My friend and I are thinking about going into business together. He's creative, he's hardworking -- and he's very irresponsible with money (he once bought a vintage video game machine instead of paying his rent). His credit isn't so hot, either. Are there ways I can protect myself?
Short of shrink-wrapping your friend in plastic, there's probably no way to completely prevent that person from impacting either your finances or those of your business. But if you are determined that this is the person with whom you want to partner up in a business venture, let's look at the damage control options for yourself first, then for the business.
To protect yourself, the key is how you set up your business. Both a corporation and a limited liability company (LLC) protect business owners from personal liability for business debts. If you organize your business this way, your personal assets will be safe. However, if you and your friend create a general partnership, you will both be personally liable for business debts -- leaving you on the hook for your friend's spendthrift tendencies.
Stopping your friend's financial hijinks from getting the company, not just you, into a bind, is going to take more day-to-day effort on your part. Here are some strategies:
Limit your friend's authority over expensive contracts and purchases. For instance, all major contracts should contain a paragraph stating that they're not binding on the business unless they're signed by at least two officers or members (depending on whether you set up a corporation or an LLC). If you set up an LLC, your operating agreement can require that both of you need to agree before entering into a contract or borrowing money. If you set up a corporation, it's best that your friend not be able to give outsiders the impression that he has authority to bind the company -- by bearing the title of president or vice president, for example.
If you really want to keep your friend's hands out of the company cookie jar, make sure you're the only signatory on the company bank account, hide the checkbook, and read your company credit card statements very, very carefully.
Keep in mind that unless your friend openly admits to his pecuniary problem, he probably won't greet these ideas with delight. But your friend shouldn't mind signing a "buy-sell agreement," which will control what happens when one of you wants out of the business (regardless of the structure you choose for your business). And who knows, maybe you'll actually enjoy the occasional video game.