Splitting equity with new business partner
Discussion
Morning all,
Got a situation I'm chewing over and would be interested in hearing some wisdom from the smart heads on here.
Quick context: me and an ex-colleague are starting a new business fulltime. We are pre-launch and own 50% of the ltd co each. I am 28, single, and willing to grind it out - whatever it takes to make this work. He is 45, with a family, and - whilst willing to work hard - has priorities which means he won't be able to commit as much time after ordinary working hours. We've had a very frank and open discussion about this, and we're both clear and comfortable with the other's position. We'll shortly be raising investment and given he has a family to support, he will be drawing a higher salary than me.
Based upon the priorities and salary point, we've agreed I should be the majority shareholder in the business (we currently own it 50-50). What I'm struggling with is how the F to split it without just plucking numbers out the air around what "feels" right. Given the business is not operating yet, I appreciate there is an element of guesswork, but I would feel more comfortable thinking about it with some structure.
In terms of what we each contribute, at a high level:
Me - more commercially-minded (I build the financial models, most of the business plan, etc), more process driven, more metrics driven
Him - more networked (very important in our market), more experienced (he understands the industry itself much better than me after working in it for 20 years vs my 2 years), more creative
I could feasibly launch this business by myself, but it would be far harder and the growth rate much slower without my partner's presence. Plus I think it's less fun to do it alone! So to cover that point off before it comes up - that's not something I'm considering!
So - does anyone have any guidance or experience on how best to approach this situation? I want to be fair on my partner, but I also want a share that properly reflects my contribution.
Got a situation I'm chewing over and would be interested in hearing some wisdom from the smart heads on here.
Quick context: me and an ex-colleague are starting a new business fulltime. We are pre-launch and own 50% of the ltd co each. I am 28, single, and willing to grind it out - whatever it takes to make this work. He is 45, with a family, and - whilst willing to work hard - has priorities which means he won't be able to commit as much time after ordinary working hours. We've had a very frank and open discussion about this, and we're both clear and comfortable with the other's position. We'll shortly be raising investment and given he has a family to support, he will be drawing a higher salary than me.
Based upon the priorities and salary point, we've agreed I should be the majority shareholder in the business (we currently own it 50-50). What I'm struggling with is how the F to split it without just plucking numbers out the air around what "feels" right. Given the business is not operating yet, I appreciate there is an element of guesswork, but I would feel more comfortable thinking about it with some structure.
In terms of what we each contribute, at a high level:
Me - more commercially-minded (I build the financial models, most of the business plan, etc), more process driven, more metrics driven
Him - more networked (very important in our market), more experienced (he understands the industry itself much better than me after working in it for 20 years vs my 2 years), more creative
I could feasibly launch this business by myself, but it would be far harder and the growth rate much slower without my partner's presence. Plus I think it's less fun to do it alone! So to cover that point off before it comes up - that's not something I'm considering!
So - does anyone have any guidance or experience on how best to approach this situation? I want to be fair on my partner, but I also want a share that properly reflects my contribution.
The wording of the shareholders agreement will be more important than the split.
You really need to get that right first.
There are a few reasons for someone to own the company.
They get a payout if its sold.
They can take dividends as well as PAYE which is sometimes (but less so now) more tax effective.
I know its a hard question to answer but do you see the business being sold?
The older partner is 17 years closer to retirement than you are. What happens when he wants out? Will he pressure you to tout the business for sale to get a feel for what his share is worth on the market and then get you to match it or sell out himself, or make things difficult for you being a sitting director?
You really need an agreement in place as to what happens to his shares if he wants out.
Do you plan to take dividends? If so the partner will either get the same proportional pay out or you will have to structure A and B shares with differential payouts.
If you have the option of owning the Ltd outright (and Ltd is in fact the right way to go) do that without a doubt. By all means give the other person an attractive employment package so they stay on board but if they aren't bothered about owning some of the company don't offer it.
I've been through this and believe me everyone looks at the ££ when they see retirement on the horizon and loyalty will easily go out of the window if they think a pot of cash is sitting in a business for them.
You really need to get that right first.
There are a few reasons for someone to own the company.
They get a payout if its sold.
They can take dividends as well as PAYE which is sometimes (but less so now) more tax effective.
I know its a hard question to answer but do you see the business being sold?
