Partners: The Good, the Bad and the Ugly.

“You can’t make a good deal with a bad partner, nor a bad deal with a good partner,” is one of Warren Buffett’s better-known quotes. Buffet doesn’t indicate however,“ how we are supposed to tell the difference between the two.”

Much of practice over 35 years, has involved business “divorces” between healthcare entrepreneurs who have been wildly successful, but can’t get along, to the point that litigation is inevitable. Here are three rules of thumb, which may be helpful to business clients of all kinds, in avoiding trouble.

The best predictor of future behavior, is past behavior. The FTC has done a lot of thinking about what makes a “bad partner.” Take a look at the ?FTC “Business Opportunity Rule,” 16 C.F.R. 437, et. seq. which goes along with the Franchise Rule?16 C.F.R. 436. These regulations provide a roadmap, a set of questions that should be considered, by potential business partners and entrepreneurs, before any investment of time and capital:?

(1) Who? Verify the identity of every person involved with the potential partner or seller, including any affiliate, officers, directors, sales managers, or any individual who occupies a position or performs a function similar to an officer, director, or sales manager of the potential partner or seller;

(2) What? ?What precisely is being offered? Is it a stake in the whole company, or some division or subsidiary??A territory? ?What line of product or service is contemplated? If one partner in a sneaker company wishes to expand to sportswear, is the other partner entitled to participate? ?Pay very close attention to the name of the LLC or limited partnership being offered. ?

(3) How much? Verification and documentation of EBITDA and earnings claims, actual or projected. The “reasonable basis” for the earnings claims at the time the claim is made.

(4) Legal actions? If anyone affiliated with the potential partner or seller has been the subject of any civil or criminal action, particularly for misrepresentation, fraud, securities law violations, or unfair or deceptive practices, including violations of any FTC Rule, within the 10 years immediately preceding the date that the business opportunity is offered.

(5) References. The name, state, and telephone number of all purchasers who have been in business with the potential partner, or entered a business opportunity within them last three years.

When people show they can’t be trusted— believe them.?When you start asking questions, “how” a partner answers, is as important as “what” the answer might be. If anything in your due diligence checklist appears suspicious, trust your instincts. This includes “fishtailing,” ?where the ?potential partner’s answers are “all over the road.” There is enough drama in running business. If a potential partner’s history requires a great deal of “explaining why thinks look bad,” (or if they won’t answer at all), this could be the sound of the “clue bus” pulling into town. ?

If it isn’t in writing, it didn’t happen. Document everything the Bylaws, Partnership Agreement or Company Agreement. ?The trouble with people, as classrooms of psychology students have proven over the years, humans are terrible witnesses, who can’t reliably agree on what we have seen with our own eyes. Stage a robbery and ask the class what color dress the victim was wearing. ?Sales pitches generally describe what happens if everything goes as planned. Contracts describe what happens— when they don’t.

It is important to document the agreement as to (1) day to day management, (2) supermajorities for fundamental transactions, such as adding partners, (3) restrictive covenants, ?non-competes, trade secrets, anti-poaching and solicitation of employees, (4) what happens in the event of divorce, or death of a partner, (5) what is a “business opportunity of the company,” versus, “side hustles” partners are allowed to explore, without offering other partners a chance to join, (6) tag-along, drag-along clauses.?