Small Business Horror Story #3: If You Don’t Listen to Your Gut, at Least Listen to Your Lawyer

A potential client called me.  We’ll call her Helen.  Over the last ten years, Helen’s partner “Jane” had perfected this FABULOUS idea that would make them both rich.  Six months ago, Helen quit her lucrative job and had since worked full-time assembling Jane’s scraps of papers and mental notes into a formal proposal they could shop around to potential clients.  Jane and Helen had hired a lawyer (not me) to put together an operating agreement and Jane had promised that Helen would become part owner in the company.  Helen even ponied up close to $10,000 as startup capital.  Sounds like the start of a great relationship, right?  Well, it wouldn’t be a horror story if it was.

The longer Helen talked, the more concerned I became.

Helen had cashed out investments in order to provide the startup capital and hadn’t been paid one red cent for the work she’d put into the company.  This wouldn’t necessarily be a problem if the way her sweat equity would be rewarded was put into writing, which it wasn’t.

Helen and Jane had taken a trip to present the proposal to a franchisor at its headquarters.  Helen paid for the entire trip and had not been reimbursed.

Because no entity had been formed, no business bank account existed.  Helen’s startup capital and whatever contributions Jane had made were in Jane’s personal bank account, to which Helen had no access.

For four months, they hadn’t heard a peep from the attorney they hired and paid handsomely to prepare the operating agreement.  Without an operating agreement, it is difficult if not impossible to prove any promises Jane made.  Jane held all the cards because she had the money.

When Helen stomped her feet, Jane finally handed over bank statements.  Helen noticed that a number of Jane’s personal expenses had been paid, including her daughter’s private school tuition.  Without an accurate accounting, chances are that $6,500 tuition bill was paid for with Helen’s startup capital.

All of this occurred before an entity was even formed.

Helen’s gut told her to run away, but she worried she was being overly cautious.  “Business owners need to take risks, right?”  Not these kinds of risks.

With all the red flags waving frantically before her, I was floored that Helen would even consider moving forward with Jane as a business partner, given these concerns.  I told her if she walked away and lost only $10,000 and six months of her time, she should consider herself lucky.  If she went into business with Jane, chances are she’d lose a lot more.

I not-so-politely told her she was nuts to go into business with Jane.  However, if she insisted on moving forward, I told her she needed to light a fire under the attorney they’d hired to get the operating agreement done.  Something needed to be reduced to writing between these two, though I warned her that a contract is only as good as the people signing it.  If Jane breached the agreement, which wouldn’t surprise me, Helen would have to fight to enforce it.  I also suggested that she get her startup capital back and begin paying company expenses as they are incurred, rather than handing over a chunk of change to someone who has proven herself untrustworthy.  I then told her that there is no shortage of business ideas out there and she’d be better off selling widgets out of the trunk of her car than deal with Jane.

Fast forward two weeks.

Helen called to tell me Jane had negotiated and secured a franchise agreement based on the presentation Helen helped with, cutting Helen out of the deal.  Helen is now no longer a part of whatever semblance of a business she had when she called me and has not been refunded her startup capital.  She is also unemployed and has depleted her savings on the empty promise that she would make close to $10 million in the first year partnering with Jane.

The moral here: Get it in writing and listen to your gut.  A business partnership is like a marriage.  If your date shows up wearing a hockey mask and carrying a bloody butcher knife, don’t ignore the signs, make excuses, and get married anyway.  Exit stage right and save your arse.