Salaries to Partners in a Partnership
It is helpful for the company to know that two main processes are involved in compensating a new business partner. The key is to achieve a balance between these two essential aspects. First, it will need to be proven that the revenue from the company is distributed evenly among all of the partners. Second, the company has to certify that it creates enough profit in order to meet its expected long-term goals.
For most companies, usually, compensation consists of a salary as well as a bonus. For business partners, bonuses can be awarded in two ways: they can be a percentage of the collected receivables or a collection of the gross income. Now, there are multiple factors to consider when weighing company compensation. Companies and their business partners must decide:
- The amount of equity in the company that will be given to the new partner.
- The fair and just level of compensation for the new partner and if the payment for current partners needs to be revisited.
- If the new business partner will be held responsible for company liabilities or not.
- The amount of equity in the company that the new partner will receive.
- The exit strategy for the new partner, including a termination clause and a buy/sell agreement
- The new partner’s buy-in price to join the company and when and how it should be paid (there are several options here, including up-front, through installments, or through salary reduction.)
- If the departing partner should be paid a certain amount.
- If a noncompete clause should be placed in the contract of the business partner who is leaving.
Partnership Equities and Liabilities
Equity is a concept that can prove difficult to pin down when a partner buys into a business since it holds different importance for different parties. Some partners value equity very highly because they see it as a way to have some control over the business. Other partners do not concern themselves with equity and focus on other things.
One of the reasons for this conjecture and uncertainty is that an equity stake that is considered “minority” is not worth much until the company is sold. Therefore, if a business is attempting to bring in a new partner and attract them with the prospect of a minority equity stake, they might not have much success. At the same time, sometimes, providing a company partner with even a minority equity stake is enough to make them feel as though they are a part of the business. When partners feel as though they have a beneficial interest in the company, they care more about the business’s welfare and will usually work harder for the company.
You may be curious about how liabilities function in situations where a partner buys into the business. Prior to a new partner buying in, the existing partners are usually expected to be already liable for some of the business’s debts. Therefore, before the new partner buys in, it should be made clear whether or not the new business partner will also be responsible for a portion of the company’s liabilities. This is an important matter that should be discussed, returning to our theme of clear communication, and its inherent value in the business world.
How is partnership buy-in calculated?
A buy-in price should be set if the choice is made to provide the incoming partner business equity. Commonly, existing partners desire a relatively high buy-in price for the incoming partner since this can help to increase the company’s cash reserves and be set aside to pay the outgoing partner or partners. However, this does not always occur because some partners know that a low buy-in price allows for there to be a low buy-out price. In addition, for some partners, the ability to change things more easily if the new partner does not work out supersedes the idea of adding to cash reserves.
The value of any business can be figured out by adding accounts receivable, assets, and goodwill together and multiplying them by the appropriate figure.
How does a new business partner pay for equity? A company partner who has just joined the business can pay this off in a variety of ways. One way is through salary reduction: the new partner usually accepts a salary reduction that lasts from 3-8 years. Another method for the new partner to pay their share is through vesting, in which the individual purchases equity over time. Some businesses prefer for their partners to use a combination of
Partnership Exit Strategies
One of the most important tasks to complete before a new partner joins the ranks is deciding upon exit strategies. Usually, exit strategies consist of a buyback of a partner’s business equity and termination of their employment. However, in the case of professional partnerships, the exit strategy and loss of one’s license implies terminating the partnership, too.
Typically included in the buy/sell agreement, what is known as a “shotgun clause” helps to deal with disputes among partners. If a disagreement occurs, the shotgun clause allows that the partnership is terminated immediately, through one partner offering to buy out the other. The other business partner is able to accept the offer of a buy-out or turn around and buy out the other partner for the exact figure.
It is also important to be familiar with what is known as a buy/sell agreement. A buy/sell agreement focuses on events that will create a buyback, such as an employee’s disability, death, or termination. Although unfortunate, it is essential to have these events covered and the terms specified before something happens. For example, if one partner were to pass away, a buy/sell agreement can dictate that the surviving partners are able to buy back equity from the deceased partner’s estate. Depending on the circumstances and the specific agreement, the agreement could also allow the partner’s family to keep their company share. The point here is that the business and its partners will be covered and ready for anything.
Company Goals and Expectations
When a company really begins to produce revenue and thrive, it is usually because the partners are all focused on similar goals, communicating with each other, and looking toward the future. While diverse partners can complement each other’s talents and skills in helpful ways, it usually helps if business partners have similar goals for the company. There is sometimes not enough clear communication, direct questions, and listening in today’s business world. The most successful companies are built on a collective sense of values, goals, and ambitions.
Many find that a marriage is an apt metaphor for a business partnership. Still, while marriages usually rely on a courtship phase and an engagement, many business partners leap too quickly into an uncertain financial future alongside partners they are not truly familiar with yet. We all know that marriages do not end up well when romantic partners’ goals and desires differ too drastically, and it is the same with business unions.
When business partners’ objectives and ideas do not line up, it can cause a problem. We are not saying that business owners must mimic each other, be carbon copies of each other, or even read the same newspapers, but they should share common goals. For example, if a business owner’s goal is to completely dominate the market and even become a household name, he or she is set on staying with the business for the long haul. However, suppose that a business partner finds out that his or her partner only wants to run the company for two years before selling it and heading out traveling with the family. What we have is a significant divergence of goals. Finding this out before the business partnership is formed is not a big deal, but when these truths are revealed too later, it can lead to problems with chemistry and even earning profits.
Here are a few questions that might help prospective business partners decide if they are on the same page and in good shape to head into business together.
- Have you been involved in any type of business partnership before, or is this your first time?
- What do you see as the motivating force behind your business career?
- Would you consider yourself a risk-taker?
- How would you say you define personal success? How would you define success for the business?
- How do you think employees should be fairly compensated?
- How would you define business failure? How would you describe personal loss? Overall, what can you learn from failure?
- What is the amount of time, on average, that you are able to invest in this business? Why?
- What are your goals for the business? What are your personal goals?
- Where would you like to see the business in one year, five years, and ten years?
These questions hopefully will provide the start to some in-depth thought and reflection and some helpful and constructive dialogue with your partner. Remember, instead of jumping into a business partnership without any preparation, take the time to ask yourself and your prospective partners some questions. Then, proceed confidently but carefully, conduct your research, communicate, and be honest with your colleagues and yourself. If you are able to do these things, you will have a long, successful career ahead of you.
Contact a Legal Professional for Questions About Buying Into an Existing Business as a Partner
Please contact our attorney for legal questions about buying into an existing business. Our California business lawyers are skilled, licensed professionals who can provide advice and counsel to existing or prospective partners. With our help, you will be ready to form a new, promising business partnership and achieve greater success. Good luck in all of your business pursuits.
