Be Careful About Changing Equity Positions in Your LLC

I get worried when a partner in an LLC tells me the other partners want to change the equity distribution. Read why…

Percentage of Ownership in an LLC is Important

Majority rules in an LLC unless your Partnership Agreement says otherwise. That means any changes in ownership affect voting power. If there are 2 partners who each have a 50% stake, decisions will be by agreement. Change that to 51%/49% and the 51% partner calls the shots unless there is a Partnership Agreement that species a different arrangement. You knew that so what’s the big deal?

Beware the Crafty Partner!

The affection between even the best of partners can erode over time. The 3 big items that cause chaffing between partners are:

1. One works more hours than the other
2. Money issues, especially over compensation related to item 1
3. Differences of vision

If you identify any of these corrosive factors in your LLC Partnership, beware of any discussion around equity!

It Can Sneak Up on You

You might find your partner constantly bringing up the issue of working hours. He works more, therefore he deserves more. That may be perfectly acceptable  in some sense. You might not want to work every weekend while your partner likes nothing more than crunching spreadsheets and analyzing new opportunities.

You can, if appropriate, offer to permit your partner to take a greater salary in recognition of his hard work. Many members in LLCs are not aware of that possibility. It’s often incorrectly assumed that equal partners must take equal salaries from the business. That’s not true. Salaries can be allocated in any way agreeable to all partners. Be wary if a conversation about working hours bends toward changing the distribution of ownership.

Beware of Mr. Generous

Another place where trouble can start is when a partner says something about wanting to reward employees by giving them a small stake in the company. That sounds like a good idea and one that could motivate key employees. But where will the 2% stake come from? Likely that your partner has you in mind when he proses giving away a small stake in the company. Ask yourself this question: if there is a need for a major decision, will the employee(s) vote with you or your partner?

I would never want the employees to be in that position, clearly. But for the sake of argument, you can pretty well assume that your partner has already mentioned his deep desire to give a key employee the stake he deserves. Knowing those shares came by way of his action is going to handicap you in the future.

The bottom line to all this is that I always recommend keeping equity the same unless a partner wants to give up control for a sunstantial cash price. You see this in family businesses. Dad is slowly stepping back and the kids are gaining control. That’s perfectly acceptable. Just be wary if your partner proposes an ownership adjustment out of the blue. It could be a sign of trouble.

Chris Reich, TeachU 

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