How to Get Rid of a Bad Partner in Real Estate Investing

If having a bad partner hasn’t happened to you yet, the chances are very good it will in the future. The problem is you take on a business partner, often a former friend, with the intent of his/her bringing something to the partnership that you and he believe will be greater than the sum of its parts. If this sounds altruistic, it is, but that’s what everyone wants to believe – the partnership will succeed because of the partners’ individual strengths.

Sometimes the partnership goes bad because one partner doesn’t pull his weight or maybe one partner feels his contribution is much greater than the other’s. This may sound like a marriage and that’s because it is similar in many ways including the nasty parts of a divorce. Divorce impacts families and so does the ending of partnerships. Divorce has specific laws that can be enforced to protect the partners’ rights but partnerships are governed by contractual law.

So, if we make a contract before the partnership starts, like a pre-nuptial agreement, it should be clear to the partners regarding what happens if they can’t agree and want to break-up. Unfortunately, like most marriages, the parties involved are “in love” initially or they wouldn’t have gotten together, and don’t think about what happens if the partners can’t agree in the future.

I could talk forever about who should be delegated to do what, who should have what responsibilities, and very importantly, who puts in money and when. All of these are very important to the partnership but the most critical element to ANY partnership is, “How do we get out if we don’t want the other partner to stay?”

As with a divorce, a partnership breakup is usually very expensive for one or both parties. For example, let’s assume you are partnering with someone to rehab a property and you agree to each put in equal money as needed. However, the project runs over-budget or takes longer than expected and the other partner says, “No more money”. You are now faced with continuing to fund it yourself with the problem that the partnership agreement didn’t account for this issue and the “other” partner is getting free equity. What do you do now? Talking it out with your partner only brings, “I’m not putting another cent in the deal!” and he is still entitled to half the profits when it is sold. Your risk in the project gets larger while his equity gets bigger at the same time.

Fighting about the problems is only going to cost both sides attorneys’ fees and if one partner can’t afford the expense of his own attorney, he can’t fight the partner who controls the checkbook. This is a common problem with an intellectual or physical property where one person produces a phenomenal product and the second partner has the capital to fund the deal – often called “venture capital”. The partnership gets the rights to the property and the stronger partner forces out the one who created the real value (written material or product) in the partnership – stronger partner (money) forces out weaker partner (brain power). It is just as common in rehabbing where one partner quits delivering labor or money and the other partner can’t move forward.

I’ve learned the lesson the hard way of having a bad partner and not being able to do anything about it – or so I thought at the time. Now I have a simple solution that I have seen used by two billionaire investors that I have known – one of whom I went into partnership with and did very well because of the following solution. Before I detail how it works, this solution can be used with any partnership and any number of partners and for any business!

For brevity, let’s assume that there are only two partners – partner “A” and partner “B”. Something goes horribly wrong and they can’t get along and the partnership’s product(s) are at risk and the very life of the partnership. Something has to be done, and under the terms of the Partnership Agreement, either Partner A or Partner B must buy out or be bought out by the other partner.

At the toss of a coin by an unbiased third party, the winner of this coin toss must make an offer to the opposite partner to buy out his interest. If he fails to make an offer within two business days, the other partner can make an offer that the former partner must accept. However, the real power of this offer is this – the first part of this procedure makes certain that the first partner has to make an offer or lose it to a ridiculous offer to the second partner.

So, let’s assume the first partner makes a ridiculous offer of $10,000 for assets worth $1,000,000. He may have done this because of the “win the flip” rule or just because he wants to get rid of the other partner and thinks he can take advantage of the situation. Let’s call him Partner A for this example. Now Partner B has two options, first to accept the offer and sell out his entire interest for $10,000 or REFUSE this offer in writing and Partner A must accept $10,000 for his interest. Usually, the “winning” partner gets 30 days to finance the purchase. If he is unable to finance the purchase in the required time, the opposing partner gets the assets for his original bid that is now paid to the “losing” partner.

Here are the options in an abbreviated form for too low of an initial offer:
Partner A offers $10,000. Partner B accepts this offer and is no longer a Partner.
Partner A offers $10,000. Partner B rejects this offer and must pay Partner A $10,000 for his assets of the partnership. Partner A is no longer a partner.
Partner B can’t get funding within the appropriate time period to buy Partner A so Partner A pays Partner B $10,000 and Partner B is no longer a partner.

In another scenario for too high an initial offer:
Partner A offers $1,000,000. Partner B accepts this offer and is no longer a Partner.
Partner B rejects this offer and counter-offers $900,000. This is not part of the contractual terms, so Partner B must accept Partner A’s offer and he is no longer a Partner.
If Partner A can’t get the funding to buy Partner B, Partner B can reoffer Partner A another initial offer (usually much lower) that Partner A must accept or pay Partner B for his portion of the partnership.

If neither party can get financing to purchase the other’s interest, the entire partnership must be sold to the best bidder at a public auction or other agreeable method. Usually there are stipulations for no more than two offers that can’t be funded before the offer is determined by an impartial panel of accountants or attorneys for both parties. If neither party can agree to anything, the National Arbitrator Association can be called upon for a binding price to either partner and a third party hired to liquidate the partnership’s assets and divide the remaining funds to all the partners.

This method of making an offer that must be accepted by the opposite party, assures that either partner making an offer will have to make a fair and reasonable offer to the opposing partner or lose his ownership to his own low offer that he thought would steal the assets from his Partner! In corporate lingo this is called a “shoot-out clause” and any attorney worth his salt can easily add it to any contract or partnership agreement.

While it may sound complicated, it is actually simplistic when all is said and done. It also insures that the partners will get an equitable payment for their portion if the partnership is no longer viable and must be sold or liquidated. And trust me, the more partnerships you do, the more you will need a clause covering the break-up or sale of the partner’s interests. Good luck with your partnership.

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