The older partner is 17 years closer to retirement than you are. What happens when he wants out? Will he pressure you to tout the business for sale to get a feel for what his share is worth on the market and then get you to match it or sell out himself, or make things difficult for you being a sitting director?
You really need an agreement in place as to what happens to his shares if he wants out.
Do you plan to take dividends? If so the partner will either get the same proportional pay out or you will have to structure A and B shares with differential payouts.
If you have the option of owning the Ltd outright (and Ltd is in fact the right way to go) do that without a doubt. By all means give the other person an attractive employment package so they stay on board but if they aren't bothered about owning some of the company don't offer it.
I've been through this and believe me everyone looks at the ££ when they see retirement on the horizon and loyalty will easily go out of the window if they think a pot of cash is sitting in a business for them.
Don't underestimate the potential implications of age difference, and don't take network / experience at face value.
Two of us are insanely driven, early / mid-thirties with individual minority stakes totalling 55%.The other has 45% and is mid-fifties. Equal voting rights though.
He has the network and experience, but no intention of using either and is manifestly coasting towards retirement having basically drawn down his account over the last few years to offset dropping profits. We carry him entirely while trying to re-build the business and it is, basically, nightmarish.
Be really careful.
Two of us are insanely driven, early / mid-thirties with individual minority stakes totalling 55%.The other has 45% and is mid-fifties. Equal voting rights though.
He has the network and experience, but no intention of using either and is manifestly coasting towards retirement having basically drawn down his account over the last few years to offset dropping profits. We carry him entirely while trying to re-build the business and it is, basically, nightmarish.
Be really careful.
Many ways of approaching this, with varying merits.
In addition to the excellent points already raised, consider your respective aspirations; does he want this to be his last job, and for it to see him through his retirement? Do you want to grow something fast and sell out, or to build sufficient equity to buy him out at his retirement? Do you (both) envisage sharing equity with key staff etc in due course? etc etc
A relatively easy way to start might be to look at your business plan and see what each will have taken out over its course (3/5 years?) and adjust shareholdings to provide equal overall value (cumulative salary and dividends, plus equity at that point) if the business plan is achieved.
In addition to the excellent points already raised, consider your respective aspirations; does he want this to be his last job, and for it to see him through his retirement? Do you want to grow something fast and sell out, or to build sufficient equity to buy him out at his retirement? Do you (both) envisage sharing equity with key staff etc in due course? etc etc
A relatively easy way to start might be to look at your business plan and see what each will have taken out over its course (3/5 years?) and adjust shareholdings to provide equal overall value (cumulative salary and dividends, plus equity at that point) if the business plan is achieved.
Also worth remembering that if it doesn’t perform as well as you hope and there is little or no profit to pay dividends he will still receive his higher salary and earn way more than you for doing less work!
I suspect this will be far from a 50:50 partnership. The fact he already wants a higher salary than you (or the business can justify) shows his level of commitment may not be as high as yours or he is unsure the business will be successful.
You are taking the greater risk (AFAICT) therefore his shareholding needs to reflect his risk.
Everything else said above should also be factored in.
Spending a bit on professional advice now may be worth a great deal in the future.
I suspect this will be far from a 50:50 partnership. The fact he already wants a higher salary than you (or the business can justify) shows his level of commitment may not be as high as yours or he is unsure the business will be successful.
You are taking the greater risk (AFAICT) therefore his shareholding needs to reflect his risk.
Everything else said above should also be factored in.
Spending a bit on professional advice now may be worth a great deal in the future.
Think the question answers itself. To assist.
I was offered part of a business 5 years ago, chose to stick at what I was doing as I had committed to a large project even though it would have been part time. The Part was offered and accepted by a person some 20 years older, also director of two other companies, incidental in this case but to assist in building a profile. What happened this week.... yep had enough and said “ c ya” without warning I am informed.
Now I am the same age as the majority shareholder/funder and I can see what he wanted and why he did it when he made his second choice decision. He told me this week and I have offered to “ help” even though I am now busier than ever. We spoke openly and I pointed out that at past retirement we will all value time differently and that as he (and I) is a no BS type this may have pushed the pace beyond comfortable. The response was that the money was all one way...
Incentives on a smaller salary sounds like a mechanisum.
