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Mediation During Business Formation or Reorganization

by David Gage, John Gromala, Dawn Martin

This article was published in FAMILY BUSINESS, Spring 1999

Jack and Alyce Schmidt started Spacesaver Systems Inc. in Kensington, Maryland, 25 years ago. A dozen years later the youngest of Jack’s two daughters, Amy Hamilton, entered the business, which provides data storage equipment and records-management software to companies and government agencies in the Washington, D.C., area. In a couple more years Alyce’s son, David Craig, left the Air Force to join the company. Then Jack’s older daughter, Carla Adam, left a public relations career at Martin Marietta to roost at Spacesaver as well. In 1998, Jack and Alyce effectively shifted management and ownership to the three step-children, and remained on as board members and mentors. The step-siblings were operating like many partners in business—doing well on the family level, and running a growing company. Like many partners, too, however, they were functioning with the knowledge that they needed to address some significant issues that were bubbling beneath the surface. They were aware of a major parental expectation, too—that they agree on fair compensation. Jack told the children that he knew from experience how inequities, real or perceived, could creep into partnerships, especially when it came to money. He never wanted that to happen to them. Because the step-siblings had joined the company at different times and had varying levels of experience, they were not paid the same. But ultimately, Jack and Alyce thought, the three children should receive equal compensation. The parents never specified when that point should be reached. Furthermore, they knew that they could not make this decision for their offspring. Amy, David, and Carla would have to reach their own decisions about compensation.

The children knew it, too. It was only a matter of time before they would be forced to grapple with the issue. After they heard a speech one of us gave to an audience of family business owners about conflict prevention, they also understood that trying to deal with compensation without examining other partnership issues would be unrealistic. They decided to use the process of creating a "partnership charter" as the way to address all the issues in their partnership, and contacted our office to act as a mediator. In a series of six half-day meetings held over two months, Amy, David, and Carla agreed on a document they would all sign that described their expectations for themselves and for each other, their company responsibilities, and how they would communicate, resolve disputes, and even handle a business or personal crisis.

During the process, the siblings also discovered that because family partnerships are highly complex, any one issue was likely to be related to numerous others. Honoring their parents’ request to struggle with the compensation issue meant they had to deal with roles and responsibilities, and sort out their different strengths and capabilities. When they did so, they found that the money issue was far less difficult to resolve than they had feared. In the end, they negotiated a system that offers not equal compensation, but a genuine sense of equity.

They concluded that for the time-being they would keep their current responsibilities, but experiment with new roles and then assess how well it was working. They also agreed to periodically review the partnership charter, and refine it to match changing circumstances. This would prove particularly prescient; Jack unexpectedly passed away in March 1999.

The process is the key

The process of creating a partnership charter is useful for people going into a partnership, or into a corporation as co-owners, who want to test whether it’s really a good idea. Partners-to-be can put themselves through the paces without taking the ultimate plunge. The process can be equally eye-opening for people in established companies who are taking on a new family member or outside partner, and for existing partners who have never really talked to each other directly on how their relationship is going. The primary use of the process, however, is for people like Amy, David, and Carla at Spacesaver, who want to take preventative action before conflicts creep up on them.

Unlike Amy, David, and Carla, most people do not tackle partnership problems before they arise. For the past decade we have been mediating disputes among family and nonfamily partners, listening to stories about what gets business partners into trouble. Inevitably, it comes down to a few recurring issues that most businesspeople know spell trouble for partnerships. Indeed, a poll of business people taken a few years ago by Inc. magazine and Xerox Corp. revealed that nearly two-thirds of the respondents thought that having a partner was a bad idea. Why? Their number one and number two reasons were the "inevitable conflict" and the "unmet expectations."

Can it really be that bad? Yes. Nobody is taught in business school how to be a good partner. The main reason sharing ownership and decision-making frequently does not work is that business people fail to realize that the partnership itself requires as much attention and energy as the business. The most successful businesses can fail when the partnerships that run them become dysfunctional.

Like cardiologists helping healthy people avoid future heart attacks, we attempted to design a prevention program that keeps partners out of trouble with one another. The program calls for the partners to prepare a partnership charter—a written document that gives them confidence and clarity about how they will operate and how the future will play out. And it works not so much because of the document itself, but because of the process partners go through to create it. The process is challenging because it demands that people think about the future in ways that they probably never have before.

The process of creating a partnership charter involves a series of meetings in which all of the partners, or potential partners, talk explicitly about their thoughts on specific topics. Four to six half-day meetings spread over a number of weeks are usually required. Although there is no one-charter-fits-all design, partnership charters usually include agreements on most or all of 10 topics: expectations, values, interpersonal equity, ownership, communication (including personal styles and dispute resolution), employment and compensation, governance, management, scenario planning, and arrangements for leaving the partnership.

The meetings are conducted by a third party. This is essential, because only an outsider can prompt the frank dialogue necessary to bring family members to terms with honest differences of opinion. We strongly suggest that professional mediators conduct the sessions; they are trained to help others speak their minds in an atmosphere of respect, and to help people conduct their own negotiations—which is fundamental if partners are to buy in to their charter once it has been agreed upon. Mediators are also skilled at varying the format of meetings to ensure that everything that needs to be said, gets said.

The facilitator meets with each partner individually as well as the group as a whole. The individual meetings are critical, because partners are sometimes reluctant to tell each other what they really think. This is especially true for family members who have decades of history. By meeting privately, the facilitator elicits the "whole story"—information, perceptions, perspectives, and hidden agendas that seldom surface when partners meet on their own. Throughout the process, the facilitator works to bridge communication gaps by carefully scheduling individual and joint sessions, asking tough questions, and challenging rigidly held views. This process is necessary so that, months or years later, the partners are not shocked when they find that some critical information has gone unsaid.

Co-owners have discovered that using their own attorneys, accountants, or other advisers to conduct such a process is not advisable. It is rare that all the owners or partners think that any of the company’s regular advisers are truly neutral, since the advisers usually have had more contact with one family member. The adviser may also have a conflict of interest in working out different agendas among their clients. Furthermore, lawyers in particular are trained to vigorously represent one individual against another, a different mindset from working for the good of the entire group.

Once the process is finished, the partnership charter finally becomes a product—a document that is signed by all partners. Requiring signatures helps ensure that each person has not glossed over issues. It also sends a message that everyone is committed to living by the provisions, and gives the partners something to rely on when memories fade or conflicts arise.

Not a partnership agreement

How the partnership charter is used is up to the partners. When Mike Hubert of Glen Construction in Gaithersburg, Maryland, asked Bill Sharabi to join him and Ed Becraft as a partner in his family’s business, the three men stated in the introduction to their charter that the ideas and agreements it contained were meant to capture their discussions about the partnership and how they will work together. They went on to say: "We also intend that it will help guide the drafting of the legal agreements we will have with one another regarding our joint ownership of Glen Construction, and do not intend for this Charter itself to be a legally binding document."

Mike, Bill, and Ed were seeking clarity on every aspect of their arrangement before going to their attorneys. The attorneys reviewed the charter and used it to guide their drafting of a legally binding, financially oriented "partnership agreement" and ancillary legal documents. These documents would be used to drive and adjudicate specific ownership and control issues.

Partners should be clear about the similarities and differences between partnership charters and partnership (or shareholder) agreements. Partnership charters are not meant to be legally binding or to replace partnership agreements. They are concerned with how partners will work with each other, maintain their partnership, and run the business. There are four primary objectives for creating a partnership charter: to achieve clarity about all issues that affect the partnership; to heighten understanding about the people involved; to strengthen the internal capacity for communication, planning, and decision-making; and to resolve issues that commonly produce conflict among partners, such as misperceptions and false expectations. The process of creating a charter deliberately requires intense work on the part of the partners, which itself creates a sense of teamwork and stronger buy-in.

In contrast, a partnership agreement is a legal document drafted by lawyers, with minimal input from the partners on matters considered non-legal. Its purpose is strictly to serve as a legally binding contract about rights and duties related to specific items such as ownership shares. While these items are significant, they are less crucial to the success of the partnership than the relationship between the partners, as ironed out in the charter-making process. Although the two documents cover some similar items, partnership charters cover them in more depth. For example, a partnership agreement must spell out who will have which titles and how much equity each person will have, but it will typically contain only the details that are legally necessary. In the process of creating a partnership charter, the partners will talk about what each title means, including the responsibilities and authority that go with each title. Also, the charter language will usually include some way of measuring whether people are living up to their duties, and what will happen if they are not.

Other issues such as managing the company, compensation, and ownership are worked out in the same thorough way. While the partnership agreement records who owns what percentages, the discussions about ownership in the partnership charter will delve into what those numbers mean to each person. For example, how was 50-50 decided upon? Was it because each person was agreeing tacitly to work as hard as the other? When and under what circumstances could that change? Is there agreement that new partners could be brought on board and under what circumstances? What are the implications of 50-50 ownership for managing the business? For resolving disputes?

