My Worst Business Mistake: Partnering With an Old Friend

By Eric Basu, Sentek Global, San Diego, Calif.
I wanted to expand my year-old IT security consulting business and move it into defense contracting, so I decided to look for a partner. I brought up the idea with two good friends of mine who had experience in the industry, and we agreed to set up a company, Sentek Global. We would each claim a one-third ownership stake, with the expectation that each partner would bring in at least $250,000 in revenue in the first year.

Before we'd formalized the arrangement, however, one of the guys just disappeared off the face of the Earth. He didn't answer our phone calls or return our e-mails. This behavior was actually pretty typical for him, so my other friend and I decided to form the business without him. I took the majority stake and we moved forward with our plans.

A year later, the two of us, along with a group of contractors, were doing about $600,000 to $700,000 in revenues. We were doing very well on our own, but then our long-lost friend decided he was finally ready to partner with us.

In hindsight, I should have made the decision then and there not to make him a partner. But he was a long-time friend, and we'd been in the military together. I felt like I owed him something, when in reality I didn't -- and once I brought him in, he was like a cancer on the company.

The new partner
My friend didn't join the company when I first approached him because he's extremely risk-averse -- he didn't want to invest in a company that might fail. But once we were already successful, he wanted a one-third stake in our business.

I told him: "We can't do that. You shouldn't get a third of what we've been working for all year." But he persisted.

So I brought him in with specific sales goals, and agreed to give him a share of the profits up to one-third of the total, depending on how well he performed. It was a generous deal, but he felt like a junior partner because he had to earn his way up to a full share. His attitude really frustrated me: He wouldn't take responsibility for managing his employees, and refused to act like an owner, yet he wanted all of the privileges of ownership.

A sub-par performance
During his three years as a partner at Sentek, he built a small practice with just three staff. And every time we sat down to make executive decisions, he would offer misguided opinions stemming from his own insecurity. When we didn't take his advice, he would get very defensive -- he'd act like a little kid who throws a tantrum every time he doesn't get his way.

The other partner and I gave him several opportunities to get out of the ownership role and transition to a highly paid employee with sales bonuses, but his ego wouldn't let him do that. So the whole time he worked with the company, our revenues were flat because we couldn't focus on growing. Every time I tried to make a decision that required us to lean forward and take a risk, he'd advocate the opposite. He wanted to make sure that he never lost any money in the company, and that mindset caused real problems for us.

He eventually left to work for a big company, but we were six months away from forcing him out at that point. I bought him out of his Sentek shares for a price that I thought was too generous, but he felt was unfair. I'd brought him in because he was an old friend, but after our disastrous experience working together, our friendship completely fell apart.

Lessons learned
I still think it's okay to do business with friends, but I believe you really need to hire them based on an objective view of their capabilities. If you're just doing it based on your friendship with them, it doesn't make sense.

I also now believe that you should only give someone a significant stake in your company -- say six percent or higher -- if you truly believe you can't run the business without him. Equity isn't free, and you should be very judicious when giving it away.

With my former friend gone from the company, we've brought on another partner to replace him. We were cautious about offering an equity stake again, but my existing partner and I talked about it and thought, "How much do we want to incentivize this person?" We thought bringing him on as a partner was appropriate given his anticipated level of contribution. We were right -- he's done a great job expanding the company into new areas. We now have 50 staff, and are bringing in $10 million in revenues, with $13 to $14 million projected for next year.

Sometimes, it can be the right call to give someone a large stake of your company --but if you're doing it out of a sense of loyalty or guilt based on your personal relationship, you're probably headed for disaster.

Eric Basu, a former Navy SEAL, is an expert in entrepreneurial leadership and information technology.
-- As told to Kathryn Hawkins

Resources:

• Learn how to choose a business partner.
• Read about how partnering in business can kill a friendship.
• Find out what steps to take when adding an equity partner.