Starting a Business with another? Here's your Homework

Don't Let a Great Partnership End in a Bad Divorce

Starting a business with a partner is a lot like marriage. In the beginning, there is plenty of 'romance' - the shared vision, the complementary skills, the excitement of pooling resources, and the comfort of knowing someone else is in the foxhole with you. You’re building something together, and the upside is massive.

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Protecting Your 'Upside' from Life’s Random Downsides'

As any seasoned advisor (or divorce lawyer) will tell you, the honeymoon phase eventually meets the messy reality of human life. In the world of Sapience, we talk a lot about the statistical realities of life, love and business. People get sick, people change their minds, and occasionally, people simply stop getting along.

If you have a co-owner, you aren't just in business with them; you are also, by extension, in business with their health, their marriage, and their estate. To protect the entity you’ve worked so hard to build, you need more than a handshake. You need a plan for when things go sideways.
We call these the Seven Ds.

The Seven Ds: The Statistical Gatecrashers

Most business setbacks aren't caused by a lack of market share or a bad product; they are caused by a 'random event' involving the people at the top. These Seven Ds are usually unplanned, highly emotional, and commercially devastating if you aren't prepared.

1. Death: The most permanent exit. Suddenly, you are in business with your partner’s grieving spouse or their executor.
2. Disability: If a partner can no longer work due to illness or injury, who does their work? And how long can the business afford to pay them a draw while they aren't contributing?
3. Divorce: A partner’s private domestic split can lead to a court-ordered valuation or a transfer of shares to an ex-spouse who knows nothing about your industry.
4. Default: What happens if a partner fails to meet their capital obligations or commits a serious breach of the shareholder agreement?
5. Departure: Sometimes people just want to retire, move to the coast, or start a new venture. Without a plan, this 'voluntary' exit can be just as disruptive as an involuntary one.
6. Disagreement: Friction is natural, but when it becomes systemic, it can paralyze decision-making and tank the company’s value.
7. Deadlock: The 50/50 nightmare. When two owners can’t agree and neither has the tie-breaking vote, the business effectively stops moving.

Each of these events requires a level of 'Trauma Informed Advice' because they don't just happen in a vacuum - they happen to families and communities.

The Fundamental Tension: Control vs. Cash

When a Seven D event strikes, a predictable conflict of interest arises.

• The Continuing Owner wants to maintain control, keep the doors open, and ensure the business stays solvent. They don't want to be forced into a 'fire sale' of lumpy assets just to pay out a departing partner.
• The Outgoing Owner (or their family) wants the fair market value of their share - and they usually want it in cash, right now, to maintain their lifestyle.

Without a pre-arranged agreement, this tension usually leads to expensive litigation, destroyed friendships, and a business that loses its competitive edge while the owners are busy fighting.

Enter the Buy-Sell Agreement: Your Business ‘Prenup’

A Buy-Sell Agreement (or buy-out agreement) is the legal machinery that governs how an owner exits the business. The beauty of this document is its flexibility; it doesn't matter if you operate as a company, a unit trust, or a partnership.

The agreement essentially creates a ‘reciprocal option.’ It grants:

• Continuing Owners the ‘first dibs’ to purchase the outgoing owner’s shares so they keep control.
• Outgoing Owners the right to have their shares purchased at a fair price, ensuring their family isn't left holding ‘paper wealth’ they can’t spend.

The Four Pillars of a Solid Agreement

To be effective, your Buy-Sell Agreement must answer four core questions with absolute clarity. If the answers are vague, you haven't solved the problem; you’ve just delayed the argument.

1. What are the Triggers?
   • You must define exactly which of the Seven Ds (or other events) trigger the option to buy or sell. For instance, does a 'disability' trigger occur after three months of absence or twelve? Defining the threshold prevents ambiguity.
2. What is the Process?
   • Once a trigger happens, what exactly occurs? Who notifies whom? How long does the continuing owner have to raise the funds? A well-drafted agreement lays out a step-by-step roadmap so that nobody has to 'think' while they are in crisis mode.
3. How do we determine the Price?
   • This is the biggest pitfall. Many owners set a Fixed Value (e.g., 'The business is worth $2M') and then forget to update it for five years. By the time a Seven D event happens, that number is either a windfall for the buyer or a theft from the seller.
   • Better approach: Use a Valuation Formula or require an independent appraisal at the time of the event. This ensures the price matches the 'statistical reality' of the market today, not five years ago.
4. Where does the Money come from?
   • This is where the strategy often fails. Having a legal right to buy your partner out is useless if you don't have the cash to do it. This brings us to the 'funding' side of the equation.

Funding the Transition: Why Insurance is the 'Heavy Lifter'

In many cases, the most cost-effective way to fund a Buy-Sell Agreement is through Specialist Life and Disability Insurance.

When a partner dies or becomes permanently disabled, the insurance policy provides a tax-effective lump sum of cash. This cash is used to pay the outgoing owner’s estate, and in exchange, the shares are transferred to the continuing owner.

Key Things to Note on Funding:

• Ownership Structure: How the policy is owned (personally, by the business, or via a trust) has massive tax implications. If structured incorrectly, a huge chunk of that payout could be eaten by Capital Gains Tax (CGT).
• The 'Pruning' Strategy: As the business grows or debt is paid down, your 'risk budget' changes. We recommend reviewing these policies regularly to 'prune' back premiums or adjust cover levels to match the current valuation of the business.
• Non-Compete Clauses: If an owner is departing (but not via death or disability), your agreement should include robust 'non-compete' and intellectual property protections. You don't want to fund someone’s exit only to have them set up shop across the street with your client list.

It Pays to be Pre-emptive

As Nassim Taleb (the former risk analyst, and author recognised for his work on probability, uncertainty, and 'Black Swan' rare events) famously suggested, 'randomness will have the last word.' You cannot prevent the Seven Ds from happening - that’s just the nature of life and business. But you can prevent them from resulting in a catastrophe for your staff, your clients, and your family.

• A Buy-Sell Agreement provides clarity when you have neither the time nor the emotional energy to consider the 'bigger picture.'
• It is an act of professional courtesy to your partner and a safety net for your own family.

Is your current partnership protected by more than just a handshake?

If you haven't reviewed your ownership strategy lately - or if you're operating without a formal Buy-Sell Agreement - let’s have a confidential chat. We can help you navigate the valuation, the legal structure, and the funding to ensure your business is built to last, no matter what randomness comes your way.

Drew Browne is a specialty Financial Risk Advisor working with Small Business Owners & their Families, Dual Income Professional Couples, and diverse families. He's an award-winning writer, speaker, financial adviser and business strategy mentor. His business Sapience Financial Group is committed to using business solutions for good in the community. In 2015 he was certified as a B Corp., and in 2017 was recognised in the inaugural Australian National Businesses of Tomorrow Awards. Today he advises Small Business Owners and their families, on how to protect themselves, from their businesses.  He writes for successful Small Business Owners and Industry publications. You can read his Modern Small Business Leadership Blog here. You can connect with him on LinkedIn.  Any information provided is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstance.