Keeping it Friendly: Avoiding Pitfalls When Going into a Franchise with Friends or Family

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Rick Liberman

Entering into a franchise with friends or family can have great benefits and be a mutually rewarding experience. Partners with existing relationships often start with a higher degree of trust, believing they know the skills, experience, and capabilities of their potential partner.

Too often, new business partners plunge into the endeavor without a full understanding of their individual roles, experience, and expectations. When things don’t turn out like the owners anticipated, frustration and resentment often build. For example, an owner finds she is working 60-hour weeks, while her partner leaves early, yet draws the same compensation. Or, one partner resents the micro-management from the other. Partners who thought they were growing a successful business together sometimes end up with not only an ailing franchise, but a damaged relationship as well.

Dysfunction is not inevitable and there are proactive measures to avoid common pitfalls. Implementing these steps can help lead business owners to a long-term, rewarding partnership.

Communication and Documentation 

Communication and documentation are keys to success. Formal communication, like holding regular company board meetings, helps assure important items are addressed in a thoughtful manner. Informal communication provides the opportunity in the interim to resolve issues as they arise. Establishing methods to cooperatively resolve issues leads to more productivity and satisfaction.

Documenting the results provides a record of the actual decisions as a reference against the time that circumstances change or memories of those agreements begin to differ. And it is much easier to reach an agreement on how to resolve potential conflict when both parties are working cooperatively together versus when they are enmeshed in conflict.

The method of documenting the agreements of the owners will differ depending on the type of business entity they have, such as a corporation or limited liability company. Examples of documents used to memorialize the agreements include the organizational documents, shareholder’s agreements, resolutions, company policies, and employment agreements.

The following are some issues partners should address, together with methods of documenting them. Although this is not an all-inclusive list of important issues, these examples will assist in starting the process of communication and documentation.

Organization and Governance

How is the company to be structured? Will one partner have authority over the other, or will they have an equal voice? Will each have authority over their own areas of responsibility? How is ownership to be divided?

The answers are unique to each company and may evolve as the franchise grows, and experience levels and skills become more apparent. The company’s organizational documents should establish fundamental roles and authorities, and provide a governance structure for how important decisions are to be made. They should also provide a method for changing those terms as circumstances evolve. Companies can implement policies establishing authority levels by function and/or amount.

Compensation

How will compensation be established and modified as circumstances change? Initial compensation arrangements are often established before the partners understand the others’ level of effort and experience; therefore, compensation may be based on inaccurate assumptions or expectations. Owners should be willing to reassess these arrangements as the relative contributions of each become more apparent. Keep in mind that circumstances change over time, so compensation arrangements should also evolve. Mutually acceptable arrangements should also be implemented for deciding which expenses should be reimbursed by the business.

Resolving Deadlocks

If the partners have an equal voice, how will they break a deadlock on an issue? Methods of resolution can range from leaving the status quo in place to more formal methods of resolving a tie, such as giving one partner an extra vote or bringing in a third party to decide the issue. If the partners find they cannot agree on a sustained basis, they may wish to permit one owner to buy out the other.

Separation Arrangements

Partners should address how to separate ownership in the event they decide, or need, to part ways. This includes dealing with death, disability, relocation, or simply a desire to separate. There are many methods that enable this to happen. For example, if the owners decide not to sell the business, the company’s documents can establish a procedure for how to value the interests of the departing owner, and how the remaining partner or a third party may purchase those interests. The company or the remaining owner may have a first right of refusal to purchase the interests of the departing owner.

Your legal counsel can help identify issues to be addressed, and document the agreements of the parties. Ultimately, addressing those issues at the front end, when the parties want to work cooperatively, is the most cost-effective method of resolving any potential disputes that might arise. Those who are “penny-wise but pound foolish” often regret not doing so. Establishing robust communication and documenting the agreements between partners is a major factor in helping friends and family remain close and run a successful business.

Richard Lieberman is Chairman of Phoenix-based Jennings, Strouss & Salmon’s Corporate, Securities and Finance Department. He has extensive experience in a broad range of business law issues, including mergers and acquisitions, securities, corporate governance, finance and banking, employment, executive compensation, bankruptcy and corporate restructuring, litigation and legislation. Among his honors by Best Lawyers in America®, Mr. Lieberman is listed in the “Corporate Governance and Compliance,” “Mergers and Acquisitions” and “Securities” categories, and was named “Lawyer of the Year” in 2014 for Corporate Governance Law in Arizona.