How to split equity fairly in new business venture
Discussion
I am considering starting a new company with a business partner but I am mulling over how best to structure the equity. Would be interested in views.
The new company would offer business/technical services. It is an area I have been interested in for a while. I have what I think are some good ideas to allow a business to scale up over a 5 year period.
I have found a potential business partner who works in this field. He currently runs as a one-man band working with very small clients and he makes around £50k per year. He has always wanted to expand but hasn't done so mainly because he has a slightly risk adverse approach. He is though credible, intelligent and competent.
We have started discussions and I've shared my ideas about how the business would be marketed, and how the sales process should work. These are probably the main weaknesses of the business partner (and is probably what has stopped him from being more successful on his own).
To get started I estimate the business would need an investment of around £200k. This would cover all of the usual stuff like website, office, IT, initial marketing budget etc. Let's assume I would invest £180k as a director's loan. The business partner might be able to input around £20k, also via a director's loan.
After the initial phase to get it up and running, I would be able to commit to around 1 day per week. My time would be spent helping choose the right areas to develop the business. My partner would be working full time in the business - he would be the effective day-to-day "MD". However, as most of the initial capital invested would be my own, I would also ensure in the shareholder agreement I retained control of certain key decisions.
I've considered that in theory I could start a company on my own and retain 100% of the equity and just recruit someone as an employee to run it for me. The downside is that I think it would likely consume much more than the 1 day per week I would like to commit. My objective isn't really financial - I'm looking to get more of the intellectual stimulation from helping the business to grow, without the grind of the day to day responsibilities.
The business partner has a number of existing small clients which bring him around £50k. It would be possible for him to retain the client facing element but outsource most of the activity to a third party, probably at a cost of around £30k per year.
So the initial idea would be business partner retains his current clients (which makes it easier for him if everything goes tits-up). But he outsources much of his current activity to free up time. He can then concentrate on working with me to implement the plan for the new business.
My aim after 5 years would be for all of the director's loans repaid, and the business to be generating net profits in the region of £300-£500k per year. I think this is realistic. I've also discussed and agreed with the business partner that the priority for the company would be to repay the director's loans before paying dividends.
The main problem is how to set it up the financials so it is fair to the business partner and gives him the right incentives, whilst also recognising I am risking of the initial money.
I could in theory pay the business partner a salary, maybe matching his current income and offer him 50% equity. But then he would have a lot of potential upside without risking too much.
Whereas, if I make the equity for example 70/30 in my favour, in 3 years time if it working as I expect it is going to lead to arguments as he will be working for £50k and a much smaller share of any dividends. He will after all be spending much more time running the business than I do.
Sorry that these might sound a collection of random thoughts - I'm trying to get clear in my mind what would work best for the long term as would be seen to be fair. This is because I don't want to take advantage of the business partner in the short term by getting him to agree to a small equity stake if I am just storing up a problem in the future.
So what do you think would be fair and the best way of organising the arrangements so they can hopefully endure for the long term?
The new company would offer business/technical services. It is an area I have been interested in for a while. I have what I think are some good ideas to allow a business to scale up over a 5 year period.
I have found a potential business partner who works in this field. He currently runs as a one-man band working with very small clients and he makes around £50k per year. He has always wanted to expand but hasn't done so mainly because he has a slightly risk adverse approach. He is though credible, intelligent and competent.
We have started discussions and I've shared my ideas about how the business would be marketed, and how the sales process should work. These are probably the main weaknesses of the business partner (and is probably what has stopped him from being more successful on his own).
To get started I estimate the business would need an investment of around £200k. This would cover all of the usual stuff like website, office, IT, initial marketing budget etc. Let's assume I would invest £180k as a director's loan. The business partner might be able to input around £20k, also via a director's loan.
After the initial phase to get it up and running, I would be able to commit to around 1 day per week. My time would be spent helping choose the right areas to develop the business. My partner would be working full time in the business - he would be the effective day-to-day "MD". However, as most of the initial capital invested would be my own, I would also ensure in the shareholder agreement I retained control of certain key decisions.
I've considered that in theory I could start a company on my own and retain 100% of the equity and just recruit someone as an employee to run it for me. The downside is that I think it would likely consume much more than the 1 day per week I would like to commit. My objective isn't really financial - I'm looking to get more of the intellectual stimulation from helping the business to grow, without the grind of the day to day responsibilities.
