How to structure group consulting business?

June 2, 2007 4:50 AM

How should I structure a growing consulting business, with partners, collaborators, and others that I want to be invested in the growth and success of the business?

I live in Ohio and am growing a consulting business providing new product development services -- design, development and marketing -- to small and large companies.

Right now it's just myself and an engineer (he manages a team of remote software and hardware engineers). He has his own corporation, through which he pays contractors. I myself have not subcontractors (in the past I've managed to get my clients to hire freelancers directly that otherwise I would have had to subcontract).

The engineer and I want to take on more clients and probably consolidate the business under one corporate entity -- and continue to leverage contractors.

My question is this... What's a good model for doing this, where the engineer and I are principals, but where we can also incent some key contractors with a higher level of ownership and/or profit-sharing?

What's the best structure and process of assessing monthly or quarterly *contributions* of non-principals -- and compensating them accordingly? Simply put, I imagine that in addition to the engineer and myself, there will be 1-2 key others that we'd like to extend some degree of ownership to -- so they share in ownership, should the business ever be sold, and also share in greater income security by being part of a group practice. One of these other contributors will be a designer and the other will be a project manager.

posted by pallen123 to work & money (3 comments total)

I've been through this a lot myself, especially around the idea of trying to set up a less conventional, fairer-seeming partnership model. One thing I've learned, though, is that it's really hard to have a structure where people are kind of half-in, half-out--they're not full-time employees, with a salary, benefits, etc., but they're not straight-out freelancers, either.

One key issue--once someone's legally a business partner, it makes it very hard to unspool the relationship later. I'm not even talking about a worst-case scenario, where things get really dramatic--what if one of these folks gets a really attractive job offer somewhere else? If they take another job, you've got to buy them out of their existing ownership share, or face a situation where you're potentially sharing profits from a sale with someone who hasn't work with you in a year. (Not that that's a reason not to try something, but it's just an example of the complexity that can come up.)

If you do want to pursue this, though, one thing you should look at is issuing different classes of stock. While I've thought about the idea extensively, I haven't yet put it into practice, so I can't give you the complete ins-and-outs, but at past businesses we have looked pretty seriously at setting up an "A" class of stock that owns 51% (or more) of the company, and so always retains control, and a "B" class for the remaining stock that's continually split between the rest of the folks you're bringing in. That way, you and your partner could share the A stock between the two of you, and you could eventually bring in 3, 7 or even a couple of dozen folks at the B level without compromising your ability to control the company.

The big caveat, again, is complexity. I forget the details off-hand (and I think they change from state to state), but I'm pretty sure you can't create different classes in the simpler business models like an LLC or LLP--you may have to jump to a C-corp to do that, which involves a _lot_ more paperwork, legal fees, accounting costs, etc. Still, it's something to think about, and it does help put the approach you're talking about into place.
posted by LairBob at 7:46 AM on June 2, 2007

If you did pursue the "two-class" approach, though, you really have to be clear on what it means to give someone the B class stock. When you really look at it, unless your business is already throwing off a _ton_ of cash, revenue-sharing is really kind of a pie-in-the-sky idea. Otherwise, any reasonable profit you could afford to skim off your cash flow should almost certainly be reinvested into the business before you start paying it out to yourself or your partners. (Almost certainly, if there's any bank financing involved, they're going to insist on that.) Revenue sharing is almost always the hallmark of a mature, well-established consulting business, not a nascent one like yours.

In any case, if your business is already doing well, and you want to share some of that profitability with preferred partners, there's a much simpler way to do that--just pay them more. Paying a preferred partner at a bit of a premium, and effectively just sharing more of your internal project margin, is a perfectly acceptable and much more straightforward way of doing what you're talking about.

If you're not planning on offering benefits to your minority partners--which kind of upends the normal model, but is something I've definitely considered along the way--and if they're not decision-making partners, then the benefits start to get a bit more intangible. You could say that they'd participate in running the company, but if they're not majority partners, you could do that informally no matter what. On the other hand, you could basically be promising them "If we sell the business (or a part of the business) you'd get a piece of the action", which is not necessarily a bad thing, but still not a simple thing. You just have to make really, really sure that you'd still want to do that with that person, 3 or 4 years down the line. From personal experience, it's easy to get caught up in the camaraderie of working together with people, and then ignore the more pragmatic possibilities.
posted by LairBob at 9:18 AM on June 2, 2007

(Just to clarify on my point about offering benefits--one additional advantage you _could_ offer, which I've also looked into before but haven't done, is to actually allow your preferred providers to sign onto your corporate benefits, even without being salaried. That's what I meant by "upending the normal model", since the normal model is to hold off on providing benefits to freelancers, part-timers, etc.--basically, no one who isn't a full-time employee. I think there's a lot of potential in saying "I can't offer you a guaranteed salary (or maybe you don't even want it), but I can give you the chance to participate in our benefits plan, and make sure your family's got health insurance, etc." There are complications with that scenario, too, of course, but it definitely seems like it's at least possible.)
posted by LairBob at 3:03 PM on June 2, 2007