Dividing equity among founders

Discussion in 'Growing and Managing a Business' started by bjenkins24, Aug 11, 2011.

  1. bjenkins24

    bjenkins24
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    Hi I'm new to the forum, but I'm excited to get involved and to learn from all of you. I'm looking for as much outside advice as I can get for my current problem. I started a business for in-home tutoring in my location. The company requires very little overhead.

    The first tutor in the company is a co-founder. We both agreed in the beginning that we would start this business together. With that understanding he invested around 70 hours and about $600 in the last two years in the company with little return other than people to tutor.

    From the beginning I never thought the company would be 50/50 split, and I thought he understood that as well. Almost everything in the business is done online. He has absolutely no computer skills, and has done very little in the business other than interviewing candidates. He also paid for the layout of the website, an investment of $300.

    I have re-coded the website myself many times including on and off page SEO. I have taught myself HTML/CSS, SEO, MYSQL, PHP, JavaScript, and Jquery so I can effectively make a website that sells. I have built a complex web application to keep track of payments, leads, students, and teachers.

    I have invested hundreds of hours in learning and writing successful marketing campaigns including adwords, on page sales letters, and direct mail. I am the one that potential students call and set their lessons up with. I answer the phones and manage the teachers. I write/sign the checks. Just upkeep of the business takes a couple hours a day, not to mention all the work that needs to be done to make it better. Some days I will wake up at 3:00 am to get as much done as possible. I have put in 12+ hour days more than once. I also teach but only about 15 hours a week. I am cutting back on hours as the business grows.

    The business is currently a sole proprietorship so I own 100% of it. We were under the understanding that once the business started to make more serious money, he would come in as an owner as well. He has definitely been there along the way as an advisor. We would often talk about where the business is going, and what steps we need to take to get there. The thing is I was always the one to implement those steps.

    The way the business works is that we find students for tutors in our local area, and then we take a cut of each lesson. To date I have received 100% of that cut, with the exception of the cut from my partner’s students. When we began, I was taking a very small cut from his students. About 6 months ago he asked if I would stop taking the cut. I agreed. Not taking that cut amounts to about $1000 a month. I thought that that would be good payment for the work he did and the work he continues to do.

    Here’s where it gets sticky. We have finally started to talk about the split. We obviously should have discussed this sooner but we didn’t. He wants to stop teaching most of his students and work full time on the business. I originally offered him 10% which I thought was generous considering the work he has done. He was under that impression that it would eventually be 50/50. I told him I appreciate the work he’s done, and he’s a good friend but that that was not fair at all. He got a little angry, agreed that I did more work and said he would take a third. The problem is he did not do a third of the work. I put in most likely over 10,000 hours and he put in around 70. Other than a few small investments, I have spent all the money out of my pocket. Admittedly that is not a lot. I have probably spent around $3000 on the business from the beginning. He claims that he wanted to work, but I didn’t give him anything to do. He says that I took over completely, and because of this he deserves more. Yes I did take over completely because he had no way to accomplish what needed to get done. I couldn’t ask him to optimize the site for Google when he knew absolutely nothing about SEO and building websites.

    That is the other problem, skill sets. He has very few that will help the business. Again it is mainly online, and he has next to no computer skills. In the near future we are looking to expand into other areas. He would be great for doing all the interviewing, which would definitely be a full time job. The issue is in a few months I should have enough money where I could hire someone to do that for salary, or by hour, which would be a lot less than a huge equity in the company.

    He has said that he is willing to work for very little pay to get the business going even faster. I feel like he deserves 5% of the company because he was there with me from the beginning and I promised him a cut. Anything beyond 5% seems like an investment from me for his future unpaid work that will help the company progress. I want to be fair, and ethical. I want to do what’s right. He’s mad and wants his share. In our conversation I eventually offered 20% because I felt bad, and also because he would promise to work in the coming years. He hated only having 20%. Now that I have had some time to think about it I think 5% is fairer. Am I being greedy? What do you think? Admittedly the company wouldn’t exist if he wasn’t the first teacher. It was created on a whim, and he helped me get here. But the time and money invested is astronomically different.

    I don’t know what to do. He is on vacation until the end of the month, so I have a few weeks to think about it. Sadly though the more I think the less he gets. I feel horrible for having promised him a cut. Because he thought we were equal partners he hasn’t been pursuing other work at all. Please, any suggestions at all would be extremely helpful!

    Thanks in advance,

    Brian
     
  2. GamingOn

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    Talk to a lawyer because he might sue you Brian!

