How Partnerships Can Make or Break a Business [e140]

January 19, 2015

Nasir and Matt kick off the week by diving into the topic of partnerships and the important things to remember before forming the partnership.

Full Podcast Transcript

NASIR: All right. Welcome to our podcast where we cover business legal news. My name is Nasir Pasha.

MATT: And I’m Matt Staub.

NASIR: And welcome to our program once again. I’ve been trolling Reddit a little bit and it’s just crazy how many times I see the exact same question and story in the startups and entrepreneurs section of Reddit of someone that is starting a business with a partner and it going horribly wrong. It’s, like, pretty much the same story over and over again so I wanted to talk a little bit about partnerships and starting a business with somebody and things like that.

MATT: Well, what’s the story that you keep reading? Since you just admitted to being a troll, I want to hear what you’re trolling on.

NASIR: Yeah, I guess that’s a negative thing. No, but it’s the same thing. Basically, I think we’ll link the particular Reddit that made me think about it. It’s kind of a long story – long story yet the same story – but I’ll summarize it. Basically, someone is the developer, another person is the business end of things, and they have a startup idea. It really doesn’t even matter what it is. The developer, they say, “Okay, let’s split it up this percentage; you get this percent, I get this percent.” It could be 50-50, it could be 40-60, it doesn’t really matter – they talk about it. And then, the developer works for six, seven months and starts, you know, actually creates the product – a minimum viable product as they say – and then they launch and then they start having discussions about raising funds and things like that and the business guy is just sitting there in the background and kind of doing his thing and, of course, the developer starts to feel that there’s some unfairness here. “Hey, what are you doing in this relationship? You’re just sitting back,” and then they go to get funds and then now this developer is complaining because the business guy came back to him and said, “Okay, here’s a deal, I’m going to give you 25 percent. I’m going to take 50 percent of the company and then the rest is going to go to other investors and things like that, and not only that, your 25 percent is going to start at – I don’t know – 15 percent and vest another 10 percent over the next 36 months or so.” I’m messing up the numbers but that’s basically the bottom-line. And so, now, all of a sudden, the deal that he thought it was is not even close to what it is and, of course, now the paperwork is not as clear. He signed some stuff but didn’t sign other stuff and then, of course, there’s always intellectual property issues. if this is the same story and I read a bunch of them, I think he showed up over Christmas at a family dinner and wanted him to sign an IP assignment which is basically the last thing that he needed on paper to make sure that this deal went through. So, this is a very classic situation. I swear I could retell it over and over again and with different numbers and different positions. But, if you read the comments, the first top comment says, “’Gentleman’s agreement.’ Hey, I found the problem!” So, I thought that was pretty clever.

MATT: That could be a female that posted that. I was disappointed that it wasn’t just an agreement. But you’re right; this happens all the time and the best analogy for a business partnership is a marriage. I mean, think of it this way, you wouldn’t just kind of meet someone and get married to them – well, you might. I don’t know. I guess that’s worked before. But your odds are better if you know someone more beforehand and do some due diligence than just jumping into something or setting the terms. I’m probably screwing this up how I’m describing it but it’s definitely something you want to get hammered out sooner rather than later and one of the things, you’re familiar with Startup Weekend, I think we might have talked about this before.

NASIR: Yeah, of course, and there’s a huge one coming in Austin this next month, by the way, yeah.

MATT: Yeah, so they’re all over – actually, all over the globe – and one of the things I ask people that win or, you know, if something happens there or any sort of startup contest where you get money or you just kind of meet that weekend, I say, “How do you decide on who owns what and what’s the equity distribution and do you guys have an entity? I guess, what’s the setup?” and pretty much no one ever really has a good answer in terms of “Oh…” They’ll just kind of say, “You know what, I haven’t really thought about it. I’m sure it’ll sort itself out,” and that’s how we get these Reddit posts. You know, everything is going well if, you know, you meet, it’s all rushed, you go through, you win, everything’s great, and then, you know, the first kind of issue comes up or, you know, you guys start making money and then that’s when you look back and say, “Oh, we probably should have figured out who owns what,” and all the details that should have been ironed out day one now come to fruition.

