Started a business with 4 partners, not seeing eye to eye- which option makes sense?

Discussion in 'Starting a Business' started by halseyb007, Aug 5, 2012.

  1. halseyb007

    halseyb007
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    Hi all- 4 people came together to start up a web based business that has very low overhead and a long term upside potential to fully replace the household income of each partner. The 4 partners are made up of 2 married couples. Two of the partners (married, one household) choose to quit their jobs to help push the business along quicker. The other partners were not part of that decision, but thought it was a good idea at the time. At the time the 2 partners quit their jobs (a few months apart) the business was making no money and there was never any formal conversation about how to manage the money. As a result, the other partners (married in one household but still with other jobs) offered to pay for the operating expenses like server costs, etc. Things went along just fine for about a year and then the revenue potential was starting to be realized. The two partners how had quit their jobs began feeling an inequity in that their 25% of the company wasn't enough. They worked all day every day and earned nothing for it. The other two partners had typical 8-5 jobs and worked on the business after work hours and on the weekends. The 2 partners who had quit their jobs initially asked for a deferred repayment of their burn rate for cost of living. After a lot of conversation the two partners with other jobs reluctantly agreed (verbally, no amended contract yet). A few weeks later, the 2 partners who had quit their jobs bring up the topic again and felt that the deferred repayment of their burn rate for cost of living was not adequate. They felt they now needed a deferred salary for their time. They demonstrated this by putting a spreadsheet together with the annual household income from the two partners with jobs versus the two partners without jobs. Over the course of the year, clearly the partners with jobs brought home significantly more money. It was pointed out to the partners without jobs that this was a lifestyle choice they made and was not a request of the company. Additionally, the two working partners felt the deferred debt on the balance sheet would only slow down the future growth of the business. After several weeks of debating, it was finally agreed to try a deferred salary of $70k a year for each of the two non-working partners, while the working partners would take $0 salary. The logic was that if the company could pay each partner $70k, we could all quit are jobs and work full time for company. With a lot of reluctance everyone agreed and the two non-working partners began drafting a new partner contract. When the contract came out, the effective start date for the non-working partners pre-dated when they quit their jobs. Additionally, they added in clauses that stated if the company could pay $70k to the working partners that they need to quit their jobs immediately or give up their 25% share.

    As you may be able to tell, I am one of the working partners in this scenario. I feel we've caved in way too far and am prepared to go back to the non-working partners with 2 options. 1) Drop all deferred salary and deferred repayment of funds. Bottom line is we don't make plans for the business with money the business doesn't have. 2) Both working partners walk away from the business and give our 50% share of the company to the other two partners, but they need to repay the ~$4500 in expense accumulated to date. All of the time and effort we've put in over the last 2 years is a donation.

    A 3rd option has presented itself as well. We've begun talking to 2 additional people (also married and same household) about helping with the business. If we share partnership with them, we could all have 1/6th share in the company. Under this arrangement, each household would have 1 person work for the business and 1 person work for another employer to support the household until the business could replace that income. The issue with this option is that the non-working partners don't want to go back to work and feel their value to the company couldn't be replaced in a timely manner.

    Please give your feedback on this situation, we really don't want to part ways but this is becoming frustrating for all involved. Thanks!
     
  2. StarkSEM

    StarkSEM
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    First of all, yeah I think you're right. You guys have caved in way too much.

    You all need to come up with a more equal share-approach, so everyone can benefit from the company. If it's divided 25%-25%-25%-25%, then everyone should get a theoretical equal share.

    If you own 50% of the company, and you work for the company, you should NOT get $0. Period. You are forecasting way too far long term. You're talking about $140,000 in profits to pay you anything? That's silly. You need to figure out a ratio that makes sense via the work that is being put in.

    First, let the company pay for the $4,500 in expense. Have a meeting and write that beginning on X day, the company will make installments to Y person in the amount of Z to fulfill the previous loan amount. $4,500 is done now. Your partners did not loan that from you, the company did. Make the company it's own SEPARATE entity.

    Now for the pay. Let's say you average $5,000 in profits each month. You need to figure out who is doing the work, and where. The two non-working partners are probably putting in 40 hours a week since they don't have jobs. You two are probably putting in about 20 hours a piece. So, 40+40+20+20 = 120 hours. The two non-working partners deserve 80/120 or 3/4 of the Profits, you because you didn't put in the amount of work they did, deserve 1/4 (as a working couple).

