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Partnership Advantages & Disadvantages


Number one, taking on a partner is serious and complex.  Consult your attorney, CPA and banker to make sure you understand the ramifications for your specific situation and that all parties agree to the structure.   Below we are not going to talk about general partner issues, such as legal, tax, personality or business vision conflicts, but rather how partners can be a positive advantage or disadvantage for your small business loan application.
 

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Most importantly and remember, if the new partner owns 20%  or more of your business, than they will have to be on the loan… and be  fully underwritten…  20% is a general rule, however some banks/lenders will lower or increase this percentage.  And remember we are discussing small business loans, not mid or large size corporations.

Main Partnership Disadvantage - Warning

If the partner is weak in any of the other areas that we have discussed throughout this guide, then they could make your situation worse!  What you do not want to do, is give up a portion of your company to someone that does not actually help your loan request. 

The biggest areas to watch out for are their levels of personal expenses and their other sources of income, as these are the most difficult and quirky to calculate.  BUT, ANY ISSUE they have, may hurt your loan request and eliminate the point of bringing them on in the first place.  So you have to be careful and thorough.     

For example, if you have low levels of cash and your prospective partner is strong in this area, but he has high levels of personal debt (relative to his other sources of income), this could “eat up” your businesses existing cash flow – solving one problem, but creating another one for you.  (Go here to see how most banks calculate personal expenses.) 

Other sources of income, such as other businesses that they own, are also very problematic.  If the other business(es) has declining gross sales or low cash flow, etc this could drag down your loan request (click here to see how business cash flow is calculated).  This has a lot to do with what’s called Global Income, which refers to calculating all sources of a borrowers business and personal income and expenses, and applying a Debt Coverage Ratio onto them all. 

So if a borrower has 3 businesses and 10 rental properties, for example, they will all be examined, including all of their personal expenses.   And to make matters worse, the 20% ownership rule mentioned above applies to all of these other businesses as well.  So if they only own 21% of another business, this company will likely also have to be examined and underwritten.  This is frustrating and complicated for all involved!       

SOLUTIONS to Disadvantages of Partnerships 

This is general advice.  Make sure you consult your attorney and CPA regarding your specific situation.  Remember the whole point of bringing on a partner, in this context, is to help you solve a weakness in your loan request.

  1. The bottom line here is that you have to make sure your potential partner is financially strong.  You may consider having them be underwritten along side of you and have your loan approved and ready to close before you formalize your relationship with them.
  2. You can keep your partners ownership lower than 20% (Again the 20% rule is different between lenders but this is the generally the case) and then they will not be on the loan as a guarantor.  NOR will they have to be underwritten…  They could put cash into the business, or bring additional assets to the table to improve your collateral position, without jeapodizing your loan request with any weaknesses they may have.    
  3. Likewise, considering having them offering you a loan, rather than a becoming a partner.   This could satisfy any lack of liquidity issues you may have and you do not have the control issues normally associated with partnerships.  However, be cautious about how the loan is structured in terms of the monthly payments.  You do not want this loan to reduce your cash flow and affect other bank loans you might be working on.
  4. Get them to provide you a loan package so you can fully review it.  Get a: personal financial statement, credit report, 3 years of personal tax returns, 3 years of business tax returns and year to date financial statements on all of their businesses so you or your banker/CPA can review their financial position.  Be thorough and don’t worry, they will not want to provide any of it J, but you have to have it all or you will be taking a huge chance.
  5. Remember, make sure the partner you bring on can really help you with the specific weaknesses you have!  For example, if the banker said you don’t have enough collateral, find out how much more you really need, and make sure the bank agrees that your potential partner does have suitable collateral!  Work hand in hand with all involved. 
  6. Here’s an example of a common strategy/structure to bring on a partner that should eliminate the need to have them underwritten and be attractive enough for the partner to want to get involved.   So, you are trying to buy a property for your business.  You need help with the down payment.  You find a person with the cash that you need and you structure a separate real estate holding LLC that your business makes legitimate monthly rent payments to.  He collects a portion of the rent, is on title, and has an equity stake in the real estate, but is not an owner of your core business.  The partner could have over 20% ownership of the real estate company and not have to be underwritten.  He might have to be on the loan as a guarantor, especially if he pledged assets, but not as a partner in the operating business.
     
    You could do this on a refinance as well.  The partner would offer you cash or additional collateral for a stake in a real estate holding company that your business occupies.  This could be an entity already set up, or a new one you created to accomplish this.           
  7. Another major advantage of having a partner is to increase revenue/profit.  Perhaps you have found a competitor that is getting ready to go out of business, but still has great contacts and contracts.  Bringing him on could translate into an immediate increase in sales.  Though “Projection” type loans (loans based on potential future income such as in a start up) are currently very rare these days, this could be an example of a loan that realistically could close.  Note that you might get resistance by bankers that will want to see that the new partner has been on board for 12 months, 2 years, etc.  This is referred to as a “seasoning”.  The solution here is often to just find a more aggressive bank that buys into your plan and sees the immediate impact that you already show on your year to date financials.               

One of the more complicated areas of bringing on a partner is due to lack of borrower experience, on your part.  If this is your weakness, than the partner you bring on will almost invariably have to be at least 21% owner of the business and will have to be on the loan as a guarantor and therefore fully underwritten.  Banks at this point in time will not budge on this issue.  Borrowers used to be able to bring on "contract employee", for 2 years or so.  Having  a contract employee that had the necessary experience, would satisfy the bank and avoid having to bring on a partner.  This was a great solution for setting up deals, but banks will no longer consider this as they want the person with the most experience, to be the main borrower.

Consult your attorney or CPA on deal structures and other nuances.  Also make sure your lenders is fully on board with the game plan before you commit to anything.  It's best to work hand in hand with all involved. 

Continuation of Report:  Other Common Causes of Small Business Loan Decline and Their SOLUTIONS 
  • Small Business Loan Help Beginning of Report
  • Dealing With Bankers An overview of how an imperfect loan submission process works, and strategies on how to overcome it. 
  • Commercial Loan Solutions General Overview of most of the Solutions.
  • How To Research Banks & avoid working with SICK banks.
  • High Loan To Value How to deal with being over leveraged.
  • Declining Gross Revenue Get over declining gross sales.
  • Disadvantages & Advantages of Partnerships Specifically related to loan requests.

  • Low Business Cash Flow AKA low debt coverage ratio's & what potential solution are.
  • Low Liquidity or to little cash, relative to the loan request.
  • High Personal Debt your personal expenses have a big impact on your cash flow, see some solutions here.
  • Bad Personal Credit Scores Best solutions to getting over low credit scores.
  • Business Debt Consolidation Loans have their own set of issues, learn best solutions here.
  •  Problems With Other Sources of Income also referred to as Affiliates
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