J
I was offered part of a business 5 years ago, chose to stick at what I was doing as I had committed to a large project even though it would have been part time. The Part was offered and accepted by a person some 20 years older, also director of two other companies, incidental in this case but to assist in building a profile. What happened this week.... yep had enough and said “ c ya” without warning I am informed.
Now I am the same age as the majority shareholder/funder and I can see what he wanted and why he did it when he made his second choice decision. He told me this week and I have offered to “ help” even though I am now busier than ever. We spoke openly and I pointed out that at past retirement we will all value time differently and that as he (and I) is a no BS type this may have pushed the pace beyond comfortable. The response was that the money was all one way...
Incentives on a smaller salary sounds like a mechanisum.
J
As has been commented, the shareholder agreement is really important here.
Consider too things such as:
1) Future share issuances (you don’t necessarily only get one bite of the cherry when it comes to determining how many shares are in issue and/or who owns them but you need to think up front about mechanisms);
2) Multiple share classes, with differing restrictions. For example, you,could both be 50/50 on the Ords, but have an A class share with sale restrictions, retention criteria, and good/bad leaver provisions - e.g. either of you leaving within x years forfeit the A shares;
3) Whether the business is likely to grow and require more senior personnel/imvestment, and what these people would need;
4) How one or both of you would exit, for example can he sell to anyone he pleases? You probably don’t want to leave things that permissive.
Getting this sort of thing right is really tough and I’ve seen companies constrained/hit issues by the early choices the founder(s) make, both by being too generous and too stingy with equity distribution. It sometimes feels easy to split down the middle, but that’s not necessarily the equitable way to do equity over the long term.
Lastly, take a long hard look at the other chap. Is he *really* your partner long term, or is it a marriage of convenience that might work for a while. Deep down you probably know the answer to this already, so base your thinking around that.
Consider too things such as:
1) Future share issuances (you don’t necessarily only get one bite of the cherry when it comes to determining how many shares are in issue and/or who owns them but you need to think up front about mechanisms);
2) Multiple share classes, with differing restrictions. For example, you,could both be 50/50 on the Ords, but have an A class share with sale restrictions, retention criteria, and good/bad leaver provisions - e.g. either of you leaving within x years forfeit the A shares;
3) Whether the business is likely to grow and require more senior personnel/imvestment, and what these people would need;
4) How one or both of you would exit, for example can he sell to anyone he pleases? You probably don’t want to leave things that permissive.
Getting this sort of thing right is really tough and I’ve seen companies constrained/hit issues by the early choices the founder(s) make, both by being too generous and too stingy with equity distribution. It sometimes feels easy to split down the middle, but that’s not necessarily the equitable way to do equity over the long term.
Lastly, take a long hard look at the other chap. Is he *really* your partner long term, or is it a marriage of convenience that might work for a while. Deep down you probably know the answer to this already, so base your thinking around that.
Partnerships, like marriage, rarely work out long term, particularly if you both have differing views and needs right at the start. Ending business relationships with a joint partner can be just as messy and expensive as divorce so make sure that; a) do you really need him as a business partner or shareholder, b) that you have a rock solid shareholders agreement covering who does what and what’s expected of each of you, and more importantly c) how either of you can exit the agreement when it doesn’t work out or one of you wants to retire/wind down/ move on.
Think carefully whether you could hire someone on a wage who could do his role and whom you could replace if they don’t perform as needed or if the business takes a different direction.
Think carefully whether you could hire someone on a wage who could do his role and whom you could replace if they don’t perform as needed or if the business takes a different direction.
Edited by 4Q on Thursday 21st March 07:33
You also mention raising investment - if you plan to do that you need to structure for that... investors will expect 100%+ effort from both of you and will likely query salaries etc - if he has family commitments which need a salary then they will just see their investment going to pay his salary and may not be happy
I was in exactly the same position as you. Almost to the exact age difference and experience.
We made a go of it for 6 months, with no agreement in place, but after that time it became clear things weren’t going to work out. We were a great pair but whereas I wanted to move quickly and take risks he wanted everything to be process driven and documented.
We were great friends, but we were not great business partners. We ended up parting ways and it was the best decision I’ve ever made.
I was the only owner of the business so my decision was technically easier, but emotionally difficult.
Your situation is different enough but when you’re in start-up mode you need everyone to be able to go above and beyond - and make cuts when necessary.
