Douglas Wade, Attorney
Many entrepreneurs are interested in becoming equity partners in a company at some point in their careers. But, do they know what the process requires?
Becoming A Business Partner: Overview
If you are considering becoming an equity partner, the chances are that you are familiar with the structure of a business partnership. Perhaps you have even been a member and owner of a successful business partnership or managed your own sole proprietorship. However, are you aware of the different structures that are used within partnerships? Here, we will break down precisely what an equity partnership is, where it can be used, and what its benefits are. While they are not as widely used as the other partnership structures, equity partnerships do offer numerous advantages and can be an interesting option for running a business.
An Equity Partnership: Overview
Let’s briefly break down the specific process of equity partnership into simple steps, and then we’ll go into greater depth.
- Step One: The equity partner buys into the business, paying an amount already agreed upon by the other partners.
- Step Two: The buy-in inserts capital funding boost into the company, ideally pushing along revenue.
- Step Three: The new partner is seen to now have an interest in the success of the business since he or she has invested in it.
- Step Four: The company may, and usually does, have competing interests at this point, which does not often cause problems; but is notable.
- Step Five: The partners receive evenly distributed profits.
- Step Six: The partners are responsible for the sum of all business debts.
- Step Seven: Predict that disputes might occur. Unfortunately, it is both prudent and wise to anticipate that business disputes may occur at this point, though hopefully, they do not.
- Step Eight: Remember to Take Note of Company Growth
Joining a Business as an Equity Partner: The Valuable Details
Step 1: The Interested Equity Partner Buys into the Business
Unlike the process of joining other business partnerships, in this case, the interested equity partner buys into the company. After the buy-in, the partner’s income is derived from the company’s profits, so the new partner is directly tied to the successes and failures of the business. The partner’s stake in the company will be used as part of their salary or, in some cases, as a bonus to their pay. It is important to note that although a partnership agreement will be utilized here and signed by all owners, and equity partnership is unique to all of the other partnership structures. In an equity partnership, the partner contributes a set amount to buy into the company and then is able to profit from the financial rewards. However, this can only occur if the business continues to flourish and grow.
Step 2: The Buy-in Provides a Boost of Capital
Equity partnerships appeal to prospective partners because of the fundamental system of investment and returns. When a buyer is invited to become an equity partner, the capital that is invested can be both valuable and advantageous for the company. The buy-in is normally predicated on market predictions that profits are on the rise, and the buy-in also can create more profits since more money is moving through the business.
Equity partners hope to see fast and lucrative returns on their investments, but this is not always the case. Sometimes the partner has based their buy-in on inadequate or misguided information about the company, and other times they simply did not conduct enough research. Therefore, we recommend contacting an investment lawyer before buying into a company. A skilled, qualified attorney can help you debate the benefits and risks of your planned investment. Also, patience is key here. While a new partner is anxious to begin seeing profits, they should be aware that their investment will benefit the business more readily and more quickly than themselves.
Step 3: The New Equity Partner Now Has a Specific Interest in the Business
Because the partner has now put money into the business, he or she has a vested interest in the company’s overall success and creation of revenue. The new equity partner is not only financially connected to the business but truly has a personal interest in helping to push the company forward and put it in the very best position to succeed. While some argue that this system presses partners to put more time into the business and work harder, it also can have the opposite effect. This means that if the company begins to suffer financially, all of the partners feel the heat, and the new partner might feel a unique sense of pressure to try to return the business to a better form. When something impacts one’s personal finances, it can be stressful for all involved. This is why we recommend due diligence and research prior to the buy-in. There is nothing worse than buying into a company that is on the verge of collapse.
Step 4: The Debate Over Competing Interests
New equity partners and all partners in the company should be aware that each may have very different interests and diverse personal situations. Why is this important? One’s interests in the business and personal and financial aims dictate their vision for the company and their own career. A new partner might be full of ambition and planning to invest at least a decade of hard work into a flourishing business. In contrast, a partner who has paid their dues and wishes to retire soon will make drastically different decisions. Whether it is about a long-term vision for the business or short-term profits, the goal for all partners should be to communicate openly and be clear about their intentions and goals. Usually, this situation can be navigated without causing damage to the partnership, but whenever there is a mix of long-term and short-term goals, it can cause trouble. In order to keep all partners focused on the company’s well-being and also keep them seeing eye-to-eye, clear, concise communication is key.
Step 5: Evenly Distributed Profits for the Partners
While it is not always true, profits from the company usually are split equally among all equity partners—unless the operating agreement dictates something else. Now, it is true that the equal distribution of profits may be complex for members who have been with the company for a while. For example, a partner who has put in 20 years could resent sharing profits with a new partner who has just bought into the company. However, the key term here for both partners to remember is “longevity.” Just as a new partner might not benefit straight away from the arrangement, the older partner must allow the company to grow.
It makes sense that equity partnerships are seen most often in accounting firms and law firms. Why? The capital that is invested pushes the company forward, and the business gains momentum. Because they are invested in the company, the partners—or employees—are usually committed to being there for the duration. As time passes, profits increase, and so on.
Step 6: Partners Are Responsible for All Business Debts
It is important to note that equity partners, new and old, do not receive the same legal protections as company directors do. In fact, a critical feature of this partnership structure is that all partners are financially responsible for debts that have been incurred by the business. If this seems risky, it is—but only if the partnership that the partner is buying into is not in strong financial standing. So again: the more a prospective partner knows about the partnership they wish to join, and the more informed they are about the finances of the company, the better.
Step 7: Understanding that Disputes May Occur
We cannot think of any business partners—or even romantic partners—who agree 100% of the time. This is why business partnerships of all shapes and sizes are often compared to marriages. They require work, patience, and fine communication skills. It is unavoidable that there will be occasions in which partners disagree about financial decisions, business moves, and more. Based on this, it is essential to pay attention to the sections of the partnership agreement that go over these disputes. This will help all partners be informed and prepared. If you find that there are no clauses within the agreement that cover conflicts, then take this to heart. Hopefully, you have not signed on the dotted line yet. This is evidence that your chosen partnership is not ready to deal with business disagreements. You should take caution before joining—or find another company to invest in.
Step 8: Remember to Take Note of Company Growth
As you may have ascertained, becoming an equity partner usually involves the use of high capital upfront to buy a stake in a company and, therefore, become a part-owner. Therefore, a partner’s income is not based on their individual salary but instead on the performance and growth rate of the company. Therefore, while choosing to become an equity partner can be an intelligent, savvy business move, it can also be challenging and result in losses if one’s expectations do not fit the reality of the situation.
Suppose you are considering becoming an equity partner in a company. In that case, it is vital that you check on the growth projections of the business first and make sure that the expected growth will match the capital you are required to invest. While it is impossible to know for sure, accurate projections can help you to make an informed decision. Also, make sure that you are in the appropriate financial position to buy into the company and absorb the gains and any losses that may occur.
Contact the Experienced Business Attorneys at Nakase Wade
Deciding to become an equity partner in a business is an exciting yet complex decision. Before you sign on the dotted line and become a partner in a new business, get in touch with our California business lawyers and corporate attorneys. We have the knowledge and experience to make your decision that much easier. Contact us for a free consultation today.