How To Structure A Partnership
First I must say, this site is quite impressive. I found it while researching partnership agreements. That being said, I am nearing a fairly important conversation with my current partner to discuss structuring our business. Below are the specifics:
He and I own another successful business together. Currently, we are in early/launch phase with a fully developed/tested concept and product. He works full time and I currently work part time. Given the stage of business, it is quite difficult for us to stay informed as it is moving at an exponential rate and I am still in my very demanding job. Discussed far prior to starting the business, it was understood that I would maintain my job until our new company could afford to pay me - however nominal the amount may be. Also, I am willing to sacrifice in order to further the business.
We are currently coming in to conflict as he is concerned with the amount of work and not being able to cover it all. His proposal includes hiring on an employee we have previous worked with in our first business who, although young (24), is quite responsible and successful (worth the $$). The problem lies in that he feels I should give up an equity state in order to incentivize the employee to join forces.
Here in lies the concern:
- Giving up an equity stake puts me at a disadvantage from a voting perspective (or does it?) Can you structure it as a non-voting equity stake? How much equity, if any, is fair? Should there be a vesting schedule? Buy-back option?
- As a new employee in a start-up, how often is equity offered? Said employee has had a successful past with us, but no true prior work experience/credentials. Starting salary roughly $12+/hr and, as I am confident in the business, should afford her a salary of $30K+ by end of year one.
Any ideas/options would be greatly appreciated!
-
Is your partner's proposal that only you will give up some of your equity? Or will both of you give up equity? What is the current equity split between the two of you? And are you both not taking a salary for now? Is the proposal that the new employee will get both salary and equity? – Zuly Gonzalez 12 years ago
-
Most importantly, what type of business is this? Is this US based? Are you operating under an LLC or a Corp? Are you filling using subchapter S? – Madd Hacker 12 years ago
-
@MaddHacker It's a Partnership. – Zuly Gonzalez 12 years ago
-
@ZulyGonzalez => I don't see which type (http://biztaxlaw.about.com/od/startingapartnership/f/typesofpartnshps.htm) also, just because there is an agreement, does not mean it's not an LLC or Corp (just less likely it's a corp). – Madd Hacker 12 years ago
-
@MaddHacker If it's legally registered as a Partnership entity it can't also be an LLC or a Corp. A company can select only one business structure at any given time. – Zuly Gonzalez 12 years ago
-
Yes, but LLC's are classified as partnerships. Since this is not in the description, the type of partnership (if it REALLY is registered as a partnership, and it's not a company, with an agreement between two parties) then the LLC, LLP, LP or GP designation will make a bit of difference in how finances are managed. Feel free to read that link from earlier, if that's not clear. – Madd Hacker 12 years ago
-
@MaddHacker I didn't see your comment until now because you didn't @ me. You are confused. What you're suggesting is impossible. If a company is legally registered as a Partnership entity, then it can't also be legally registered as an LLC. A company cannot be legally registered as 2 different entities at the same time. **It's impossible.** I can't emphasize that enough - it's impossible. There are several incorrect statements in your comment. First, an LLC is not a Partnership, it's an LLC. An LLC can choose to be **taxed** as a Partnership, or it can choose to be **taxed** as a Corporation. – Zuly Gonzalez 12 years ago
-
In either case it is still an LLC. That's simply a taxation issue, because the IRS doesn't have a special tax classification for LLCs. There are several types of Partnerships, fx GP vs LP, but an LLC is not one of them. Second, a Partnership is a company. To be more precise, a company can be structured as a Partnership. We're getting off-topic here (our conversation is no longer related to the question), but I would be happy to explain this to you in our chat. Just ping me from there. – Zuly Gonzalez 12 years ago
-
@ZulyGonzalez - we are beyond topic here, but to be clear: there is no mention of a legal "Partnership" thus my original questions. Also, I'm aware of what you're saying, but I'm trying to understand the business type in order to provide useful information. We're not talking about taxes, we're talking operating agreements here, which LLCs can opt to structure like a partnership. Finally (and more importantly) : Icon - have you managed to get your question answered? – Madd Hacker 12 years ago
-
@ZulyGonzalez Current equity split is 50/50 between he and I and he has suggested that the equity come out of my shares. Both of us are not taking a salary currently. It is proposed that the new employee get both salary and equity. – Icon 12 years ago
-
@MaddHacker Sorry for the tardy reply, but we recently changed to an S Corp. – Icon 12 years ago
-
If you have now changed to an S Corp, please edit your post to reflect that. Otherwise you are going to get unhelpful answers since nobody is going to read over 10 comments to find that information. – Zuly Gonzalez 12 years ago
3 Answers
Since you're looking at an S-corp, you have limited options when it comes to equity.
An S-corp is restricted to one type of share, and all parties who "own" the business are shareholders. This means there is no preferred or common stock, it's all the same type.
If you choose to offer ownership of your company to any employees, it does mean that they become shareholders, with voting rights. Using numbers, if you have 100 shares total, and you and your partner each hold 50 shares, you must determine how many to give an employee. If you choose to give them 20, then you can pull the 20 shares equally, or in-equally out of the 100 you and your partner share. Ideally, you would turn this into 20, 40 and 40 shares. Now, if your business makes $10,000 in a fiscal year, your tax return for the business will show this, and given that S-Corps are pass through entities, you will show monies earned as $2,000, $4,000 and $4,000. This would be on top of the monies you are contributing to the salary of the employee, since they are entitled to share in your profits.
Basically S-Corps work very well if everyone is sharing in the work (and the contributions) in equal part to the shares they own. If you want employees, C-Corps are a better, since they stop the pass through income (each of you would need to draw salaries), and allow for common and preferred stock (or voting or non-voting stock).
My personal rules about employees is I only hire contractors, unless I'm running a C-corp, and making enough money to cover the cost of an employee (don't forget about the tax/insurance/benefits/etc).
Hopefully this helps give some perspective, please let me know if you need more information, or if this is not clear.
Best of luck!
I'm a Harvard lawyer and I feel you're overcomplicating this with legalese over not much money.
I would figure out something fair and durable for all parties and go with that.
The law permits a lot of flexibility in how you divvy up voting rights vs. ownership interests, etc.
Once you guys reach a fair business arrangement, hire a lawyer to draft it up.
-
I appreciate the input. – Icon 12 years ago
Have you reviewed the following:
Forming a new software startup, how do I allocate ownership fairly? Yes, I understand you have an S corp, and this advice is more applicable to C corp types, but the perception of fairness comes into play here. Also, I'd second @MaddHackers advice and consider moving to a C corp if you intend on offering options / equity to staffers as an incentive to join.
