Shareholder Agreement Advice

Discussion in 'Growing and Managing a Business' started by Tigger, Jun 13, 2013.

  1. Tigger

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    Jun 13, 2013
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    I am hoping for some business advice about formalizing a business agreement and hopefully some help to clarify some confusions I have.

    My location is in Australia, so all dollar amounts I mention are in Australian dollars.

    I am a software engineer, with 15 years commercial experience. For the past 18 months I have been working with two other parties (three people, in two separate parties), there was an informal arrangement that we would be starting up a new entity together and that we would be equal partners in that entity. It was an arrangement that was never formalized and has since been replaced with a new proposal that is close to being formalized.

    I have been working at a reduced wage, about $40,000 p.a. I am a well rounded system architect, database designer and web application developer... basically I am competent in architecting and building everything from the database to the front end, setting up and manage servers etc. etc. So, it is entirely possible for me to find myself a $100,000+ p.a. wage in the corporate world.

    The other two parties have an existing business... which has been operating for 5 or so years. One party has some skills using Excel and basic skills with Access databases, the other party has basically zero skill with software.

    The industry we work in is the events industry, specifically registration and ticketing... there is a heavy component of software involved, registration websites, onsite ticketing systems, lead tracking systems... all systems are built by me. They barely get involved with testing... yet if anything goes wrong with the system there are very serious consequences, there's no second chance to run an event and leads being captured are potentially worth millions of dollars to exhibitors.

    In simple terms, the proposal being put on the table is this:

    1. The business is valued at about $300,000
    2. We will become equal partners
    3. I will be expected to pay my share of the business value to "buy in"... i.e. $100,000
    4. I am not expected to pay my share up-front, my payment will come in the form of a reduced wage over a period of 36 months (three years)
    5. My ownership of the company will come in the form of vested shares... which will be actualized every 12 months, one third of my share each 12 months, in other words I will own my third of the company after 36 months

    So, without taking GST (goods and services tax) into account, my reduced wage will be about $3,500 per month, where-as the other two parties will be on $6,000 per month.

    In some ways it seems like a fair arrangement... but I am not feeling comfortable for a few reasons.

    Although I value the work of the other two parties, I feel that the worth and potential of my work exceeds theirs. I do understand that things aren't always fair and there has to be some give and take, but in all honesty my work is so very much more complex and mentally taxing AND is the major component for potential growth. For example I am about to begin development of a system that will replace a third party system that cost the business $120,000 last year... obviously there is a cost to my development so it's not quite right to say I will have saved $120,000 p.a.... but it will certainly be at least $80,000 p.a.

    I think that is one of my confusions and questions... even though we might be equal owners of a business is there a need for us all to draw the same income? I think I might feel more comfortable with the proposal if I was drawing a salary that is more commensurate to the complexity and worth of my input.

    Having worked at a reduced salary already for 18 months I wonder why that isn't taken into account when drawing up the agreement now... for example shouldn't the proposal take that into account with perhaps some of my "buy in" already paid off... or perhaps immediate ownership of some shares rather than having to wait yet another 12 months.

    Part of me is thinking I should walk away from this venture and head into the corporate world again where I can draw on the order of triple the salary.

    Oh, I'm in my late thirties... with little savings and no investments of any worth... which obviously impacts my thinking somewhat. I am renting, with my girlfriend... which I can afford on the reduced salary, but if something happened and I had to survive on my own it would be difficult.

    If you have any advice about any aspect I would appreciate it so much, I'm really a bit stuck within myself... I don't want to throw away an opportunity, but I don't want to make an obvious mistake either!
  2. ArcSine

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    Jun 2, 2010
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    Agreeing with you on both counts. In such arrangements, whereby the partners are also 9-to-5ers in the biz, I prefer that the profit-split agreement properly recognizes that each partner is wearing two hats, and each separate hat should be compensated appropriately. That usually takes shape as a two-tiered arrangement with each partner first getting a salary, and then the remaining post-salary net profit (or loss) is divvied up. The salary component should reflect any differences in the amount of work (either regarding total hours, or relative value, or both) performed by the partners. Hence the partner working twice as many hours, or performing a more difficult or valuable job, gets the higher salary. The post-salary net should be allocated based on the partners' relative "investor" factors, such as amount of capital contributed, amount of risk assumed, or value of certain intangible assets (key customer contacts, e.g.) brought to the table.

