Tips and traps for referral partnerships

Mere referrals

The simplest is a mere referral, where the referrer provides the prospect with the business’ contact details and some information about the services you provide. These can be wonderful sources of new clients but they are a little uncertain.

If the referrer does no more than hand over information, there is no guarantee that the prospect will contact the business. It’s more effective for the referrer to ask the prospect’s permission for you, the business, to contact them.

If you’re efficient and do so promptly, there is a good chance that you will convert the prospect into a client. It is then up to you to service and develop a professional relationship of trust with the client.

If the referral arrangement comes to an end, there’s a high likelihood that the client will stay with you, due to the personal nature of the services that you will have provided.

Joint venture

Another common structure for a referral arrangement is a joint venture.

The rationale for this is that the business and referrer can both share in the benefits brought by the client. If the referral arrangement is successful, the development of a valuable asset can be formed.

Generally, a separate company will be incorporated in which the business and referrer hold shares. The joint-venture company can either provide the services or if it is an arm’s length entity to both you and the referrer, it can be appointed as your corporate authorised representative.

Either way, as shareholders, the referrer and business will be able to participate in the profits earned by the joint-venture company and in the value of the business they create.

Common pitfalls

Let’s look at some of the pitfalls of joint venture and authorised representative arrangements:

No referrals

What if the referrer’s promise of a ready and willing client base of referrals does not eventuate? Tying the referrer’s revenue share to client referrals incentivises the referrer to bring profitable clients to the business.

Expenses

If you share offices and resources with the referrer, agree the basis on which you will pay for those resources upfront. Link it to market pricing.

If you are dealing with service providers, such as accountants or lawyers, pre-define the basis on which they contribute their services to the joint venture. Should they be entitled to do so at full (or even partial) commercial rates when you are contributing your time, expertise and systems for a salary plus profit? Or should they be compensated on a cost recovery basis?

Avoid tying your contribution to expenses to the share of revenue that you generate for the business. One client with this arrangement, who successfully developed the business, ended up subsidising the rest of the referrer’s business.

Termination

Perhaps the biggest issue is, what happens when the relationship irretrievably breaks down or even if it happily terminates?

For example, the referrer might decide to reach a potentially more profitable relationship with another business. Who will have the ongoing right to service the clients of the joint venture?

Are you happy for the referrer to directly compete against you? When going into a joint arrangement, it’s easy to overlook the fact that over the life of the venture, just like a marriage, the relationship will become increasingly complex.

Think about your friends and colleagues who have been divorced. Did they split amicably with no arguments about kids or property? Did they have to go through the Family Court? Were they happy with how much it cost them in legal fees? How much easier would it have been if they had a pre-nuptial agreement?

Unless the rules are laid down in advance, when negotiations and discussions are easy because goodwill abounds, significant and sometimes irretrievable problems can occur after the relationship has broken down and communication is poor.

And that is what a shareholder’s agreement in effect is – a pre-nuptial agreement for businesses.

There will be a cost to obtain a well-drafted shareholder’s agreement that is customised for your circumstances. Many clients initially feel that they cannot justify the cost. But this small upfront outlay will pale in comparison to the potential legal fees, personal time and loss you could incur if you don’t have one.

One of our clients’ separation from his referral partner was made so difficult that it affected his health for years afterwards, impacting his ability to look after his clients and operate the business. He had no documentation in place to govern their rights and responsibilities – a form of corporate Russian roulette.

As a wise man once said, “Bad advice is much more expensive than good advice”.