We made a go of it for 6 months, with no agreement in place, but after that time it became clear things weren’t going to work out. We were a great pair but whereas I wanted to move quickly and take risks he wanted everything to be process driven and documented.
We were great friends, but we were not great business partners. We ended up parting ways and it was the best decision I’ve ever made.
I was the only owner of the business so my decision was technically easier, but emotionally difficult.
Your situation is different enough but when you’re in start-up mode you need everyone to be able to go above and beyond - and make cuts when necessary.
Edited by nite_narc on Thursday 21st March 08:29
I was in exactly the same position as you. Almost to the exact age difference and experience.
We made a go of it for 6 months, with no agreement in place, but after that time it became clear things weren’t going to work out. We were a great pair but whereas I wanted to move quickly and take risks he wanted everything to be process driven and documented.
We were great friends, but we were not great business partners. We ended up parting ways and it was the best decision I’ve ever made.
I was the only owner of the business so my decision was technically easier, but emotionally difficult.
Your situation is different enough but when you’re in start-up mode you need everyone to be able to go above and beyond - and make cuts when necessary.
We made a go of it for 6 months, with no agreement in place, but after that time it became clear things weren’t going to work out. We were a great pair but whereas I wanted to move quickly and take risks he wanted everything to be process driven and documented.
We were great friends, but we were not great business partners. We ended up parting ways and it was the best decision I’ve ever made.
I was the only owner of the business so my decision was technically easier, but emotionally difficult.
Your situation is different enough but when you’re in start-up mode you need everyone to be able to go above and beyond - and make cuts when necessary.
Edited by nite_narc on Thursday 21st March 08:38
Some good advice already given. I have direct (and numerous) experiences identical to you and upon which I'm happy to hopefully add some more food for though for you.
I really wouldn't worry about the age gap. 45 is not 'old' by any stretch of the imagination but old enough to have acquired experience and a level of reason that can act as a good balance to youthful exuberance and inexperience. 45 to 55 is, IMO, the golden age for business people; still enough ahead for the required drive and ambition, enough energy too but with enough behind you to know what's what. My business partner is 16 years older than me. Has worked out absolutely fine.
Shares.
Ideas, time spent, contacts and networks, experience and everything else are all important things. However, none of these can be used to pay suppliers or wages.
When you strip everything away, business is about risk and money.
If your start up costs are £100k and you each put in £50k - or secure £50k personally, then 50-50 it is. But if he's drawing a salary, the risk to him is less so it's right that he gets less shares proportionally. So if that salary is £25k then his risk is half as much as yours. In this case, you'd be looking at 75/25 in your favour.
There's many ways to skin a cat but I have found it best not to over-think it and keep the simple risk/money premise and weight the shares accordingly.
I own 25% of my company, despite my partner not doing any work (or very little) in it. I am the one with the skills, the reputation in the market and he would not argue with me being seen 'as the business'. But it was his money that set it up and his financial commitment that is used to support it as we go forward. I'm quite happy with that arrangement and it is exactly how it should be.
I really wouldn't worry about the age gap. 45 is not 'old' by any stretch of the imagination but old enough to have acquired experience and a level of reason that can act as a good balance to youthful exuberance and inexperience. 45 to 55 is, IMO, the golden age for business people; still enough ahead for the required drive and ambition, enough energy too but with enough behind you to know what's what. My business partner is 16 years older than me. Has worked out absolutely fine.
Shares.
Ideas, time spent, contacts and networks, experience and everything else are all important things. However, none of these can be used to pay suppliers or wages.
When you strip everything away, business is about risk and money.
If your start up costs are £100k and you each put in £50k - or secure £50k personally, then 50-50 it is. But if he's drawing a salary, the risk to him is less so it's right that he gets less shares proportionally. So if that salary is £25k then his risk is half as much as yours. In this case, you'd be looking at 75/25 in your favour.
There's many ways to skin a cat but I have found it best not to over-think it and keep the simple risk/money premise and weight the shares accordingly.
I own 25% of my company, despite my partner not doing any work (or very little) in it. I am the one with the skills, the reputation in the market and he would not argue with me being seen 'as the business'. But it was his money that set it up and his financial commitment that is used to support it as we go forward. I'm quite happy with that arrangement and it is exactly how it should be.