NASIR: Even though, as lawyers, of course, we’re going to say, “Of course, you need to get it in writing. In fact, you even need to hire an attorney to do it,” and so forth, but it reminds me, have you ever seen the show, I think it’s called The Prophet?

MATT: Yes, yeah.

NASIR: It’s basically a reality show. A guy comes in and basically says, “Okay, this is what you’re doing wrong with your business. I’m going to give you X amount of money for this percentage and we’re going to do this, this, and that. Here’s my hand, do you agree or not?” and he does things on a handshake – because I always wondered, literally, within a day, the next day, he’s in there doing his thing and I’m always trying to figure out, like, “Well, after they did that handshake, did they do all the paperwork on the background and then they signed it beforehand? That’s a pretty short turnaround.” You know, as a lawyer, I’m thinking about that stuff.

MATT: Yeah.

NASIR: In another episode, he talks about how, apparently, that’s just how he does things – he does thing on a handshake and a gentleman’s agreement and he’s been burned in the past for that but, because he does it that way, he also learns a lot about who he’s working with pretty fast, and if people are going to be able to fulfil their promises and so forth. So, I do see, you know, especially in that startup weekend kind of context, like, how practical was it to have anything in writing at that point. but I think the more important aspect of it is to keep that in mind and to make sure that, when it is time to put it in writing, that you do do it, and though it’s idealistic to do it as early as possible, it is possible to put things in writing that don’t necessarily bind yourselves, and I think the vesting strategy is probably the most prominent – I think – legal strategy from the startup perspective and that’s simply for those that are not familiar with it, there’s different mechanisms to how you can implement this, but basically, you have a business and an entity and your equity interest is increased or I should say is vested as time goes on. Let’s say every week that you are operating and fulfilling your operations as agreed upon in the startup or in the business, you earn one share. And so, every week, you’re earning one share that’s vested and let’s say you intend to do it 50-50. First week, everyone’s fine, put in their time, second week, third week, fourth week, fifth week, and after five weeks, one partner has five shares, the other partner has five shares and it’s still 50-50 split. But then, let’s say, after five weeks, one of the partners is like, “Look, you know, this is not for me,” and they go off another place. And so, maybe you have some kind of buyback agreement and so forth, but maybe those five shares have already vested and the sixth week – and I should just make this months to make it more believable – after six months, maybe the partner leaves and now only one partner is vesting shares. In six months, seventh month, and so forth where all of a sudden now the actual proportion is proportional to what they actually put into the business.

MATT: Sometimes, it’s tough to figure too. You know, you need to give the person enough skin in the game but at the same time you don’t want to give up too much control. So, you have to find something that’s a right fit and, you know, you definitely don’t want the situation where someone sticks around for a certain period of time and then ends up leaving and they walk away with a decent chunk of equity of the company.

NASIR: No.

MATT: So, even the way you describe can sometimes come back to burn you. But, like we said from the beginning, you’ve got to know who you’re going into business with and sometimes things happen fast but there’s always time to slow down and sort that stuff out before it becomes a huge issue later on.

