Avoid common red flags for effective partnerships

After working with partnerships over the years, we learn that certain repeated patterns are “red flags” indicating possible conflict among the owners that can result in failure of the partnership. Below are some red flags that potential partners should be aware before agreeing to become joint owners together.

Do all the partners need each other?

The surest reason for a failed partnership is lack of mutuality. One example is Ford’s and Volkswagen’s partnership to manufacture, sell, and service luxury vans in Portugal. Ford decided it could manufacture, sell, and service the vans directly through its French subsidiary without Volkswagen and withdrew, leaving Volkswagen with virtually no return on its investment. Due diligence by each party on the other is essential to any partnership. Had Volkswagon done proper due diligence on Ford, this bad business deal could have been avoided.

To avoid costly litigation, consider adding these provisions to your partnership agreement:

• Window to withdraw provision. This provides each partner with a window of three to six months, within the first year or two, to withdraw with no penalty.
• A put/call option provision. This allows one partner to request the other partner set a price at which he/she has the option to either sell his/her interest or buy the other partner’s interest. 
• A break-up fee provision. This fee must be paid by the partner that elects to withdraw. The break-up fee is a form of liquidated damages to the other partner.
• Coin flip provision. The owners agree to resolve disputes by a coin flip. The uncertain outcome usually makes reasonable minds avoid deadlocking disputes.

Can competing interests between the partners' respective organizations be eliminated?

An example is a partnership between IBM, Apple, and Motorola to create a new PC chip to compete with Intel and Microsoft. IBM was so embedded with Intel chips that the management of IBM’s PC division viewed the organization as a competitor. IBM eventually withdrew. To avoid such a withdrawal, consider adding the following provisions to your agreement:

• Covenants protecting partnership property. These covenants provide that property developed or purchased by the partnership belongs exclusively to the partnership. They also require partners to protect the proprietary and confidential nature of all the partnership's property.
• Covenants protecting partnership opportunity. These covenants prohibit competition with the partnership, diversion of business away from the partnership, and interference with its employees, customers, or suppliers.

The more successful covenants allow the injured partner to terminate the partnership and receive liquidated damages.

Will resources be dedicated exclusively to the partnership or divided between the new company and the contributing partners?

An example is Intel’s and SAP’s joint venture known as Pendesic. Sales for Pendesic were supervised by managers of Intel and SAP who were simultaneously engaged in sales for Intel and SAP, respectively. Because these key resources were divided rather than dedicated to the joint venture, they focused on the sales of their own products instead of the joint venture’s products.

To avoid this, consider having a requirement that both partners, as owners with respect to their own businesses, act in good faith in the best interest or not opposed to the best interest of the joint venture. Although most corporate and limited liability company law imposes a duty of loyalty on directors and officers, owners are not subject to such a duty unless created contractually. Any duty of loyalty provision should include remedies for breach of the duty, including giving the injured partner the right to enjoin the disloyal act or allowing the injured partner to terminate the joint venture and receive liquidated damages from the disloyal partner.

Can the partners agree on a form of governance that they can trust?

Good governance involving either a governing or advisory board having members independent of the owners is the best way to avoid conflict. A governing or advisory board level is especially important when one or more partners will be passive in management. An example is the partnership between France Telecom, Deutsche Telekom, and Sprint, known as the Global One. Frustrated with the partnership, Deutsche Telekom struck out on its own and acquired a competitor. 

A governing board having at least one independent member not only provides a mechanism for making decisions among competing interests of different owners. An advisory board can serve the same decision-making function if there is agreement by the owners that any deadlock will be resolved by the advisory board. Although an arbitrator or mediator is a possibility for resolving conflicts, a governing or advisory board that meets over a time or a variety of issues will have more familiarity with the history and culture not only of the business, but also of the owners, than any mediator or arbitrator will even have.
Finally, a governing or advisory board should serve as mentors to the owners. Often times mentoring can resolve conflicts before they become irreparable. The Business First Advisory Board Exchange is a great resource for setting up a board and finding independent members.