- Experts say starting a business on a handshake can be a dangerous proposition, yet many people are doing just that.
- Small business advocates say it is a good idea to hire an attorney within the first 90 days.
- Vetting a partner for your small business demands thorough attention. Hiring a professional firm can help limit liability and awkwardness.
In an era of gig work and side hustles, many budding entrepreneurs may be ignoring a cardinal rule of business: Get it in writing.
"There are a lot of businesses that are transacted purely on handshakes and good faith, and unfortunately that often leads to some pretty messy situations," small business attorney Andrea Tarshus told CNBC's "American Greed."
In one of the most extreme examples of a business partnership gone bad, Charles "Chase" Merritt murdered business partner Joseph McStay, along with McStay's wife and two children, in an apparent dispute involving nearly $43,000 that Merritt owed McStay.
"Someone who's brought into your business can turn on you when it comes to greed," said Britt Imes, deputy district attorney in San Bernardino County, California.
A California jury convicted Merritt in 2019 on four counts of first-degree murder, and he's on death row at the state prison in San Quentin.
It took more than four years after the McStay family disappeared in 2010 for investigators to tie the murders to Merritt, who installed custom water features that McStay designed and built.
Authorities eventually determined that Merritt withdrew thousands of dollars from the business account after the family disappeared. Prosecutors argued that McStay had been trying to sideline Merritt from the business.
Although this is an extreme case of a partnership going bad, business disputes can cause enormous damage.
"The partners disagree, or all of a sudden they've got a lawsuit that they're surprised with and they're trying to figure out how to fix things," said Tarshus, whose law firm is in Buffalo, New York.
The National Federation of Independent Business, the nation's leading small business advocacy group, urges entrepreneurs to hire an attorney early on — ideally within the first 90 days of setting up the business.
"Before you unlock your door, make sure your legal house is in order," the organization said in a recent blog post.
An attorney can help you decide on the right corporate structure, review any contracts that need to be signed, help you manage your risk and advise you on labor laws.
If you will be working with a partner, a written agreement can help head off disputes. For example, Tarshus typically recommends that partnership agreements include caps on the amounts that partners can withdraw from company accounts.
"When one of the partners goes out and makes a huge transaction or a purchase, or agrees to spend a certain amount on a project, or to buy equipment, or to sell property or acquire property, the other partner is sitting there going, why would you do that without running it by me first?" Tarshus said. "Well, if you have a cap built into your company governance document, that would prevent that type of issue from even occurring in the first place."
Tarshus also suggests running a thorough background check on any prospective partners, and allowing your partner to check on you, even if you think you know each other well.
"Sometimes, the way that people behave in the workplace is not the way that they behave personally or in their circle of friends," Tarshus said.
The process should include verifying former employer, and thoroughly checking references with an eye toward understanding how partners conduct themselves in everyday business situations.
"Even if the two of you have the same vision for a company, if one person has a different set of ethics and principles that they abide by, you might run into some conflicts," she said.
In many cases, it may be appropriate to ask your partner to share three years' worth of personal tax returns.
The vetting process should also include a criminal background check. Tarshus said hiring a professional firm to conduct that check can ensure that it is thorough. It can also help shield you from liability, not to mention any awkwardness.
At the very least, she said, start with a basic Google search. But don't just type in the person's name.
"You can also add the word 'lawsuit' after their name. 'Bankruptcy.' You can get 'criminal record,' 'mug shot.' These are all keywords that will pull up a lot of information."
It is unclear how much checking McStay did when it came to Merritt, or how it might have affected McStay's decision to go into business with him. But a background check would have revealed Merritt had a criminal record, including two felony convictions for burglary.
If your partner resists that type of vetting, that alone might be a red flag.
"You really need to trust your instincts," Tarshus said. "And if a person is unwilling to share or be vulnerable with you, or let you have a look into their private life, then it would really give me caution to enter into a business relationship with them, because I would have concerns that they would keep some things secret."
Above all, resist the instinct to put off what may seem like an unpleasant or uncomfortable process. Tarshus said that all too often, business partners think their operation is too small or informal to warrant such an extensive process.
"You might not be anybody today, but you are trying to be. The point of having your business is to become successful," she said. "And for that reason, it's really important to make sure that you lay a solid foundation for your business today."
Follow the trail as investigators trace the mysterious disappearance of a young California family to Chase Merritt, who claimed that business partner Joseph McStay was his "best friend." Watch an ALL NEW episode of "American Greed," Monday, February 15 at 10 p.m. ET/PT only on CNBC.