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Started By
Message
Give me insight on partnerships please
Posted on 7/17/23 at 9:40 am
Posted on 7/17/23 at 9:40 am
I've known a guy for a few years and we started talking about opening up a small business. He's got a lot more freedom to devote to projects like this during the week but less money, and I have more money but less free time. I'm trying to get a sense of if this is practical or foolish, where one person is the operating partner who puts up less but does a lot more day to day and one puts up more money. Questions I was thinking of:
1 Is this a common setup or ill-advised?
2 How would you split up returns / ownership?
3 What do you think on grounds for resentment down the road? Either I feel like better work could be done, or the operating partner feels like he deserves more based on work.
Just trying to wrap my head around this.
1 Is this a common setup or ill-advised?
2 How would you split up returns / ownership?
3 What do you think on grounds for resentment down the road? Either I feel like better work could be done, or the operating partner feels like he deserves more based on work.
Just trying to wrap my head around this.
6
Posted on 7/17/23 at 10:14 am to Thundercles
A partnership is just a business form recognized under the law. There are others, e.g. corporations, LLCs, LLPs, etc. Regardless of the form, there are generally underlying documents agreed to at formation that govern the rights and responsibilities of the owners. There is too much to cover here. Sounds like you need to talk to a lawyer if you are serious. Especially if you are fronting the money.
Posted on 7/17/23 at 10:43 am to SloaneRanger
Sure, I realize there will be some legally guiding documents. I just mean from a functional standpoint, I'm looking to see if someone has experience in this. It would likely be a 75/25 money split or something like that.
Posted on 7/17/23 at 11:01 am to Thundercles
quote:
It would likely be a 75/25 money split or something like that.
Does the partner with the sweat equity expect to make a salary, or is the 75/25 money split strictly payment for his sweat equity + seed money?
Posted on 7/17/23 at 11:53 am to Witty_Username
quote:
Does the partner with the sweat equity expect to make a salary
This is the part I'm trying to wrap my head around. We wouldn't be earning enough just from the business nor would they require enough time to justify a salary. So in theory he'd be fronting less for doing more of the work. But I could see that becoming unbalanced down the road like 1-2 years in.
Posted on 7/17/23 at 12:19 pm to Thundercles
You have to define the agreement. It works if it's palatable to both of you, but make sure it's written down. I would get a lawyer to draft the Operating Agreement who has experience dealing with the aftermath of poorly written Operating Agreements. What may seem good today may not seem good tomorrow.
You can treat capital investment separately from ordinary business expenses. Chances are that he wouldn't be interested in this arrangement. Or, he could get equity over time up to a specific ownership percentage in the business in exchange for his work. Then you get into if and how you measure his level of work, etc. Or, you can agree it's essentially equal ownership, but he does it all. Anything is on the table.
A good lawyer could also help you identify a contingency plan if you don't want to work with each other anymore. Talking about these things ahead of time can be useful.
You can treat capital investment separately from ordinary business expenses. Chances are that he wouldn't be interested in this arrangement. Or, he could get equity over time up to a specific ownership percentage in the business in exchange for his work. Then you get into if and how you measure his level of work, etc. Or, you can agree it's essentially equal ownership, but he does it all. Anything is on the table.
A good lawyer could also help you identify a contingency plan if you don't want to work with each other anymore. Talking about these things ahead of time can be useful.
Posted on 7/17/23 at 12:19 pm to Thundercles
Have you considered your contribution to the business in terms of the skills you each bring and the deliverables you can point to that prove you are contributing? Without that, the money/time wont matter. You will resent each other.
Posted on 7/17/23 at 12:20 pm to Thundercles
I'm sure you've heard that partnerships of any kind are hard to keep intact. Knowing that,
The ways to structure anything are infinite, and something that you and him will have to agree on, and then agree to change the structure should it grow into something.
One way to reward his time versus your money is agreeing to a profit split one way or the other on each unit sold (or service sold).
Is his time worth 50% of the profit?