    You need to make it simple. You can't have one half of a company's employees work for nothing, and the other half work for everything. Your company is it's own separate entity. Make the company pay out as work is put in. Whatever the ratio is, the working partners need to be paid as well, or all four of you are really running your company as a Sole Proprietorship and come tax time, you're all going to be screwed. You're not documenting enough to merit 50% of the employees getting paid nothing and 50% is getting everything.

    Split the monthly income up as work put in dictates.
     
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  3. ArcSine

    ArcSine
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    Stating the obvious, getting this far down the road with it sans a pre-agreed-upon written arrangement makes it exponentially more challenging to reach a resolution everyone's happy with.

    One possible approach is to make a fair and equitable assessment of the total contributions each couple has made to the business up to this point, and make a serious effort at attaching reasonable dollar values thereto. Important: Previous salary levels, household "burn rates", personal costs of living, and spreadsheets thereof are completely irrelevant.

    Suppose I spend 200K a year in total living expenses, supported by a job with a 200K take-home pay. Suppose further I choose to quit that job and go to work for McDonald's. Mickey D's will pay me exactly what the McDonald's job is worth. They will not give me an additional $185K a year or so to cover the portion of my personal household costs not funded by the new burger-flipping job. I'm entitled to a wage from McD's commensurate with the value of the McD's job, no more, no less. Whether I had previously earned 10K a year or 100K a year is irrelevant.

    Similarly, but a bit closer to the point, if you and I form a partnership to which we're both contributing equal quantities of time and talent, obviously we'd split the pie 50/50. My pre-partnership salary and household expenses have no bearing, nor does yours.

    Keeping this in mind, we have that for some period of time (the "pre-revenue start-up" phase) one couple contributed full-time labor and talents, while the other couple contributed some hours working evenings and weekends, and ≈ 4.5K in capital contributions. Now the difficult-but-doable part is to place a reasonable valuation on those contributed labor hours. Depending on the particular fact-set at hand, you might reach a palatable approximation by looking at the going market rate for similar services. If, e.g., a partner had worked X hours doing job Y in helping get the venture off the ground, and further, there are contractors in the market to whom you could've hired out job Y for $25 an hour, it'd make no sense to credit that partner with, say, $75 per hour for job Y, nor $10 an hour.

    Whether by looking to going rates in the market, or by some other means, you arrive at an assessment that one couple has contributed $X worth of labor, and the other couple has contributed $Y in the form of labor plus capital contribution. And presumably from your post, X > Y.

    Then going forward, skew the profit-sharing split in such a way that the former couple eventually recoups the X - Y differential. It could come in the form of a % difference mechanism; e.g., split the profits 55 / 45 (say) until such time as the differential has been made up, after which the profit allocation reverts to 50 / 50. Or it could take shape as a fixed dollar amount off the top; e.g. the first $Z of profit each quarter goes to the one couple, then the residual profit is divvied 50 / 50. (And again, this arrangement holds only until the X minus Y differential has been repaid.) Obviously the latter arrangement shifts more risk to the "working" couple, but these are just skeletal examples you might want to flesh out with details and variations.

    Ultimately, the argument for the foregoing methodology rests on the following logic: If the services contributed to the venture by the couples during the pre-revenue phase could have been acquired in the market for $X, it'd be inequitable to credit a partner with significantly more than X for those services (which represents an unfair transfer of value from the other partners who could've hired out the work instead); or significantly less than X (an unfair transfer of value in the other direction).

    One other bit: I'd strongly recommend that (a) you have your arrangement described thoroughly and definitively in a partnership agreement drafted with the assistance of an attorney experienced in partner agreements; and (b) you rent the services of an accountant / CPA / tax professional. The former, because the attorney will know how to translate the partners' wishes and intentions into the precise language that avoids the ambiguities that inevitably cause headaches down the road, and also because s/he'll anticipate issues that should be in the agreement, but which you haven't yet thought of. The latter, because such profit-sharing arrangements give rise to certain tax complexities, and you want to make sure that your tax returns reflect proper compliance with the tax code, after giving effect to such complexities. There might also be some favorable tax planning opportunities you'd miss out on if the arrangement wasn't vetted by a pro.

    Best of luck with the resolution, and with the business!
     
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  4. Arro12

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    That sounds like a sticky situation, but then again, compromise is the name of the game. If you feel you're putting in too much effort and haven't been either recognized or compromised, you need a long, detailed meeting with all partners. Identify priorities for everyone involved and find a way to monitor progress from there.
     