I would say that it doesn't sound right for his salary to be higher than yours, regardless of personal situations. If it's an even partnership, then it should be even pay.
If you want to be recompensed with additional shares, I am afraid there is simply no way to calculate that, and an accountant would need much more information to come up with a guestimate, but you are better off just doing it on gut feel, once you know whether you are expecting to sell the company in a few years, whether you will pay each other through dividends, etc. As everyone has said, this will need to be covered in your Shareholders Agreement, which you will need a lawyer to draft.
If you want to be recompensed with additional shares, I am afraid there is simply no way to calculate that, and an accountant would need much more information to come up with a guestimate, but you are better off just doing it on gut feel, once you know whether you are expecting to sell the company in a few years, whether you will pay each other through dividends, etc. As everyone has said, this will need to be covered in your Shareholders Agreement, which you will need a lawyer to draft.
StevieBee said:
I own 25% of my company, despite my partner not doing any work (or very little) in it. I am the one with the skills, the reputation in the market and he would not argue with me being seen 'as the business'. But it was his money that set it up and his financial commitment that is used to support it as we go forward. I'm quite happy with that arrangement and it is exactly how it should be.
Hmm, not sure I follow this approach. I'm sure it's much more than just money your business partner brings, however I'd be asking myself, if I brought in an investor or lender, would I give them the majority of my business in return for nothing more than funding? I wouldn't. To me it's not quite so simple as looking at who's taken the biggest financial risk and apportioning equity on that basis. The money advanced by the financier will amount to nothing without the ideas, skills and efforts of the people driving the business. The person driving is also taking a risk, except with their time and reputation rather than money. I value both of these things as highly as money when looking at the risk I'm taking with a new venture.
Also, in your case, 75% to the other party can be a really bad idea, as absent provisions in a shareholder agreement they have the magic number to pass members' special resolutions, to do things such as change the articles.
OP, the I would sit down with your business partner and between you form a very open and frank view on what you want from the business over the next 3 to 5 years (as individuals what earnings are needed month to month, is income needed from divis or can it be PAYE, most importantly, what is the aim for the new venture? Growth into something big in its own right? Sale to competitor/aligned partner? JV?). If you don't both know and agree WHY you're starting the venture, you can't hope to stay on the same page.
Once you know whether you have enough common ground, you can formalise the relationship (might be as equity holders, might be as employer/employee) and protect yourself with professionally written shareholders agreements, articles and employment contracts.
Shareholder disputes in quasi partnerships are ultra expensive and complex. Often in SME land the cost of the dispute can outweigh the value of the business and by the time the dust settles there is no business. Better to get the lines drawn up now so it doesn't cost 10x as much later.
janesmith1950 said:
StevieBee said:
I own 25% of my company, despite my partner not doing any work (or very little) in it. I am the one with the skills, the reputation in the market and he would not argue with me being seen 'as the business'. But it was his money that set it up and his financial commitment that is used to support it as we go forward. I'm quite happy with that arrangement and it is exactly how it should be.
Hmm, not sure I follow this approach. I'm sure it's much more than just money your business partner brings, however I'd be asking myself, if I brought in an investor or lender, would I give them the majority of my business in return for nothing more than funding? I wouldn't. To me it's not quite so simple as looking at who's taken the biggest financial risk and apportioning equity on that basis. The money advanced by the financier will amount to nothing without the ideas, skills and efforts of the people driving the business. The person driving is also taking a risk, except with their time and reputation rather than money. I value both of these things as highly as money when looking at the risk I'm taking with a new venture.
Also, in your case, 75% to the other party can be a really bad idea, as absent provisions in a shareholder agreement they have the magic number to pass members' special resolutions, to do things such as change the articles.
An idea is worthless until it reaches the point at which it generates cash and to get to that point, it needs investment of money and money is on the whole, the only tangible factor upon which the allocation of risk, and thus equity, can apply.
I too value my time, reputation and creative integrity but unfortunately, banks and investors do not. They couldn't give a monkeys. Their only (or primary) interest is the bottom line.
You only have to watch Dragon's Den to see this in play. Almost every pitch suffers because those who pitch over-value their inputs and over value the business and thus their expectations in terms in investment : equity ratio is completely out of kilter.