Is your capital worth 50%?
Might be a place to start.
Then you have to agree if either of take anything off the profits, and do plan to stay at that structure, or let him begin to buy you out of the debt?
If you plan to start a business with him, you need to be able to sit and brainstorm different ways of compensation with him. Maybe assemble 2 different structures that you both like, and then let him pick.
Good luck
The ways to structure anything are infinite, and something that you and him will have to agree on, and then agree to change the structure should it grow into something.
One way to reward his time versus your money is agreeing to a profit split one way or the other on each unit sold (or service sold).
Is his time worth 50% of the profit?
Is your capital worth 50%?
Might be a place to start.
Then you have to agree if either of take anything off the profits, and do plan to stay at that structure, or let him begin to buy you out of the debt?
If you plan to start a business with him, you need to be able to sit and brainstorm different ways of compensation with him. Maybe assemble 2 different structures that you both like, and then let him pick.
Good luck
Posted on 7/17/23 at 12:24 pm to Thundercles
You would state all of those provisions in the agreement. I suggest being really specific about the capital accounts.
Posted on 7/17/23 at 1:08 pm to Thundercles
You should start a restaurant business and then pay a 1099 employee to take 40% of the profits. No contract required.
Posted on 7/17/23 at 1:13 pm to FinleyStreet
quote:
You should start a restaurant business and then pay a 1099 employee to take 40% of the profits. No contract required.
Nothing could ever go awry there.
Posted on 7/17/23 at 2:25 pm to Thundercles
quote:
It would likely be a 75/25 money split or something like that.
Could you structure a “buy in” for him over time?
You front the money.
At start you own 75%.
You get 75% of net profit after expenses- including his salary.
He could use his 25% to buy in over time.
Then after some years, you are 50/50.
Get an attorney is the answer.
Posted on 7/17/23 at 2:35 pm to Thundercles
Yes, it can be done, but it can get tricky. You definitely want a good lawyer to advise you and document your agreement (be it a partnership, LLC or whatever). You already seem to realize there are usually resentments that come into play after a while - either you feel he isn't putting enough "sweat equity" into the deal or he feels he's not getting enough return on his "sweat equity".
You need to define parameters of how much money you're willing to put in, what, if any, money he's putting in, what his and/or your level of job duties and amount of time devoted to the enterprise will be, etc.
If you are putting in the money, you can set a cash waterfall whereby the first distributions go to paying back all initial capital contributions (so you get your money out first), then usually some sort of a preferred return on those capital contributions (say 10-15% annually until the capital contributions are repaid), and then after that a split between the partners (depending on your decide to divide it, be it 50/50, 75/25 or some other split).
There are tons of way you can handle all of this, but again, make sure it is documented well and that there is a clear and defined mechanism for divorce if you 2 become deadlocked on decision making or the inevitable resentments become unworkable.
Good luck.
You need to define parameters of how much money you're willing to put in, what, if any, money he's putting in, what his and/or your level of job duties and amount of time devoted to the enterprise will be, etc.
If you are putting in the money, you can set a cash waterfall whereby the first distributions go to paying back all initial capital contributions (so you get your money out first), then usually some sort of a preferred return on those capital contributions (say 10-15% annually until the capital contributions are repaid), and then after that a split between the partners (depending on your decide to divide it, be it 50/50, 75/25 or some other split).
There are tons of way you can handle all of this, but again, make sure it is documented well and that there is a clear and defined mechanism for divorce if you 2 become deadlocked on decision making or the inevitable resentments become unworkable.
Good luck.
Posted on 7/17/23 at 9:10 pm to Thundercles
What’s the long term goal for this small biz? Will it grow into a full time gig for you and him or y’all just trying to make some extra cash? Most of the big disagreements will likely happen when it gets big enough to be making significant money. I’d handle differently depending on the long term goal. If it’s just a small company meant to make some extra front pocket money I wouldn’t worry too much about complicated structures. Probably just roll with 50/50 and make sure he’s clear that you never have any intent of participating in operations. I’d always add repayment of investment within a certain timeframe…possibly with a return premium. You could stipulate this is to be paid prior to any other distributions to you or him.
