Adding a part­ner or share­hold­er is not sim­ple.  As with any agree­ment involv­ing mon­ey, spend­ing the time hav­ing dif­fi­cult con­ver­sa­tions up front is well worth your time and ener­gy.  A clear agree­ment avoids unnec­es­sary con­flicts that can sab­o­tage or derail your busi­ness by tak­ing ener­gy from the busi­ness and focus­ing it on the con­flict. 

The typ­i­cal sce­nar­ios for part­ner­ship are two:

One, we are new­bies and we know we will always get along.  We agree to be 50/50 and we will decide lat­er if there are oth­er things to work thru.

Two, I have owned my busi­ness for some time and to grow I take on a part­ner or new share­hold­er with a minor­i­ty inter­est.  I have always done things my own way and don’t con­sid­er that maybe now with some­one else com­ing in, there are agree­ments need­ed.

Even more com­plex than a mar­riage, when indi­vid­u­als choose to do busi­ness as part­ners or share­hold­ers, there is more than one rela­tion­ship which is formed.  Each one deserves your atten­tion and a writ­ten agree­ment.

The pur­pose of this memo is not to give legal advice, that we leave to your attor­ney.  Rather the pur­pose of this memo is to pro­vide a blue­print for clear con­ver­sa­tions and agree­ments pri­or to engag­ing an attor­ney to write the agree­ment as you have decid­ed.

The lev­els of finan­cial rela­tion­ship in a busi­ness part­ner­ship or as joint share­hold­ers involve three lev­els: 

  1. Cap­i­tal: Con­sid­er both ini­tial­ly and as cap­i­tal may be need­ed to expand or keep the busi­ness con­tin­u­ing.
  2. Work: Each part­ner or share­hold­er may or may not work in their busi­ness and their work may or may not be worth the same val­ue in the mar­ket­place.
  3. Earn­ings and dis­tri­b­u­tions:  Earn­ings of a busi­ness may be in cash or as the busi­ness grows they may be tied up with items such as receiv­ables, inven­to­ry and R&D costs.  How will items like earn­ings, tax­es and dis­tri­b­u­tions be han­dled?

Cap­i­tal

How will we own the busi­ness togeth­er?  50/50, 80/20, 55/45?   Why?  Cap­i­tal con­tributed based on fair mar­ket val­ue should be con­sis­tent with own­er­ship per­cent­ages. 

If you are con­sid­er­ing a 50/50 split, real­ize that in a dis­agree­ment there is no major­i­ty share­hold­er with the pow­er to decide.  This could lead to no deci­sion being the deci­sion. If 50/50 is decid­ed, who makes the final deci­sion if there is a dis­agree­ment?

For a new busi­ness:

What will each partner(s) or share­hold­er con­tribute to the busi­ness to gain own­er­ship? Will it be cash, exist­ing tan­gi­ble or intan­gi­ble prop­er­ty or sweat equi­ty?  If it is sweat equi­ty or intan­gi­bles, how will this be val­ued? What hap­pens when the busi­ness has a hic­cup and cash gets con­strained? Will part­ners and share­hold­ers add new cap­i­tal in pro­por­tion to own­er­ship?

For an exist­ing busi­ness:

What is the fair mar­ket val­ue of the busi­ness cur­rent­ly?   How much will the new part­ner or share­hold­er own?  Will it be cash, exist­ing tan­gi­ble or intan­gi­ble prop­er­ty or sweat equi­ty invest­ed?  If it is sweat equi­ty or intan­gi­bles, how will this be val­ued? How will they buy in?  Via pay­ment to the exist­ing part­ner or share­hold­er or as new cap­i­tal direct­ly to the busi­ness to fund growth? What hap­pens when the busi­ness has a hic­cup and cash gets con­strained? Will part­ners and share­hold­ers add new cap­i­tal in pro­por­tion to own­er­ship?

Work

Write a job descrip­tion for each part­ner or share­hold­er.  Con­duct mar­ket research to deter­mine the mar­ket val­ue for the job that each part­ner or share­hold­er will be per­form­ing. 

What should each share­hold­er be paid for their work? Gen­er­al­ly, this should be based on your mar­ket research for the val­ue of the posi­tion.  Often 50/50 part­ner or share­hold­ers set their com­pen­sa­tion equal­ly even though their mar­ket based com­pen­sa­tion is unequal.  Think through that this leaves the under­paid part­ner or share­hold­er able to make more mon­ey out­side the busi­ness than in, and unfair­ly rewards the over­com­pen­sat­ed part­ner or share­hold­er for their work. 

Earn­ings and dis­tri­b­u­tions

Most busi­ness­es con­sume cash as they grow.  You may have heard the say­ing, “Growth eats cash flow for break­fast, lunch and din­ner.”  In many busi­ness­es, this is true.

So, in the first year if you are lucky enough to make mon­ey, will you dis­trib­ute it all to the share­hold­ers?  How will the busi­ness gain cap­i­tal to grow?  Typ­i­cal­ly, cap­i­tal for an exist­ing busi­ness is from earn­ings retained in the busi­ness.  If the busi­ness dis­trib­utes them all, there is noth­ing left to fund growth.

How will tax­es be paid?  Will each part­ner or share­hold­er be required to pay tax­es out of their per­son­al funds or will the busi­ness dis­trib­ute funds for this?  What if the busi­ness doesn’t have the funds?

What if one part­ner or share­hold­er is hav­ing a per­son­al cri­sis?  Will they be able to bor­row from the busi­ness?  At what inter­est rate?  For what busi­ness pur­pose?

Your busi­ness is like­ly to be your largest asset.  Strate­gi­cal­ly think through, what is a rea­son­able return on invest­ment (ROI) for each part­ner or share­hold­er? How is this ROI achieved? What is the plan to build the busi­ness so this is real­is­tic?

As always, we at Mack­ey Advi­sors are here to help you pas­sion­ate­ly pur­sue pros­per­i­ty, what­ev­er that may be for you. If we can help, reach out to us at Lisa@MackeyAdvisors.com or at 859–331-7755.