Business Partnership Advisor

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Chris Reich, Business Luminary

7 Steps to Work Out Compensation Issues Between Business Partners

Partnership Compensation Doesn’t Have to Be a Flash Point of Tension

Here are 7 important points to consider as you work out an agreement on compensation with your business partner. Above all, remember you can do anything that legal and agreeable to all partners. That means pay doesn’t have to be equal. One partner might get paid and the other not. As long as that’s agreed, you can do it. Let’s look at the 7 considerations of partnership compensation.

#1  When Should Partnership Compensation Commence?

If you or your partner(s) are beginning to experience burnout, it’s time to try to get some money paid to partners. You want to make some payments if partners need money even if the business isn’t yet profitable. Working hard and making nothing leads to burnout and that’s more destructive than the stress overreaching the point of profitability. I’m a big believer in paying partners as soon as possible for the sake of the partnership and the survival of the business. You must exercise caution and no go overboard with early compensation but even small amounts help.

#2  Pay Vs. Draw Vs. Expense Reimbursement

There are different ways to get money into the hands of partners without starting a salary commitment. Let’s look at various forms of payment that might be an option in your Partnership or Partnership LLC.

Pay

This is payment for work and is generally paid as a salary. If the business can support making regular payments, you can set up a small salary agreement. The amounts can be small. Minimum wage laws do not apply to owners. Each partner might get $100 per week. That’s not much, certainly, but it might be enough to quench the fires of pending burnout. Never forget that appreciation for each other is extremely important. Initiating a small salary along with your appreciation will go a long way toward cooling tension over the subject of money.

Draw

A draw is generally an amount taken against anticipated profit distribution. Let’s say that we all agree that the business will have a profit of $100,000 this year. Each of our 3 members of our LLC can anticipate getting $33,333 since we’re equal partners. If a partner needs money now and the partners agree, we can issue the partner in need a draw of $10,000 against her distribution. Later, when the profit ends up as projected at $100,000, the draw is deducted from the distribution for that partner.

Expense Reimbursement

This is often a big issue in a business in its second and third years. You and your partner both put up $50,000 to start the business. A couple of things came up this year that could be opportunities and you decide to kick in $2,500 to buy a machine at a steep discount. A few months later, the question comes up about why the extra money I put in isn’t counted. What does that $2,500 get me? Sure, the business is better off with the new equipment but should the money for that come from me alone?

My approach to things like this is to get them all on the table to get a clear and fair sense of what everyone contributed. If that is out of balance, or if there is full agreement, those little extra expense items paid by one partner should be treated as reimbursable expenses. Each partner may have some of these.

Once we have the list and everyone agrees on that list, we can treat the items as “cash calls” necessary to keep the business going or we can have each partner fill out an expense form and submit for reimbursement. I like the reimbursement method because it settles a lot of tension between partners when someone feels they are putting money in but not getting anything back.

There are two very important things to consider when reimbursing for expenses.

  1. We do not count startup money as an expense
  2. We want to get money issues balanced, solved, booked and eventually paid before someone starts talking about adjusting the equity. If that comes up, there is big trouble ahead.

Accountants, bookkeepers, and lawyers hate me for this approach. Partners, especially partners in LLCs love me. The problems dissolve and partners are motivated for success. Further, we eliminate ALL discussion about who has a greater stake in the business.

#3  Do You Need a Formal Agreement About Partner Compensation?

Yes. (Not really, but it’s a very good idea.) The agreement can be as simple as a partner-drafted resolution.

“Resolved, we agree that until annual sales reach $150,000, each partner will receive a salary of $300 per month.”  That’s about it. If we need more definition, we can draft it. It’s not the U.S. Constitution so it can be somewhat informal so long as there is agreement. (See why lawyers hate me?!)

7 Steps to Partner Compensation

These 7 points will help think about how to fix problems around Partner Compensation in an LLC.

Partnership Mediation by Chris Reich, TeachU

#4  How Is Partner Pay Calculated?

If the business is mature and profitable, partners should be paid at least what they would make in the same position working for another company. That’s a good start. Then, of course, partners get distributed profits.

If the business is young and not yet profitable, you can set up whatever you agree that the business can afford and is fair. You’ll want to agree on something stable. It’s not wise to change the number every month as that can encourage disagreement. Start out being very conservative and increase the pay as the business grows.

Partner pay does not have to be equal. If one partner, by agreement, works in the business full time and the other partner keeps the books doing all the entry on weekends, it’s fine to pay the working partner a bigger salary. As I said above, you can do whatever you agree to.

#5  Working Vs. Non-Working Partners

We touched on this already. If there is a partner working full time and a partner who does not work in the business at all, and if they are equal partners, their salaries do not have to be equal.

I often see cases where one partner put up more money and, by agreement, will quit his job and work in the business after a year. The other partner, who put in less money, will work at a very low salary for the first year. The hope is to grow the business enough to support both partners after a year. That’s creative, brilliant, and workable. The key? AGREEMENT. (You can do anything with agreement!)

#6  What About Raises and Bonuses?

Once you set salaries by agreement, you should define when partners will get raises or when the subject of partner pay will be reviewed. Setting a low partner pay now without a plan for better pay later will probably lead to trouble down the road. Set either a time frame for the current agreement or a financial threshold. You might do something like, “if sales exceed $50,000 for a given month, each partner will receive a $5,000 bonus (or draw). Just be sure to set it high enough that it is a fairly rare event. Otherwise, you might as well set higher salaries and have less bookkeeping to handle.

#7 Ask Yourselves This Question: Will This Compensation Agreement Prevent Further Disagreement over Money?

If you cannot say “yes” then talk with your partner about what is needed to make a good, solid agreement on compensation.  If your partner insists on being paid a lot more after a year, be sure to define business goals along with future salary expectations.

Partnership tension over money is one of the most common causes of breakdown. Good agreements make good partners so do not be timid about drafting your agreements.

If you address these 7 items, you’ll successfully work through the biggest strain on a business partnership. And, if you want help working through these points, call me. That’s what I do!

Chris Reich
(530) 467-5690

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“The key to resolving partnership problems rising out of money issues is to draft clear agreements. Talking it through using these points and then putting an agreement on paper is cathartic and fruitful.”

Chris Reich

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