    Tell him 25% is fair if it's lower then that it's kinda mean. Good advice here to get a lawyer because then you will not have to worry just say you never agreed now you must agree. I think 25% for half of the investment is something to consider though. I read your post. You are being greedy 20% is fair 20-25% for intial investment what you learned can be used to do other things it's not his fault you learned extra stuff without asking him to do the same.
     
  3. ArcSine

    ArcSine
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    Your first two points above are key. From a purely economics standpoint, the percentage share someone receives as a co-owner should be based on two things: (1) The value of contributions made to date (whether cash, non-cash assets, intangibles such as a pre-existing customer base or valuable contacts, or personal skill and services; and (2) the value of such contributions to be made henceforth. As you put it, there's an astronomical diff between the two of you for both (1) and (2).

    Given that, then, you might ask him to analytically and objectively justify his requested percentage. He's not allowed to use subjective arguments involving phrases such as "old friends" or "it's only fair"....he must offer a rigorous justification of his number based solely on hard economic concepts.

    He won't be able to make a black-and-white case for his percentage, but this exercise might be the cold splash of reality that makes him soften his position.

    The second point, that of his not chasing after other work because of his expectations, is a different matter. How much of his erroneous expectation is attributable to his lack of realism, or to statements you may have made there were potentially misleading (albeit unintentionally), or to simple misunderstanding and miscommunication, only the two of you know. But to whatever degree you feel a burden for this, one possible compromise is to allow him a larger-than-fair percentage for some defined time frame, enough to allow him to make up for lost time regarding other income sources. The size of this 'extra' percentage, and the length of the time frame, depends of course on the details involved.

    With respect to that final point, that's probably a factor in most successful partnerships....I'm sure that at some point along the way, both Mr Smith and Mr Wesson thought to themselves, "Boy, in hindsight I could-a hired someone to do what that partner of mine does every day, an' fer a lot less than half the pie!" And your analysis of the question is spot-on: In trying to set a value for someone's contribution of services to a venture, it's instructive to consider the market's going rate for similar services and skills.

    Still, it's likely that S&W never would have become what it has, had either partner been merely an employee of the other. I won't abandon the "market-rate" analysis of the last paragraph, and in very many cases I'm sure that it's the best approach. But I acknowledge that there exist cases (S&W, e.g.) where there's some fuzzy hard-to-pin-down intangible arising from the chemistry of the right two people, which makes the whole more than the simple sum of the parts.

    So give a critical look at the situation and see if your instincts are telling you whether it's a matter of....(a) the company would evolve to the same level of success whether you kept the partner or had his work performed by a hired hand; or (b) there might exist some positive chemistry which would help drive the growth of the firm to greater heights that what you'd likely achieve with a hired substitute.

    It's not an easy spot you're in, and I sympathize. Best of luck with it.
     
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  4. bjenkins24

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    Thank you so much for the thoughtful replies. They will definitely help me make the best decision. Currently I am working on a list of how much we have individually invested in the business as well as the time put into it. Hopefully by putting it on paper he will see that the % he is asking for is not fair. I also feel that what ArcSine said about S&W has some merit here as well. Perhaps a lot of the value is in the chemistry of the partnership. I think I will go ahead and offer 10% which I feel is more than generous with a vested extra 15%. Meaning if he works underpaid for a certain period of time he can work up to 25% total. I know he won't like the idea, but I think it's more than fair and anything more than that would hurt the business. If there are any more suggestions I am still very open to hearing what others think!
     
  5. James Greg

    James Greg
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    25% is fair enough but apart from that reading your post I think the lust of money has now changed your feelings. I won't say you are being greedy but as you had not thought this situation would arise, you had dreamed for the company to grow but had not expected it consciously in the beginning or this percentage thing would have been decided a long time before. Your friend did lay the foundation of your business and putting your work on paper surely will help him understand better.
     
  6. Fergal

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    Welcome to Business Advice Forum Brian and sorry to hear about the difficult situation that you are in. ArcSine has given you some excellent advice and there is not much that I can add to it.

    The point that ArcSine makes relating to chemistry is a very interesting one. You might want to give some thought to how motivated your co-founder is and how driven he is to moving the business forward. Not all contributions are tangible and he may have contributed more to the business than what you have given him credit for. Ideas, suggestions and advice are intangible yet they are invaluable nonetheless.

    Try to also consider the business from his point of view and think about what will happen if you both decide to go your separate ways. How successful would he be, if he hired a web designer and an SEO firm and then set up in competition with you?

    The above is not to suggest that you are wrong in any way or that you are looking for too much, just really different ways that you might want to think about it.

    If you both decide to stay in business together, ensure that everything you agree is documented and signed and that you are both happy and committed to the new arrangement. It would obviously be vital to the business success that you are both committed to the business and motivated to move it forward.

    Good luck with it all and please do keep us updated.
     

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