Look at it like this. Say you've spent three years developing an idea for a business, working evenings and weekends on it but spending no meaningful money on it. You approach me for investment and I invest £100k to get the thing up and running and then in six months it goes bust....what have you lost compared to what I have lost? Conversely, that £100k investment could lead to a very viable business from which you draw a healthy salary and dividends. You've invested your time to create a healthy business at very little personal risk. An it's not like you'd have no equity. So if you had 25% and in five years time the company is sold for £1m, you'd get £250k. Add to that the dividends and salary you've earned along the way, you will have done very well - for near zero financial risk.
Of course there's many scenarios of investment and exceptions to this common rule but the basic economic principles of risk/reward/money tends to hold true.
You can keep justifying your poor deal with your investor all you like. 
You would note even the Dragons of the Den rarely dare to venture beyond the halfway point of ownership.
One of the key things you've missed from the equation is motivation. Entrepreneurs are generally motivated by money and reward for success. They are often narcessistic. Investors know that if they take away too much turkey from the entrepreneur, the enthusiasm drains away and it has a greater chance of falling flat.
As wiser men than I once said, better to have 10% of something valuable than 100% of f
k all!
You would note even the Dragons of the Den rarely dare to venture beyond the halfway point of ownership.
One of the key things you've missed from the equation is motivation. Entrepreneurs are generally motivated by money and reward for success. They are often narcessistic. Investors know that if they take away too much turkey from the entrepreneur, the enthusiasm drains away and it has a greater chance of falling flat.
As wiser men than I once said, better to have 10% of something valuable than 100% of f
k all!LooneyTunes said:
As has been commented, the shareholder agreement is really important here.
Consider too things such as:
1) Future share issuances (you don’t necessarily only get one bite of the cherry when it comes to determining how many shares are in issue and/or who owns them but you need to think up front about mechanisms);
2) Multiple share classes, with differing restrictions. For example, you,could both be 50/50 on the Ords, but have an A class share with sale restrictions, retention criteria, and good/bad leaver provisions - e.g. either of you leaving within x years forfeit the A shares;
3) Whether the business is likely to grow and require more senior personnel/imvestment, and what these people would need;
4) How one or both of you would exit, for example can he sell to anyone he pleases? You probably don’t want to leave things that permissive.
Getting this sort of thing right is really tough and I’ve seen companies constrained/hit issues by the early choices the founder(s) make, both by being too generous and too stingy with equity distribution. It sometimes feels easy to split down the middle, but that’s not necessarily the equitable way to do equity over the long term.
Lastly, take a long hard look at the other chap. Is he *really* your partner long term, or is it a marriage of convenience that might work for a while. Deep down you probably know the answer to this already, so base your thinking around that.
This tips are really useful and have a strong economic backgroundConsider too things such as:
1) Future share issuances (you don’t necessarily only get one bite of the cherry when it comes to determining how many shares are in issue and/or who owns them but you need to think up front about mechanisms);
2) Multiple share classes, with differing restrictions. For example, you,could both be 50/50 on the Ords, but have an A class share with sale restrictions, retention criteria, and good/bad leaver provisions - e.g. either of you leaving within x years forfeit the A shares;
3) Whether the business is likely to grow and require more senior personnel/imvestment, and what these people would need;
4) How one or both of you would exit, for example can he sell to anyone he pleases? You probably don’t want to leave things that permissive.
Getting this sort of thing right is really tough and I’ve seen companies constrained/hit issues by the early choices the founder(s) make, both by being too generous and too stingy with equity distribution. It sometimes feels easy to split down the middle, but that’s not necessarily the equitable way to do equity over the long term.
Lastly, take a long hard look at the other chap. Is he *really* your partner long term, or is it a marriage of convenience that might work for a while. Deep down you probably know the answer to this already, so base your thinking around that.
I agree with everything and recommend you to follow them
I'd be a bit wary of alphabet shares in this scenario, as it sounds like they might be a symptom of an underlying problem rather than the solution to it. Alphabets add complication to the structure of a business and you might have to explain your need for them if seeking investment or new business partners later down the line. Simple is often best, particularly in the early stages of a business' life.
Ultimately, if one side feels there is inequality in the distribution of profit the relationship is doomed to failure.
Ultimately, if one side feels there is inequality in the distribution of profit the relationship is doomed to failure.
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