I know we need income distribution rules in writing. What does the writing say?

September 27, 2007 5:32 PM

How to divide up a company amongst 3 people when 2 people will be doing most of the work for the first 6-12 months.

A small consulting firm, built from scratch. We've had almost no expenses thus far and are about to land our first client. Everyone is fine with 1/3 ownership and we all want all 3 on board, but partner C will be able to do considerably less work over the next year or so due to a full-time gig he's committed to during that time.

I know we solve part of this by how we distribute income - i.e., we track hours put into project and pay out accordingly. Problem is, we also want to invest as much into the company as possible, because expenses are on the near horizon. So if we land a 10,000 project and the work is divided 45-45-10 amongst A, B, & C, but A & B want to invest 2000 of their respective 4500 into the company, how are the 1/3 splits best maintained? Is it customary for C to match that contribution out of pocket, for example, or do we need to break it down to represent contributions more accurately?

posted by andifsohow to work & money (10 comments total)

Lawyer up. Do it now.
posted by The World Famous at 5:33 PM on September 27, 2007

I agree. You think you don't need a lawyer, but you do.

Someday, you will be extremely pleased you sat down with a professional and clarified all of this on paper. It will keep the two workers from muttering cranky things at 11 PM about how the third person didn't do jack, and the third person from feeling hurt that his initial building-the-company effort isn't being recognized, and will generally help the three of you to remain pals as opposed to hating each other a lot.
posted by thehmsbeagle at 5:37 PM on September 27, 2007

ax the third person, get the others to increase their contributions
posted by Salvatorparadise at 6:15 PM on September 27, 2007

I think you should dispense with the idea that 1/3 ownership is desirable. In a service partnership, equal ownership only really makes sense if all the partners are contributing the same amount of services.

You can still provide for equal control (i.e. equal say in the partnership's business decisions), but that might not even be a good idea, since the heavily-invested partners may resent the influence that the light-invested partner has over their money.

Anyway, to keep track of things, you need to conceptually distinguish between the allocation of partnership income and expenses to the partners, the allocation of partnership assets and liabilities to the partners, and the payments/contribution of cash/property to/from the partners.

Each partner's interest in the partnership is represented by a "capital account." The capital account increases when 1) the partner contributes cash or services, or 2) when the partner is allocated partnership income. The account decreases when 1) the partner is paid cash by the partnership, or 2) the partner is allocated partnership expenses.

It sounds like you want to allocate income in proportion to the work done by each partner on the project giving rise to the income, but I don't know what the best way to allocate expenses is. That's something you have to think about.

You also have to think about when and how you'll allow partners to receive payments of partnership cash. There's not a single right way to do this.

I would say you need a lawyer.
posted by Mr. President Dr. Steve Elvis America at 6:53 PM on September 27, 2007 [1 favorite]

Check the title - I know I need it in writing, and I have a lawyer session already lined up. I need to know what sort of solutions usually fit these scenarios so I can use as little of the lawyer's time as possible - one of those "expenses on the near horizon" I alluded to.
posted by andifsohow at 6:53 PM on September 27, 2007

I am in an analogous situation. I am one of 3 people setting up a business. I am contributing money, connections, strategy, ideas, while the others will focus on executing the projects themselves, and we will all work on getting new business, networking, and marketing. The other two want to work in the business full time, while right now I am more interested in setting it up and getting it going. So I am curious to hear the answers, as I also have a lawyer meeting next week.
posted by lsemel at 7:03 PM on September 27, 2007

If you feel that ms. 10% now will be valuable down the road, it would be best not to alienate her early, for the long term viability of the partnership.
posted by Pants! at 7:38 PM on September 27, 2007

Some more ramblings.

As I see it, the difficulty of expenses stems from your income distribution plan.

Obviously some expenses will relate rather directly to a particular project, and these are easy to deal with. Just subtract them from the receipts attributable to that project to determine the net income from the project (which will then be divided among the partners in proportion to the amount of work they did on it).

The harder expenses are those that don't relate to a particular project (like the legal fees you're about to pay). Paying these expenses obviously reduces the value of the partnership, and thus the capital accounts of the partners need to be reduced, but in what proportion I can't tell you.

Also, you need a way to allocate losses. You might lose money on a project (expenses exceed receipts, if any), and these losses need to come out of the partners' capital accounts. Again, I can't tell you what the proper proportion is.

If the partnership borrows, the liabilities (if unsecured, particularly) need to be distributed among the partners in some way so that if the partnership winds down while owing more than its assets will cover, it's clear which partners have to contribute what to pay those debts off. Even if you don't plan on doing any borrowing, you should agree now how liabilities will be allocated.

As for distributions (actual payments of cash from a partner's capital account to the partner), there needs to be some predetermined way for determining when the partnership has sufficient cash to make a payout and the timing of such payouts, and there should probably be some sort of "emergency" provision for a partner who has a positive capital account and needs cash for some reason.

More generally, for when the partnership is doing well, there should probably be an agreement about what percentage of income will be reinvested and what percentage will be distributed. Also, do the partners need an as-guaranteed-as-possible stream of cash in their pocket (assuming the partnership income is there)? Maybe a provision like "50% of net income will be distributed annually, but no less than $50,000 per partner (capital accounts and liquidity allowing)" would be desirable.

You'll also need to decide what will happen if a partner wants out. Can a partner sell his interest to someone else? Can a partner sell his interest to another partner without the third partner's consent?
posted by Mr. President Dr. Steve Elvis America at 8:23 PM on September 27, 2007

Separate the idea between the owners of the company, and the employees of the company. Just because these are the same people doesn't mean the money works the same. It can be easier to conceptualize that way. Owner's get profit through dividends, employees get paid salary. Money from clients goes to the company, which then allocates the money, some of which may be pay to employees.

Realize, however that cutting partner 3 into the business without any investment on her part could certainly cause bad feelings down the road.
posted by garlic at 8:29 PM on September 27, 2007

Why partner up at all? A consulting company generally has minimal assets and little enterprise value; nearly the entire value of the company is the billing capability of its employees. Setting up a shared-ownership structure is going to throw away work effort that could be better spent consulting. Have one person own the corporation with two groups of employees: "partners" with appropriate profit-sharing and full access to the company's books and "staff" with little/no profit-sharing and no book access. Yes, this puts everyone at the mercy of the single owner, but he or she is also at the employees' mercy. If the single owner needs capital, loans can be arranged with the partner-level employees.

I would have disagreed with this advice before I was a partner in a consulting company. It added a lot of drama to my life but destroyed a lot of value through wasted time and money.
posted by backupjesus at 8:53 AM on September 28, 2007