    What you've described doesn't sound equitable. Sounds like your contribution of expertise outweighs the other guys' by a considerable margin, which difference should indeed be captured in the salary levels. Also, if you "contributed" a portion of your salary for the last year and a half, you should be entitled to something in return.

    Couple of questions that might put it into a clarifying light: If you were to go solo with an identical operation, how much would you have to pay, at the going rates, to replace the inputs of the other guys (i.e., hire people to perform those same tasks?) How much profit would you then have left in your pocket under this hypothetical arrangement, and how does that compare to the total income you'd expect under the deal proposed by your potential partners?

    Similarly, if the other guys set up an identical operation, except with replacing you with a purely salaried employee, (a) how much would they have to pay this fellow? (b) how much net profit would that leave them? and (c) how does this latter amount compare to what they expect to get under the actual deal proposal on the table?

    I'd bet that answering those questions, even rough back-of-the-cocktail-napkin-ish, would suggest that the deal, as currently proposed, is better for them while not such a hot ticket for you.
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  3. Tigger

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    Jun 13, 2013
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    Thank you so much Arcsine, your reply has moved my thinking forward a lot! Very much appreciated :)

    After writing my first post here I Googled a lawyer that is close by and inquired about the possibility of sitting down for an hour or so to discuss the proposed agreement and options I have. In my heart of hearts I now think I will not so much be discussing how to forge a workable agreement as much as how to deal with existing intellectual property with the aim for me to leave the venture behind. But, I have not given up yet.

    Having a background in physics I love a good thought experiment... your questions / thought experiments lead me to the following thoughts:

    If I was to be replaced by a software architect / developer with similar skills on a purely salary basis:

    - That would cost them on the order of $100,000 per year

    - It would also cost them time... because they would be very unlikely to find someone with my IT skills combined with more than 5 years industry experience... hence they would be spending a lot more time working directly with the developer to forge technical requirements and business rules

    - They would have more profit / loss split at the end of each year. Having been given the opportunity to look at the yearly financial report I can see this is about $10,000 profit for the last couple of years. They always make mention of extinguishing franking credits when paying themselves from that profit... not sure what that means

    If I was to go solo:

    - I would have to pay something like $35,000 p.a. for one party and they would not be required full time. The other party I estimate something like $55,000... full time

    - I would not have as many business contacts to begin with

    I am trying to be considerate of the fact that they have an existing clientele and that that has value. I keep reminding myself that I shouldn't simply see things in terms of my relative work value and that there is great value in existing clientele... it has been that thinking that has kept me going... but I do feel in my gut that I am trying to talk myself out of an inequality that is very real.

    Over the past few months while going through the motions of forming a new proposal I have tried to communicate my thoughts about wages and value of work, attempting to make the point that my intrinsic work value is significantly higher. It has always fallen on deaf ears. They have a more traditional view of business and that in small business everyone gets an equal split of everything... regardless of the work input or work value.

    I think I could probably argue the case that the last 18 months of my commitment at a reduced wage should be taken into account... I think they might understand that. But, I really don't hold out much hope that they would welcome the idea that my wage should be higher than theirs.

    A couple of months ago we met to discuss possible ways forward after it became clear the original proposal wouldn't work... the concept of me being employed as a traditional / no-stakeholder employee was brought up during that discussion... and shot down straight away as they said the business simply couldn't afford it.

    My current thinking now after having read your reply and thought things through again at this early hour of 5am in the morning is:

    - Propose that my "buy in" be 50% paid to begin with, since I have already committed myself to the venture for 18 months

    - Propose that upon completion of the software solution that replaces the existing third party solution costing the business $120,000 p.a. that my wage be increased... to what amount I'm not sure yet... but essentially I am proposing here that my wage would then essentially be greater than theirs, but certainly not to the extent that it extinguishes the whole $120,000 p.a. so they would still see a measurable increase in their own profit

    I think I need to start seriously preparing for the real possibility that an agreement can't be reached and how to then deal with existing intellectual property / software. It would be a shame for all the work to be thrown away, hopefully if it comes to the crunch they would see sense in paying me out for the rights to move forward on their own with the software... or perhaps I can contract in my own time at a proper hourly rate to help them out... though I'm concerned about how much spare time I would have if I found myself in a corporate role.

    Thank you again for your thoughts, I am a bit nervous about the next move... maybe some legal advice will help clarify things too, though I suspect there won't be anything new in that.
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