If you and your business partners have decided to split the equity in your business, you need to make sure that it is done formally to ensure there aren’t any legal problems and that everyone gets what they earn or are otherwise entitled to. But, in many cases, I find the division amongst partners to be one more of art than science. Each partnership is different and everyone’s value to the partnership may vary.
50/50 May Not be Right
Many people assume that an even split of the equity is the right option, but that isn’t always the case. Splitting equity should be done based each partner’s contribution or value to the business, not necessarily just a headcount. Partners may be contributing money, “sweat”, expertise, connection, etc. All of those contributions should be considered.
I often hear that 50/50 is never right. Generally, yes, many problems (from a corporate governance standpoint) can be avoided if there is only one party who makes the final decision on matters. But, my experience has shown that 50/50 can work out for the partners; but, in addition to luck, it requires some great planning and communication. If you do wind up agreeing to a 50/50 partnership, you need to some extra planning on how the partnership will function and solve problems or disagreements.
Where Was Value Added?
A person can add value to a business in many different ways. When it comes time to split equity, looking at who added what value will be critical. The following are some of the most significant ways that someone can add value to a company:
- Work – Performing the day-to-day work of a company is certainly essential to its success. Owners often perform this type of work, especially during the initial years.
- Financial Contributions – Companies often need infusions of cash to operate or expand. If someone contributes in this way, it has to be taken into account.
- Ideas & Innovation – The value of ideas and innovation for a company often can’t be overestimated. Coming up with new ideas for a business is a significant form of value.
- Management – Managing day-to-day operations as well as managing employees is difficult. When done right, it can benefit the company greatly.
- Expertise or Experience- Providing very specialized skills or knowledge.
- Connections – Providing connections to capital or key customers.
Vesting
If I’ve said it once, I’ve said it 100,000 times. You have to consider vesting everyone’s interest – particularly for those that are earning it with their labor rather than contributing capital or making an investment. For more, see our blog about vesting here.
The division of equity among partners or founders comes down to more art than science. Nonetheless, there are several good tools out there to help entrepreneurs decide how to divide up the equity. But, again, there’s many ways to “skin the cat.” Here are a couple helpful links that I often send to clients:
Avoid Legal Trouble
One of the best ways to split equity while avoiding any tax issues, legal problems, or even disputes between the owners is to bring in an experienced attorney to help along the way. Please contact us to schedule a consultation and see how we can help you through this process.