How to split business ownership fairly?

December 7, 2009 7:11 AM

How should my business partner and I split the ownership and income of our start up?

A parter (let's call him Bob) and I (let's call me Alice) started a business with no formal agreement regarding ownership. Currently, the business has minimal income and users. We expect this to change very soon.

Alice: Alice created the project in August '08. Alice has spent $1200 out of pocket on expenses.
Bob: Bob joined the project in June '09. Bob has spent $700 out of pocket on expenses, but is fine with spending the next $500 to equal this out.

Bob and Alice have each spent an equal amount of time working on the project each month that they have been working on it. So, Alice has been working on the project for 16 months and Bob has been working on it for 6 months.

What we want to know:

How should we split ownership?
How should we split income? We're interested in splitting the income evenly until we're each making a decent/living wage.

Alice and Bob have a completely amiable relationship. We're both interested in doing what's fair.

posted by anonymous to work & money (16 answers total)

One way of splitting it fairly would be to set aside the 10 months Alice worked on this project alone and let the business generate income and after a pre agreed time take the 'run rate' income and give Alice a bonus of 10 months worth of income over the coming ~3 years. This way you take into account the extra effort put in by Alice but make it fair on Bob to pay it down over 3 years. To make it even fairer you can add a small interest rate over the 3 years.

This idea takes into account your desire to have an even split and equal ownership.
posted by london302 at 7:21 AM on December 7, 2009

You're going to have taxation, liability, etc. issues. You should consult a lawyer with knowledge of the ins and outs of corporate/partnership/etc. structures and have that lawyer explain everything to you. There may come a point at which you each need you own lawyer (not out of animosity, but with an eye toward eliminating conflicts of interest in structuring the business); a good lawyer will tell you about this long before it becomes an immediate necessity.
posted by Inspector.Gadget at 7:21 AM on December 7, 2009

Form an LLC. In the business agreement, spell this out explicitly, in writing, NOW, before income grows and things get sticky. You'll thank yourself later for doing so now.
posted by rachelpapers at 7:27 AM on December 7, 2009

As someone who has owned a small business with a partner, and now just owns the business, please consider the following:

1. Form an LLC. It's cheap and will help in many ways. Get a lawyer or go to Legal Zoom if you have to. Most attorneys can form an LLC very inexpensively.

2. Set out an agreement in writing on what will happen when one of you decides that you don't want to spend an equal amount of time anymore, or any time at all. What happens when one of you essentially abandons the project and the other person continues working?

3. Reconsider whether you even need a partnership. Are you sure you don't want to just bring this person on as a consultant? Assuming you are the person who has been doing this longer, are you sure this new person has the same passion for the project? If they don't, you will both be unhappy.

4. What happens when one of you wants to move to the next level, but the other person is unwilling or unable to put in any more money?

5. Who handles the money? Who is responsible for what? If the project involves selling something, do you need a CPA? Set out as much as possible in writing.

6. An incredibly small minority of partnerships works out. Prepare now for the worst, so that if things don't go as planned, everyone knows what to expect.
posted by 2legit2quit at 7:46 AM on December 7, 2009

Also, to answer your actual question:

1. Consider a 51/49 split so that the project starter retains complete control, but the other person also has significant sway.

2. In all likelihood, there will be no money to pay out for a while. Go ahead and agree on how you want any profits to work out. Will you reinvest in the company until it can sustain itself? Will you guys continue to pay in for operating expenses? Consider a dollar amount you want to reach before you each begin negotiations about the payout structure.

In my old partnership, we agreed to hit $10,000 before we began a conversation about payout. by the time we hit $10,000 he was no longer interested in the project and I had earned most of the money for the business. We agreed then that he should be bought out for $5,000 and I would receive and and all future profits. Had we already had a 50/50 split, it would not have worked out so well for me.
posted by 2legit2quit at 7:50 AM on December 7, 2009 [1 favorite]

Alice: Alice created the project in August '08. Alice has spent $1200 out of pocket on expenses.

Bob: Bob joined the project in June '09. Bob has spent $700 out of pocket on expenses, but is fine with spending the next $500 to equal this out.

That's ridiculous. The value of the company is worth more then it was in August of '08, and it's probably worth more then it was when in June of this year.

You have to value the work that you put in, as well as the dollars. Try to estimate out how many hours each of you put in, value those hours at some figure ($20/hr maybe?) and then divide up the company based on the hours + cash.

I don't think it's fair that someone who came in a year after you started should get half the company.

Anyway, this is why formal agreements are good before you start.
posted by delmoi at 7:52 AM on December 7, 2009

I don't think this question can be answered adequately without understanding the status and prospects of the business at the time Bob joined. If Alice hit a wall on her own, and Bob joining really turned things around, or if Bob added tremendous value with his ideas, contacts or other expertise, then it seems something similar to 50/50 (probably favoring Alice slightly) would be fair from both an income and equity perspective. In contrast, if Alice really took the business to a good spot before Bob joined, and there were other potential Bob-like people" out there that Alice could have easily partnered with instead of Bob, then Alice should be entitled to the majority of both income and equity, to the extent Bob is still receiving a fair wage. In the latter, case Alice is really the true founder of the company and could have taken it to success without Bob or with a different Bob.