Clarifying expectations

Unmet expectations are the most frequent cause of trouble in partnerships. This may have been most clearly expressed by Richard Hayman, president of Hayman Systems, a family business in Maryland, who has been in numerous partnerships over the years. At a recent Family Business Forum meeting at American University, he described his personal strategy for combating disappointment with one particular partner: "I went in with zero expectations and it worked beautifully. My partner didn’t do much, but that was probably perfect given the circumstances. The company became a great success."

Unrealistic expectations are a prescription for disappointment, and ambiguous expectations are a prescription for conflict. Having zero expectations is certainly rare. As a homework assignment during the process of creating a charter, partners are asked to list their expectations for each individual partner, for the business, and for the partnership as a group. They then bring in their lists and discuss them. The objective is to make sure that everyone knows the other’s expectations and accepts them. If they don’t, more discussion must ensue. The expectations of the partners form the basis of their commitments to one another.

In the process of clarifying expectations, Amy, David, and Carla managed to bring certain unclear or unstated matters to light. For example, David and Amy heard from Carla that in order to really get up to speed as a co-owner with them (one of her expectations for herself), she wanted more mentoring from them. Amy learned that Carla would appreciate more frequent communication about the progress of the software development team. David, in turn, wrote on his list that he expected Carla to "help bring and implement solutions to problems, and not simply identify the problems."

In these discussions, family business members have to be sure to address a whole layer of expectation that is usually hidden: the expectations of those who have gone before—mothers, fathers, grandparents, and the ever-present founder, no matter how many generations ago he or she started the company. Even though founders die or retire from their businesses, their presence can remain alive in the form of their stated or unstated expectations for their offspring.

Interpersonal equity

The second fundamental topic addressed in a partnership charter is interpersonal equity. In business, as in life, the perception of a lack of fairness is a major source of conflict. Part of the problem lies in the difficulty people have in talking about what is fair and what is not. Disgruntled partners insist, "It is just a feeling I have." But what precedes the feeling is much more critical. From a little book written years ago by Richard Huseman and John Hatfield called "Managing the Equity Factor," we have developed a concept we call "partners’ interpersonal equity." It puts meat on the bones of fairness and makes the issue easier to discuss.

According to our concept, partners constantly, and perhaps unconsciously, monitor what they put into the partnership and what they get out of it. This is not just about money. It is about the expertise each person brings, the ability each has to control his or her own work life, how hard each is working, and how much each contributes to realizing the company’s goals. What results from these comparisons is tantamount to an interpersonal balance sheet—which is based more on emotion than money, and more on perception than reality. This is an important concept that experienced partners appreciate more often than younger partners.

When partners feel they get more out than they put in, they usually feel highly motivated. When the converse is true, we say a state of partnership distress exists. Partnership distress is eventually relieved in one of five ways: The disadvantaged partner puts in less time or effort; finds a way to create more "equity" by taking more sick days or vacation or perks; sabotages the partnership; tries to end the partnership or his or her role in it; or notifies the other partners that the partnership deal must be renegotiated. Obviously, only the last option is healthy, but it is usually the one least taken.

To avoid a sense of interpersonal inequity, partners who are creating a charter draft lists of what they think they each contributes to the partnership and the business, as well as what each wants to get out of it. Each partner develops lists for the other partners, too (see "Common complaints of family partners," p.24). Then they meet and discuss their ideas. This exercise is very important to the long-term health of the partnership because it gives everyone a way to appreciate what their partners value, and to see if it fits with their own notions of how they should be operating. By knowing what each other thinks is important and values, partners can attempt to give each other more of it, thereby increasing their partners’ upside and ultimately their satisfaction with the partnership.

Surprise scenarios

The third fundamental item to be expressed in a partnership charter is scenario planning. It is a technique to help partners minimize surprises and create guidelines for how they will deal with the unexpected if it happens. Each person creates a list of all the crucial decision points the team could face. Then the whole group comes together, combines the individual lists, and brainstorms about other possibilities they may have missed.

The siblings at Spacesaver had over 20 items, including such extreme business and personal events as a major downturn in the marketplace, a buyout offer from a competitor, and abysmal performance by one of them. They considered various alternative strategies to handle the hypothetical situations, and created guidelines for what they would do as a team. One of the issues confronted at a later meeting was the unexpected death of a key person. When Jack died suddenly, all three of the children knew what to expect as far as the business was concerned. They were thus free to grieve over the loss of Jack without the confusion of what it meant for them as owners or executives.

Scenario planning is particularly useful for partners who are just coming together and have little experience and knowledge of each other—the two building blocks of trust essential to a healthy partnership. Scenario planning helps jump-start partner trust by helping partners learn a lot about how each would operate in difficult circumstances. Even partners who have known each other for some time usually gain new insight into one another’s judgment.

