Business Partnership Advisor
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Chris Reich, Business Luminary
I Put in Money and He Worked for Free
Email of the week:
Chris, we started our business 2 years ago and have just started to make money. I put up $50,000 to get the business started. My partner didn’t put in any money but he did work for free for about a year. Now he thinks he’s entitled to half the business but I think 60-40 split is fair. Am I right?
Percentage of Ownership When Only One Partner Contributes Actual Money
I get a lot of calls about the subject of dividing the percentages of ownership when the contributions are not perceived as being equal. Squabbles over equity also bleed into other issues such as control of the business and, in some cases, whether the partner who put in cash has a “right” to dismiss the partner who contributed work. So, what is more valuable? Cash or Sweat? Let’s explore this.
We have 2 questions to consider as we try to untangle this misunderstanding.
What is the original agreement or understanding?
What is the value of each partners’ contribution?
The answer to the first question tells me a lot about the ethics of the partners. Most people who work without compensation assume that their contribution is equal to that of the cash investor unless there is a written or clearly stated (oral) agreement. By the way, oral agreements are just as binding as written agreements, but they are harder to prove. If there is no written Partnership Agreement, I want to know why no documents were drafted. It’s telling if there was resistance to creating a written contract. I’ve seen cases where a partner clearly wanted the labor and planned to take control once the business was rooted. Sometimes, once the business is running, the partner who put in the cash assumes that the cash is of greater worth than the labor that went into launching the venture. If I cannot find any evidence of a prior agreement, I’ll then move to the second question.
How can we put a value on the partner’s work contribution? Before we do that math, let me say that I start by encouraging partners to agree on a split before entering a process to make that determination. Did you think it was going to be a 50-50 partnership? Then start there. Agree on that. Get on with the business. I push strongly for agreement because the process of working out an equity split can be painful.
Imagine that you have worked for a year or more without taking a cent only to have your business partner say that your contribution isn’t worth much. I hear that in nearly every case involving equity splits that involve cash versus labor investments. It goes like this.
Partner 1, “I put up real money and took all the risk.”
Partner 2, “I created the logo, made the website, and did social media for a year.”
Partner 1, “the logo is just our name and I worked on that too. And those Facebook posts didn’t get us anything.”
Partner 2, “are you saying my work isn’t worth anything?”
Partner 1, “no, I love the website and everything you’ve done. I just think without my money there wouldn’t be a business at all.”
And around and around it goes from there.
Determining the Value of a Partner’s Labor Contribution
We have to assume that the working partner acted in the best interest of the company and made every effort to do a good job. Why? Because you will seldom get that from a basic wage employee. We look at the tasks performed and set a value on that work. Creating a logo? What’s that worth if you had to hire a professional? Let’s be fair. Don’t say that your nephew could have done it for $50. What about the other work? $20/hr.? $50? Did your partner leave a well-paying job to work for free? How many hours were worked? We need to consider all of these factors when determining the value of the labor contribution.
If the working partner spent 30 hours a week for a year and we agree on a rate of $35/Hr., then we calculate the contribution as:
30 X 52 X $35 = $54,600 and we could add consideration for taxes and the fact that the money was not paid in real money. If you are asked to work for something you want rather than money, you’ll set the rate at a premium because you could just take the money and buy what you want. In an exchange, you lose some freedom of choice.
How to Balance the Equity
What if the investing partner contributed $30,000 to the startup fund? Didn’t the working partner contribute more? You can see how messy this can get. It’s always a hurtful discussion and seldom is there a happy resolution. How can there be?! After saying that the working contribution isn’t worth much, you cannot expect things to get back to a happy place ever again. Typically, the labor contributing partner will capitulate and accept a smaller stake, especially if the partner with money will be investing more cash. That may be fair in some sense but it always sours the partnership.
The Best Solution to Equity Distribution Disputes
Agree. That’s right. Just agree. If you want the partnership to survive, agree.
The sooner the parties reach an agreement, the more likely the partnership will survive. Shifting equity unexpectedly creates mistrust that is hard to repair. The big mistake has been made, take your lumps and agree. I say that to both parties. Give. Compromise. Agree.
The big mistake is the failure to document your agreement before the issue presents. Entering into good-faith deals often leads to misunderstanding. Drafting a simple agreement in advance will help you avoid all the tension that springs up later.
Drafting an agreement on the split of equity is especially important in a family business. It’s sad when bothers fight brothers or sisters fight with Dad. Draft an agreement!
I’ve seen brothers, sisters, parents, cousins, and best friends shatter relationships over this issue. To avoid fracturing a valuable relationship, draft an agreement. If it’s too late for that, then buck up and agree now. It’s never too late to create a Partnership Agreement. It just gets harder as time passes.
“The best thing to do when there is a disagreement about the equity division is to compromise and agree quickly. The conversation about dividing ownership can be hurtful. Sometimes relationships break permanently.”
Chris Reich, Mediator
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