How much is everyone investing in the company?
Say you need $1,000,000 of startup money to get the business operational. If you have four partners–for example, one who is in charge of finances, one who will head up the business dealings, one a technical lead and the last to run marketing -with each partner pitching in $250,000, then an even split of ownership is probably a good place to start. There are some folks out there that have tried to make the split much more mathematical, but that frankly strikes us a too much brain damage in many cases.
However, if two partners put in $50,000 of their own money into starting up the company and the third partner won’t invest any capital but will handle setting everything up and getting the company going, how do you split the stock? Even thirds might work in this case, but the third person who is doing all the work will likely feel like his efforts are undervalued after a time.
Both time and money are valuable investments. A business fails without both, and to say one is more important than the other, is simplistic and immature. You need both to start and maintain a functioning company, but you need to decide what fair compensation is for the amount of risk each person is taking. With new companies, it’s hard to tell from the start what the returns will be like.
How important is each person to the success of the venture?
Using the leading hypothetical venture, we had a CEO type, CFO, CTO and CMO as our four partners. Are all of these equally critical to the business? Will each of these people be working the same long nights and putting in the same amount of effort from the get-go to get the company going? Unless you have already worked with your partners before, it’s going to be difficult to ascertain how much of an impact they’re going to have. It also may be completely different in a different environment.
It’s not easy to make these decisions, but careful planning and a bit of patience will go a long way, as this areas is often where partner disputes arise. Over time, one partner end ups doing more work and picking up tasks that other partners are leaving behind. This partner can become resentful and feel as though they aren’t being compensated enough for their efforts.
It’s not an uncommon problem that arises down the road, so rather than focusing on redistributing shares, focus on working together as a team to make the pie bigger. This way, everyone will share in the growing profits.
What happens if you want add partners or substantial employee equity holders later?
You would expect founders to have more equity and control than later comers, including the early employees. If that’s the case, how will you decide how much equity they get? Will existing partners give up an equal number of shares, or will it be based on percentage? These are all things you need to lay out at the start in your partnership agreement to avoid conflicts down the line. But experienced attorneys can help you draft the documents necessary to make the equity grants and still retain the control in the founding team.
What happens if a partner wants out?
Will the other partners buy them out? Will you let them keep their shares, but simply not have voting options? If you do need to buy out a member, you’ll need to properly assess the value of the business in order to calculate the current value of that partner’s shares. You can hire a business valuation service to assign an estimated value to your company. This will make it easier to figure out how much their portion is worth.
Drawing up the Partnership Agreement
Once you’ve discussed all of these details with your partners, you’ll need to codify it in a partnership agreement document. Since this is the founding document of your company, similar to an LLC’s Operating Agreement or a corporation’s bylaws, you’re going to want to consult a legal expert. When drafted properly, this document can save you and your partners from many unpleasant disagreements in the future.
With new ventures, finances can be tight and legal advice is notoriously expensive. Forefront is a great place for small businesses to find a lawyer that fits their needs and budget. We run a lean operation andutilize powerful technology, so we’re able to pass the savings on to our clients. Starting up involves a lot of paperwork, with various contracts and licenses often required. Having an expert who can review everything with a professional set of eyes can help ensure you’re setting everything up properly and help you avoid costly mistakes. And you don’t always have to pay by the hour. Firms like Forefront have established very attractive flat-fee subscription packages for early stage ventures.
You’ll need to establish a total number of shares and then divide those up among the partners. Keep in mind the shares represent not only the ownership, but also the profits and losses of the company (unless your agreement specifies otherwise).
Once the agreement is drafted, with all the other sections about how the business is to be run, the partners need to sign it and have it notarized. Depending on your sector and state, you may need to provide the state with a copy of this agreement.
Dividing up ownership between two or more partners can be a tricky endeavor. It’s hard to know at the outset how hard each person will work and be able to predict a truly fair split in ownership and profits. Splitting based on initial investment is clear cut, but can’t guarantee fairness in the long term. Over time, things change as well, so all you and your partners can do is set up ground rules to ensure proper communications and conflict resolution.
As your company grows, you may consider restructuring the business into an LLC or Corporation at some future point. At this stage, you would have the opportunity to reevaluate and redistribute ownership from a better vantage point, with the experience of operation under your belt. But keep in mind any such restructuring might come with a good deal of documentation and forms to draft and execute.
Add a one of our top Forefront Attorneys to your team today to make sure you have the peace of mind to give your business the focus it needs.
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