The business partner has a number of existing small clients which bring him around £50k. It would be possible for him to retain the client facing element but outsource most of the activity to a third party, probably at a cost of around £30k per year.
So the initial idea would be business partner retains his current clients (which makes it easier for him if everything goes tits-up). But he outsources much of his current activity to free up time. He can then concentrate on working with me to implement the plan for the new business.
My aim after 5 years would be for all of the director's loans repaid, and the business to be generating net profits in the region of £300-£500k per year. I think this is realistic. I've also discussed and agreed with the business partner that the priority for the company would be to repay the director's loans before paying dividends.
The main problem is how to set it up the financials so it is fair to the business partner and gives him the right incentives, whilst also recognising I am risking of the initial money.
I could in theory pay the business partner a salary, maybe matching his current income and offer him 50% equity. But then he would have a lot of potential upside without risking too much.
Whereas, if I make the equity for example 70/30 in my favour, in 3 years time if it working as I expect it is going to lead to arguments as he will be working for £50k and a much smaller share of any dividends. He will after all be spending much more time running the business than I do.
Sorry that these might sound a collection of random thoughts - I'm trying to get clear in my mind what would work best for the long term as would be seen to be fair. This is because I don't want to take advantage of the business partner in the short term by getting him to agree to a small equity stake if I am just storing up a problem in the future.
So what do you think would be fair and the best way of organising the arrangements so they can hopefully endure for the long term?
An idea to throw into the pot. Start with say 70/30 as you suggest but then each year end he can buy more of the equity by sacrificing some of his dividends that year i.e. the equity split changes (if targets are hit, so you keep him incentivised) 1 day before dividends are declared.
The initial split would need to be worked out. 1 idea for that split could be:
So he is putting in in year 1 say £20k plus £50k plus a factor of £50k to represent what he might get if he sold the business, say 3 for arguments sake. So he's putting in 170k.
You are putting in 180k plus lets say £500 for 1 day a week = £125k = £305k
That's 65% to 35% split on those packet maths.
The initial split would need to be worked out. 1 idea for that split could be:
So he is putting in in year 1 say £20k plus £50k plus a factor of £50k to represent what he might get if he sold the business, say 3 for arguments sake. So he's putting in 170k.
You are putting in 180k plus lets say £500 for 1 day a week = £125k = £305k
That's 65% to 35% split on those packet maths.
Mr Overheads said:
An idea to throw into the pot. Start with say 70/30 as you suggest but then each year end he can buy more of the equity by sacrificing some of his dividends that year i.e. the equity split changes (if targets are hit, so you keep him incentivised) 1 day before dividends are declared.
The initial split would need to be worked out. 1 idea for that split could be:
So he is putting in in year 1 say £20k plus £50k plus a factor of £50k to represent what he might get if he sold the business, say 3 for arguments sake. So he's putting in 170k.
You are putting in 180k plus lets say £500 for 1 day a week = £125k = £305k
That's 65% to 35% split on those packet maths.
Actually that's quite a neat idea, and I can see something like that might work.The initial split would need to be worked out. 1 idea for that split could be:
So he is putting in in year 1 say £20k plus £50k plus a factor of £50k to represent what he might get if he sold the business, say 3 for arguments sake. So he's putting in 170k.
You are putting in 180k plus lets say £500 for 1 day a week = £125k = £305k
That's 65% to 35% split on those packet maths.
One detail point related to his current business - whilst it makes £50k, that is basically the profit directly from his labour i.e. if he employed someone to do this work, his actual net profit might only be £15-£20k. So maybe the net figure might be the better figure to use as a multiple to value his current business?
EddieSteadyGo said:
DSLiverpool said:
£200k to start a service biz - have you costed that?
Yes. It could be done for less, but would take longer. Moving faster requires more money up front, plus it gives breathing space for allow time for marketing to work. What is he being paid in comparison to his current income?
You could also consider an initial equity stake of 10% (his £20k into the £200k) but an increase in equity as the business achieves agreed numbers in the business plan, maybe up to 25%.
You are taking the risk, not him. And that needs to be recognised in the equity.
You could also consider an initial equity stake of 10% (his £20k into the £200k) but an increase in equity as the business achieves agreed numbers in the business plan, maybe up to 25%.
You are taking the risk, not him. And that needs to be recognised in the equity.
Gassing Station | Business | Top of Page | What's New | My Stuff