The hazards of going into business with family and friends

It seems like almost every month the CSU Bakersfield SBDC gets calls from individuals who have lost money by going into business with family, friends, or neighbors that they have trusted, but who have no business acumen. Usually, they have not properly documented their relationship as a partnership either.

Often, these individuals have given someone a short-term, high-interest loan to help their family or friends get started in business under the pretense that they will provide the cash and their new “partner” will provide the labor. Some have invested into these projects directly out of their retirement plan and wonder if now all is lost.

In nearly every case, there is the anticipation of making money with little to no risk, and of course, they always say, “they had a track record of success. I never thought I’d lose my money!” However, by the time they get around to calling us, the money is gone, and they want to know what to do next.

A quick search of the history of their new business partner often uncovers bankruptcies or judgments that were not disclosed by the person who took the money. Sometimes it is outright fraud, but usually, it’s incompetence that led to the failure. It often goes like this, the individual who received the money works for a successful company and is a good employee knowing the technical end of what needs to be done but has no idea of how to manage a budget, employees, and all of the day-to-day activities that small business owners need to handle. They believe that the business is successful because of their efforts and now they are going to make it big on their own, with a little help from their friends. Family and friends see the success and like the business and say, “yeah, let’s do this. I can give you the money to get started. Let’s be partners!”

In the worst cases, people have refinanced their homes or used their retirement plans to fund these risky endeavors in anticipation of “living the dream,” but now their nest egg is gone.

Going into business with people you know or who seemingly have a great reputation or track record may give you comfort, but it has no bearing on whether the business plan is sound, or whether the legal structure will protect you against disaster. I would never recommend going into business with a partner, but if you do, it’s imperative that you take the necessary steps to protect yourself. A partnership is like a marriage, and just like a marriage, when a partnership goes bad it may end in total devastation, emotionally and financially. You need to be prepared that if things get nasty and go wrong, you will not hesitate to protect your interests to the fullest extent.

Most people don’t like to sue their family and friends as it can make a family get together, local community events, neighborhood parties, and church functions too uncomfortable to attend. I would encourage you to think about this before going into business with someone you would hesitate to file a lawsuit against when needed. Make sure you go into the project with your eyes wide open. If you feel you could never sue this person and wouldn’t be willing to involve an attorney at least to send them a nasty letter, then don’t do it.

You have to protect yourself. Ironically, I see people use less documentation when it’s family and friends they are dealing with, and that’s when they should use more.

As with any business opportunity, it is crucial you do your homework before investing your hard earned cash. Use your attorney to check the legal structure of what you are planning to do. I’m amazed at how many people will loan hundreds of thousands of dollars to their neighbors without getting anything in writing or having security in place. I hear the excuse, “I didn’t want to hire a lawyer because it was too expensive or I didn’t know a lawyer I could trust.”

If you’re considering a new partnership and haven’t “run it by” your attorney, or you don’t have an attorney you can trust, please take the time to find one. Ask your friends for referrals. It doesn’t always have to be expensive to have a second pair of eyes to look at your project and give you advice on what you’re trying to do. Your hard earned cash is too valuable to shoot from the hip and not take proper precautions.

In summary, if you’re going into business with others, please have someone look at the documentation and the potential risk of losing your investment. Your attorney won’t tell you if the investment is good or not, but they will let you know if everything is properly documented and if the right legal structure is in place to protect you if things don’t work out as expected.

Your CSU Bakersfield SBDC consultant will go over your plan with you and let you know if your business idea makes sense. You can then move forward fully prepared for whatever comes your way.

Jay Thompson is a Business Consultant with the CSU Bakersfield Small Business Development Center. The CSUB SBDC provides premium, one on one, no cost consulting to small business owners in Kern, Inyo and Mono Counties. For more information visit their website at http://www.csub.edu/sbdc.