Likewise, it may be helpful to consider how much out of pocket Alice had incurred at the time Bob joined, though expenses, in this case, should not necessarily be used as a proxy for "value-added," because effort, expertise and creativity are more important factors than providing the incidental amounts of financing described. (Though, if the expenses outlaid were, say, in the tens of thousands of dollars, than that monetary "risk" should be entitled to a substantial equity stake in of itself, irrespective of what the person added).
posted by jameslavelle3 at 7:52 AM on December 7, 2009

Also, read this:

http://ask.metafilter.com/42583/Should-I-bring-someone-on-as-a-business-partner
posted by 2legit2quit at 8:02 AM on December 7, 2009

I think 2legit2quit has a very good point : a start up's success is largely about drive. A person spending an extra 10 months is a big ass deal. A person sticking it out is a big ass deal too. A person involved now could get bored and wonder off easily.

I'd track the actual hours worked and other appropriate factors, so that if anyone quits you can cash out fairly.
posted by jeffburdges at 8:08 AM on December 7, 2009

I don't think it's fair that someone who came in a year after you started should get half the company.

Capitalism does not work like this, mostly. In certain countries, it's not possible to get company shares based on labor! If a partner funds a company, the other partners must match this funding in money to be considered a partner in the company. The system is called "capitalism" because it rewards people who invest money. If it was about how many hours you invested, it would be called "laborism".

And you might be overvaluing the company that Alice built. It's quite possible that Alice was squandering her initial capital until Bob came along.

I would see it like this:

- if there's no real, steady income or sales yet, and Bob brings considerable expertise or contacts that are vital to the company, then he is well entitled to half of the company by putting up another 500 $
- if there's a steady, predictable cash flow and a profitable business model, then you should use a multiplier to see how much the company is worth now. Like: 5x annual profits, or 2x cash flow, although this would seem very high for a company with likely no brand equity and virtually no client portfolio yet.
posted by NekulturnY at 8:24 AM on December 7, 2009

The money is a red herring, given the year of difference. If Bob wants to give Alice $250 to at least get that part out of the equation, though, fine. But it doesn't make them equal because of Alice's 10 extra months of labor.

Also, maybe there's a language/terminology problem here, but you don't split the "income" (revenue) of a company. You probably want to split the profits. That is, you want to pay all the bills and taxes and pad the rainy-day fund and such first, and then split whatever is left.

Also, ownership seldom comes into play in terms of personal income until/unless the firm is sold. It's quite possible and common for a 10% owner to be paid more than a 90% owner in terms of the month-to-month operations. It's only if the firm is sold that the 90% owner realizes the 9x windfall.

Think of Scruffy the Janitor.
posted by rokusan at 8:48 AM on December 7, 2009

However you divide the equity, you should also ensure that it vests (or is restricted) over a period of time. One standard vesting schedule for startups is four years with a one year cliff. (That is, after one year you receive the first 25% of your equity, and the remaining 75% vests monthly over the next three years.) Then it's clear what will happen if one person leaves while the other remains and continues to build the business.

Since you have each put in some time already, you can count that toward any vesting schedule you decide on.

Secondly, for a two-person venture, consider a shotgun clause. This provides a clear and fair way to decide what happens if the two founders no longer want to work together.

Absolutely hire a lawyer to help you with all of the above.

I disagree with NekulturnY. If the business has been going for over a year with less than $2000 of capital, then this is clearly not a capital-intensive industry. The value of the labor either of you has put in is worth far, far more than the tiny cash investments. This isn't a retail or manufacturing business that requires hundreds of thousands of dollars to launch. Sweat equity should be the main consideration.
posted by mbrubeck at 9:27 AM on December 7, 2009

It's very smart of you and Alice to address this issue. There is no set way of defining ownership, liability, profit share. If you can find a branch of the Small Business Administration, the may be offer technical support to help you look at different models of ownership. Absolutely get a lawyer to help you put it all together.
posted by theora55 at 12:57 PM on December 7, 2009

Capitalism does not work like this, mostly. In certain countries, it's not possible to get company shares based on labor! If a partner funds a company, the other partners must match this funding in money to be considered a partner in the company. The system is called "capitalism" because it rewards people who invest money. If it was about how many hours you invested, it would be called "laborism".

Labor and money are interchangeable. That's kind of the whole point.
posted by delmoi at 6:17 AM on December 9, 2009

Labor and money are interchangeable. That's kind of the whole point.

It's not because they are exchangeable that they are interchangeable. As in: sometimes using money is not optional, or interchangeable at all, but mandatory. As I said, in some European countries, you cannot receive equity or shares based on hours worked for a certain company.

I'm not a Marxist, but it is quite clear that the capitalist system shows traces of ideology, and that legal systems based on capitalism will reflect this ideology. So: sometimes the law wants to give certain legal advantages to the people with real, actual, liquid money. The example I spoke of is one of these instances.
posted by NekulturnY at 8:25 AM on December 10, 2009

certain legal advantages to the people with real, actual, liquid money

Oh, and forgot to add: the idea of capital and equity is as much about the protection of creditors as it is for the benefit of the equity partners. You can execute a bill against equity, but not against labor.
posted by NekulturnY at 11:19 AM on December 10, 2009