If the goal is to be more significant I’d probably start off with you at 75%-80%. Keep the same initial investment payback I mentioned above and then add in a buyout timeframe. He could buy 5%-10% per yr from you until he owns 75%-80%. That would put you in a fully bought down position in 5-10 yrs. This allows him to always be headed for majority ownership position and will lessen the likelihood of the “I do more work than you” conversation. I have a company like this now where we set up a 3 yr payback of investment capital and a 7 yr buyout of equity from 70/30 to 30/70. You have to agree on the front end of how you will value the business for these targeted buybacks. If he can’t fully fund one of the buyback offerings then the next available purchase opportunity won’t happen until he fully funds the current offer.
Basically, anything you or he has reservations about needs to be addressed on the front end. There will never be an easier time to do it. If you think it’s awkward now, just think how difficult it’ll be when you both have money on the line. It’s all about communication…just ask the hard questions now so y’all can both understand each others motivations for starting in the first place.
If the goal is to be more significant I’d probably start off with you at 75%-80%. Keep the same initial investment payback I mentioned above and then add in a buyout timeframe. He could buy 5%-10% per yr from you until he owns 75%-80%. That would put you in a fully bought down position in 5-10 yrs. This allows him to always be headed for majority ownership position and will lessen the likelihood of the “I do more work than you” conversation. I have a company like this now where we set up a 3 yr payback of investment capital and a 7 yr buyout of equity from 70/30 to 30/70. You have to agree on the front end of how you will value the business for these targeted buybacks. If he can’t fully fund one of the buyback offerings then the next available purchase opportunity won’t happen until he fully funds the current offer.
Basically, anything you or he has reservations about needs to be addressed on the front end. There will never be an easier time to do it. If you think it’s awkward now, just think how difficult it’ll be when you both have money on the line. It’s all about communication…just ask the hard questions now so y’all can both understand each others motivations for starting in the first place.
Posted on 7/17/23 at 9:39 pm to jfw3535
This is really good insight, thank you. I think the toughest part to even begin to visualize is how to properly the time and labor.
Posted on 7/18/23 at 1:57 pm to Thundercles
quote:
Does the partner with the sweat equity expect to make a salary
This is the part I'm trying to wrap my head around. We wouldn't be earning enough just from the business nor would they require enough time to justify a salary. So in theory he'd be fronting less for doing more of the work. But I could see that becoming unbalanced down the road like 1-2 years in.
FYI, capital contribution in exchange for services is taxable compensation to the parter providing services. No point in paying a salary at the beginning if set up as a partnership. Consult with a CPA to consider tax implications. A good CPA can do most of what a lawyer can do and advise you of consequences to your personal taxes now and in the future.
Edit: Forgot to also mention, if you give your partner a profits only interest, then it would not be taxable compensation to him/her.
This post was edited on 7/18/23 at 2:17 pm
Posted on 7/18/23 at 2:05 pm to jordan21210
Excellent point by jordan21210.
Posted on 7/18/23 at 5:10 pm to jordan21210
Profit sharing is not taxable? Never heard of that, but if true it could be a game changer for me in the private equity world. I do a lot of small ownership type investments. Granted the goal is always to sell the company so the equity is crucial for that, but it’s an interesting concept to think on nonetheless.
Posted on 7/18/23 at 6:58 pm to TyOconner
Only at formation of a partnership if a partner is offering services in exchange for an interest in the partnership. If providing services in exchange for capital/equity interest the value of services is taxable compensation to the partner providing services. If providing services in exchange for a profits only interest, the value of services is not taxable compensation to the partner providing services.
Someone smarter than me may be able to explain it better.
Someone smarter than me may be able to explain it better.
Posted on 7/19/23 at 3:40 pm to jordan21210
Interesting. Seems like a loophole that you could exploit pretty easily but maybe I’m wrong.
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