business to get sued?

Now both partners’ business and personal assets are on the line for something one partner didn’t do.

Small Business Partnerships & The Bottom Line

Establishing your business as a partnership is a common small business mistake.

But just because 1.6 million nonemployer small businesses are partnerships doesn’t mean you have to follow suit.

The flaws of human nature create too many ways for small business partnerships to go wrong.

Fortunately, human ingenuity has created plenty of alternative business structures that accomplish the same goals with fewer risks, such as starting separate companies built around each of your strengths.

Consider an S corp or a C corp, for example, if you want to limit your personal liability.

Then you can work together without being completely dependent on each other and without having your finances, personal lives, and legal liabilities completely intertwined.

Amy Fontinelle Finance Journalist

Amy Fontinelle is a writer, editor, and personal finance expert.

Her articles have appeared at Investopedia, Bankrate, MassMutual.com, The Simple Dollar, Interest.com, Yahoo, Forbes.com, SFGate.com, Bankaholic, Mortgage-Calc.com, Saving Advice and other sites.

Amy’s clients include personal finance websites, financial institutions, public policy organizations, academic journals, and professional economists.

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