NASIR: Absolutely. And, when it comes to startups that are dealing with technology and so forth, intellectual property is probably one of the biggest issues that are very much misunderstood and, in this case, that’s something that may actually need to be settled in writing very early because, in this case, for example, even though they had some kind of partnership, there’s ambiguity as to who owns that actual intellectual property and, most likely, the developer does – at least some of the copyright rights to it. And so, now I’m just looking back at the story. So, I think, at the end, they decide, “Okay,” they’re not going to work out together but basically that business guy, that business partner, he offered to purchase the software by paying him one percent of the company profits up to X dollars – no equity – which, whatever it was, is not enough for him and basically he’s asking what he should do and he mentioned that’s already on GitHub. He could easily just make it public or he’s already copied the code onto an SD card and mailed it to himself which is a very fair way to make sure that you’re the one that created it and so forth. It’s not necessary but it’s a great evidentiary tool. And then, some people are saying, “Look, just take the software and do something else on your own,” and other items. But, it’s just funny, this particular Reddit post is just so typical that I don’t understand why this still keeps happening because you would think these startup founders are very tech-savvy in their understanding of what’s going on in the internet. It would seem this is a pretty obvious thing to avoid.

MATT: Yeah, and then, going back to the Startup Weekend and what I was saying before, a lot of times, like, all they have is what they developed and that’s one of the questions I’ve asked them before. You know, “Do all of you guys own this or just the person that is the one developer?” and, if you go to those Startup Weekends – at least the ones I’ve been to – the developers are the ones that are always in need and so sometimes I’ve even seen cases where, you know, someone’s there, the developer works on multiple projects or works with multiple groups just because such a crucial part of those short periods of time that they have to come up with an idea and actually have something to show for.

NASIR: Yeah.

MATT: Developers can walk away from those with a lot of ownership.

NASIR: I agree. In fact, I mean, in this business, it seems like the IP is the only thing that has value in the business, but they haven’t done anything else. Even one commenter says – it’s funny reading this out loud but I’ll read it as it’s stated – “Dude, you own the IP. You have a ton of leverage here. Go get no less than 30 percent equity and get a good lawyer to watch him like a hawk.” And then, the response to that is, “F that! Demand 51 percent. He has all the leverage.” And then, another comment is like, “Dude, he has 100 percent of everything.” So, all very fair points in that respect. The IP is the business in this case, it seems like.

MATT: Definitely. I think we gave a lot of advice or a lot of our opinion on this. Is there anything you would really say? I mean, other than, of course, just have everything tied up sooner at the beginning, is there any other words of wisdom you would give to someone who posts something like this?

NASIR: I think when it comes to partnerships, I think it takes at least six-plus months working with them to really get to know somebody in business, and that’s just my kind of thought. And then, second is, at the end of the day, no matter what legal documents you have, you have to have a trusted partner. You have to have a partner that will do the right thing and so forth, even when facing monetary gain where there’s that temptation to go another way about it. Obviously, this particular guy – and I think that someone even mentioned this – a guy that does these types of things and I didn’t give all the details of some of the kind of douche-y acts that he did but my point is that those types of people will never go forward, in my opinion, you know, especially when you plan on being in a partnership. You really need to find synergy. It doesn’t mean you have to be the nice guy all the time but there are certain things that you don’t do and you have to reward developers. I think, a lot of times, these business hats are given too much credit, especially in a startup world. I don’t really consider them to be putting as much value into the business that a developer would, in my opinion, humble opinion.

MATT: Yeah, I mean, I think that’s good advice. I don’t know what else we can really tell people. The problem is – it’s the same for you – I say this to people all the time and it always get pushed to the side.

NASIR: Because people are uncomfortable. People are uncomfortable having that conversation and, frankly, in business, you have to be able to have those conversations and it doesn’t have to be as complicated as people it either.

MATT: Right.

NASIR: All right. Well, thanks for joining us again. If you have any ideas or questions that you want to send in to our show, send it in to ask@legallysoundsmartbusiness.com.

MATT: Unless it’s about what to do with your business partner because you already know the answer to that.

NASIR: I love reading those stories so keep those up, though. It’s good fan fiction for me – non-fiction, I should say.

MATT: Yeah, keep it sound and keep it smart.

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Legally Sound Smart Business

A business podcast with a legal twist

Legally Sound Smart Business is a podcast by Pasha Law PC covering different topics in business advice and news with a legal twist with attorneys Nasir Pasha and Matt Staub.
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