I tell many of the start-ups I coach that the best partnership you can have is no partnership. The real reason so many of us end up in partnerships is that we lack the confidence to try it on our own, not that we need our partner’s money or expertise. Entrepreneurs can not have one foot on the shore and one foot in the boat. They have to get in the boat and row like hell and get to the other side of the ocean. There is no Plan B. There shouldn’t be a Plan B.
As soon as you put a net under an entrepreneur and they know they have something to fall back on (like a JOB to go back to), they are way more likely to fail. The same is true for partnerships.
In most partnerships, ‘there is no there, there’. No one makes decisions, no one has the final say and no one has overall responsibility for the success (or failure) of the enterprise. It is a recipe for delay- delay in decision-making, delay in changing strategy when something isn’t working. It is also easy to spare your ego if the thing fails. “It wasn’t my fault. My partner was an anchor; it’s all his fault…” That’s pretty weak but it happens all the time.
Seth Godin recommends against 50/50 partnerships and I certainly agree with that. If you are going to have a partner, at least make sure someone has 51% and everyone knows, going in, who makes the final decisions.
A start-up I coached a few years ago had four equal partners. Now that is really a recipe for failure. I recommended that, at a minimum, they have a voting trust agreement amongst themselves. They should decide on one of their founders as CEO or President and give him voting control over all the shares in the Company for the first five years. That is when most businesses fail and when you need fast decision making. They agreed and went on to build a strong enterprise.
Most entrepreneurs don’t realize that equity is way more expensive than debt. VCs and Angel investors are looking for at least a 30% per annum return on their investment. Equity isn’t free. Debt, even expensive junk debt, isn’t usually more than 15%.
Well, you say, with debt you have to service it or bad things happen to your company like the lender calls your loan or tries to put your firm into receivership. But, trust me, if you accept VC money, you have just become a rent-a-CEO; you are not long for your job. If the Company is successful, they will want to bring in someone with more experience to run it and, you’re out of the company you founded. If it isn’t successful, they will either replace you with someone else who can turn it around (and you’re out again) or shut it down altogether and you’re gone anyway.
If you can afford to pay someone cash to help you with something you are not good at, like say, you need $5,000 worth of tech support, you are usually much better off paying them the cash (even if it is $500 a month for 10 months) than giving them, say, 5% of your company.
If you give a techie 5% of your company and even if your business is just a modest success, say doing $500,000 in sales in its fifth year, that equity is going to cost you 35% per annum under certain assumptions, like, you are going to want that techie out of the business within five years and you are going to have to redeem his or her shares at the then FMV (Fair Market Value). In the spreadsheet I did for this example, I assumed that your business is worth a multiple of 0.9 times sales. If you click on the above link, you can download it in .xls and fool around with it yourself and make other assumptions.
But the point is, equity is very valuable and you should be careful what you do with it. And, don’t forget, take responsibility for the success of your business. Don’t for a minute think you can delegate that, you can’t.
Dr. Bruce