Every Agreement Is Perfect, Until Something Goes Wrong [2012-03-08] :

I had a client (Rob for this article’s purpose) who was a successful entrepreneur. He had an astute business sense for determining businesses that consumers were interested in, but became bored pretty easily after the business became established. When he was young, a local businessman had originally invited him into his first business venture, letting Rob put in his disproportionate amount of savings together with his “sweat equity” for equal ownership. They shared the profits equally and after a few years, they agreed to sell the business and divide the sale proceeds equally. There was no written agreement between them, and they made no provisions for what would happen if the venture didn’t work out, but they both made money without a problem. Their agreement was perfect.

For the next 20 years, Rob had started up one successful business venture after another. Each time he began a new venture, he followed the same process the old businessman had done with him. He chose a younger partner interested in that business, they pooled money (although disproportionate for the younger as had happened with him), and they shared the sweat equity for the startup. They built the business together to a profitable level and shared equally in the profits. As he became bored with each venture once it began operating regularly, he would sell out his “one-half” interest to the partner, rolling his profits into his next project. He once described this process as a passion for the new deal … the excitement of the chase … and his way to help young entrepreneurs the way he was first helped. In each instance, he never sat down with the partner to agree on what would happen if the venture did not work out.

During his career, he never once entered into a written agreement with any of his partners. He never once sought the advice of an attorney when entering the venture with someone he never previously worked with. Each time he had decided he wanted to move on, his partners were themselves interested in owning that business on their own, and therefore were willing to come to good terms with the buyout. There was no need for setting up the exit terms before the venture started. He didn’t need anything formal because he confidently chose the right partners and his business agreements with each of them ended up fine … they always worked out well for both. His agreements were perfect.

Over three decades Rob had different lawyers offering to perform contract work for him, but he determined that they were unnecessary and a waste of money. The lawyers insisted that a few hundred to a couple of thousand dollars in each instance would be well worth the cost. But for Rob, there was no need for any lawyers because all the lawyers were interested in was discussing what protections they would put into the venture agreement for Rob in the event something went wrong. Success without formalizing the agreement bred contempt for the need of formalities. The lawyers only dampened the anticipated exciting prospects of a new venture and were just looking for problems when there weren’t any. That was no way to start a new business relationship with a new partner.

When Rob turned 58, he began his latest venture; a real estate development in an up and coming suburb. Although he had not had a venture like this in the past, he was certain that it was no different than any of his past business ventures. He did his market research for the right location, decided the type of houses he intended to build were desirable to the people wanting to move there, found reputable contractors to do the building, and therefore he had a great business plan. He found his new younger partner, he put in his own substantial start up money, and his partner agreed to put his sweat equity into the development. Rob had the money, clout and financing contacts, so he signed all the loans.

Unfortunately, the economy crashed and the real estate bubble burst. The young partner began looking for other work, stopped working on the development, and was otherwise not responsive to Rob’s requests for help. The bank began demanding payment, but the properties were not selling to pay down the mortgages. The bank and contractors filed suits that he had to defend and pay. He demanded that his partner contribute whatever he could to keep the project afloat until they got through the crash, but the partner just ignored the requests. Rob couldn’t file bankruptcy because he in fact had money to pay the obligations. He couldn’t get his partner to agree that Rob’s infusion of cash be deemed a loan to the corporation. So, Rob ended up using all his savings, millions of dollars he had amassed over his career, including ultimately refinancing his own home, just to save the development. He ultimately succeeded in either paying off or buying out the banks and the claims, but at a huge cost to him personally. He lost his retirement that he spent decades creating.

When the claims were paid off, and the market leveled off, the partner showed up again. As the houses began to sell, the partner had his hand out for his 50% profit on the house sales as was originally agreed. The corporation documents Rob bought online didn’t have a written shareholder agreement, which, if created by a lawyer, may have addressed Rob recouping the capital he put in before he split proceeds with his partner. In fact, the general unwritten agreement Rob had used during his entire career with all his other partners was that his partner would be an equal co-owner, despite the fact that every prior partner had not put in equal amounts of investment equity. Rob had therefore set his own precedent without putting anything in writing. He had no agreement to prove he was entitled to a recoupment of all his unanticipated excess investments before splitting the sale proceeds with his partner.

When Rob finished paying out his partner one-half of the sale proceeds of each house sold, he finally did an accounting. He determined that in this last venture, he had paid his partner hundreds of thousands of dollars and lost the aggregate profits he himself had built over his 30 prior years. His perfect agreement for which he needed no help from lawyers was no longer perfect.

A few hundred to a couple of thousand dollars at the commencement of each venture would most likely have saved Rob’s entire retirement. Rob is now 66 years old and works as a barista at a coffee shop near his down-sized “retirement” home.