Better communication

Finally, partnership charters must spell out how the parties will communicate, also crucial to a working partnership. In order to hone their communication skills, Amy, David, and Carla took a brief personality test (the Personal Profile System), the results of which helped them expand on what they already knew about one another.

In a nutshell, Amy is an inspirational type who thrives on working through people. That helps explain why she has been the driving force behind the company’s rapid movement into the software products market. She is clear about the results she wants and effective at securing assistance with time-consuming details.

Similarly, Carla likes achieving results by utilizing the strengths of others. She exhibits enthusiasm and friendliness and judges others by their ability to verbalize their ideas. Her outgoing manner is typical of people who are good sellers and can close a deal. In contrast, David is more easygoing, deliberate, and patient. His style is to be calm, steady, and persistent in accomplishing challenging assignments. He is strong on analyzing technical and logistical requirements of complex assignments, which is why he recently decided to take full control of Spacesaver’s installation department and improve its overall efficiency. His conscientiousness serves him and the company well when he attends to the quality-control concerns of clients.

Understanding their personalities helped the siblings appreciate their respective strengths more fully and enabled them to talk more articulately about their differences. This, in turn, provided the necessary information for discussions about how they could communicate and work more effectively together—that is, be a more effective team. Amy and Carla, for example, learned that to be more effective with David, they would do well to prepare and organize what they want to discuss with him; they would have to ease up on their sometimes impulsive style and present David with the pros and cons of ideas. David could try to be more direct with them—get to the point quickly and stress the results of his ideas and plans. He has discovered that they appreciate it when he is encouraging, and when he goes easy on the details. To maximize their chances of making these modifications in their day-to-day interactions stick, they chose to incorporate these notions into their charter.

What if my partner resists?

Committing to create a partnership charter is not something people do lightly. It requires time and energy and a willingness to be open and honest with one another—to hear things that may be difficult to hear.

Often getting everyone involved is not easy. Five partners may think a charter is exactly what they need while a sixth may oppose the idea. When we recently discussed this issue with Rick Maurer, who wrote the book "Beyond the Wall of Resistance" (Bards Books, 1996), he offered the following insights: People who are opposed to sitting down with family members are likely to wish to retain the status quo, particularly if they happen to hold the most power. They may talk about the time and expense of creating a charter, or say that such preventative work is unnecessary. But deep down, Maurer says, the problem is often an unspoken fear. "Most people fear change, so any serious discussion about expectations for the future can feel threatening." He also points out, "When the need for change is greatest, the resistance to planning is strongest." To understand what may be behind a person’s rational objections, Maurer recommends imagining what it is like for the person who does not want to talk. He suggests asking oneself: "If I were sitting in that person’s seat, what would I be afraid of? Why would I be hesitant to try such a process?" Once the resistance is understood, he says, then reassurance often will bring that person around.

Another impediment to candid discussion among family members is the desire "not to hurt the feelings of those whom we love and respect." Families that appear to be happy can be avoiding sensitive topics. Left alone, matters fester until some unexpected event produces a gut-wrenching explosion. Controversy arises among business owners more often as a result of misunderstanding than malevolent motives. When owners get beyond the resistance and begin working together on a partnership charter, they discover that openly dealing with issues lessens the likelihood of misperception, builds trust and confidence, and improves their chances for long-term success.

Biography



David Gage, Ph.D., is a clinical psychologist and founder of BMC Associates. He is the author of The Partnership Charter: How To Start Out Right with Your New Business Partnership (Or Fix the One You're In). He is a former adjunct faculty member a the Kogod School of Business at American University. BMC is a multidisciplinary team of mediators with backgrounds in law, psychology, business, and finance. The firm specializes in preventing and resolving disputes among business partners, family business owners, board members, and co-inheritors.

John Gromala
John A. Gromala, J.D., has more than 30 years of experience in transactional law and estate planning. He practices exclusively as a mediator in all aspects of trusts, wills, and conservatorship disputes (www.mediation-adr.com/gromala). He has given seminars for attorneys, business people, and mediators in the United States and Europe. His roles while practicing law included Fellow, American College of Trust and Estate Counsel; Member, Executive Committee—Estate Planning, Trust & Probate Law Section, California State Bar; and President, Humboldt County Bar Association. He is the West Coast Director of Business Mediation Associates.

Dawn Martin is President of Martin & Laguna, a Washington, DC mediation firm serving families, businesses and public sector entities. In early 2007, Ms. Martin founded Simply in Place which provides productivity and organizing consulting services for individuals, families and small to mid-sized businesses.

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