  5. halseyb007

    halseyb007
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    StartkSEM- Thanks for the response. I like your ideas, but the $5000 in profits is part of the issue. If we made $5000 in profits and the 'working partners' could take that money, then this may not even be an issue. The reality is that we make closer to $700 a month now. We (the non-working partners) have no issue letting the 'working partners' take the full $700 or some equitable percentage based on their time spent working. The problem becomes that doesn't cover their cost of living. Additionally, once the company does make $5000 a month, if one of the non-working partners becomes a working partner, do they get an equal share of the revenue per the scheme you mentioned? If so, the issue will be that for the last year when the company was making barely any money they working partners gave up more when the company was making less money. Once the company starts making money the non-working partners can become working partners because the money is there for them to take- this is not agreeable by the working partners because they felt the sacrificed more to get the company to the profitable state.
     
  6. halseyb007

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    Excellent advise! Really appreciate the detailed explanation.
     
  7. halseyb007

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    Ok- based on the feed back from the thread, I think we're going to propose the following:

    Our goal is to keep our balance sheet clean and avoid spending money the company doesn't have. To that end, we'll give up repayment of the $4,500 offered up in capital in exchange for the time and effort from the two partners working full time for the company to date. Because all earning have been distributed 100% to the two partners working full time for the company to date, no additional repayment will be considered for those partners. Going forward, we'll consider the hours of the full time partners to be 40 hours a week each and the hours of the part time partners to be 15 hours a week each. each full time partner will receive 40/110 of all revenue and each part time partner will receive 15/110 revenue. If the full time partners work more than 40 hours a week, that is a contribution to the company outside of the payment. Similarly, if the part time partners work more than 15 hours a week, that time will not be compensated. Once the part time partners become full time, revenue will be shared evenly among all 4 partners.

    Let me know if that sounds reasonable- I think its a nice compromise and offers a little of all the recommendations above. Thanks again for all the feedback!
     
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  8. chixfashionz

    chixfashionz
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    I could not quite grasp whether you have formally incorporated a company or just have a partnership agreement in place. A partnership agreement probably should have been written up in the first instance, to fully detail remuneration and profit sharing. There might be ongoing issues here, as no agreement appears to have been drafted prior to going into business.

    If you have incorporated a company, the register should detail who the shareholders are and what shares they hold. There should be formal employment contracts for each person working in the business on a day-to-day basis. The $70,000 for each of the working employees sounds a bit high in the first year, but then again this not so bad if you company is turning over a million dollars and already well into profit!!!

    I would be more inclined to start with a lower salary, but offer performance incentives such as bonuses and dividends to really drive the business forward.
     
  9. BAFHarvest

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    that is an awesome information. that would surely be a big help specially to those who are starting with their business and having trouble with some things. thank you!:)
     
  10. StarkSEM

    StarkSEM
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    I think that's very reasonable. It's a hard process, but you HAVE to make the best attempt at letting the company be it's own separate entity.

    Once you're giving and taking, then the company is only a formality between four friends. If the two non-working partners, in this case, are fighting over $700/mo., then everyone involved needs to re-assess the situation. If they are asking the company to shell out $70k a year, when it's not making that... well, they may not want to, but they may NEED to get another job. Doesn't have to be full time, but a part time job would suffice for the income that they are missing. Your company is only making 1/9th of what it needs to support a single salary of 70k. The non-working partner need to come up with the extra revenue, as the company needs to be able to stand on it's own two feet.

    Even with loans, honestly how long could the company support a 70k salary? One? Maybe Two Years? Then the company itself will sink, and the non-working partners would have to find jobs regardless.

    Either way, you need to help the non-working partners out by explaining that 70k salary they are after isn't good long-term.


    EDIT: You also need to consider your operating costs before payment.

    Gross Sales - Materials/Services = Gross Profit

    Gross Profit - Overhead/Investment/Operating Costs = Net Profit

    Once again, you must treat your own business as a separate entity, so the business model can grow and you can get that $70k in revenue.
     
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    #10 StarkSEM, Aug 8, 2012
    Last edited: Aug 8, 2012
  11. halseyb007

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    We missed the boat on nailing down a partnership agreement from the beginning. Things start out very slow and informal and moved very quickly from there. It was something we talked about but felt could wait as the company wasn't making much money. Now that we're showing some serious upside potential, things seem to have changed. Appreciate the feedback!
     
  12. halseyb007

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    Thank you StarkSEM- you get it! I truly hope this makes sense to them when we present it, but the advice here has been very reassuring. Thank you all!
     

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