Douglas Wade, Attorney
As the business world changes, so do the ideas involved with becoming an equity partner in a firm. There are both benefits and losses to the new definition of being an equity partner, and it is essential for prospective partners to stay updated.
Introduction
Many young and eager non-equity partners are searching for their next career move. They are curious about how to become an equity partner in a business and how they will be compensated. Some individuals focus only on moving to companies that will make them equity partners. Why is this so important to some partners? They share the traditional belief that being recognized as an equity partner shows the firm’s long-term commitment to them. It also provides increased job security and more influence concerning important issues impacting the firm.
However, these days, becoming an equity partner is a different concept. Within a changing industry, some experts believe that entering into a new firm as an equity partner does not provide the advantages that it used to. In addition, as policies and metrics fluctuate, the process of receiving compensation as an equity partner is also changing. So, what should prospective partners do, who should they believe, and to whom should they turn?
Here, we will cover how becoming an equity partner—and being compensated as one—are changing and what is essential for prospective partners and business owners to know. From capital contributions to hybrid partnerships, we have got you covered. Now, let’s talk equity.
Putting the Cap on Capital Contributions
It used to be that firms would collect capital contributions from equity partners and no one else. This policy has begun to evolve, and a small number of firms now ask for contributions from non-equity partners. However, most companies still do not request or collect capital from non-equities.
Why is this so important? The normal expected rate for equity partners to pay in the capital is 25-35% of the current annual compensation. Yet, some companies ask for as much as 65%, and the majority of partnership agreements stipulate that the firm has several years to repay the partner if he or she decides to leave the firm.
Therefore, a new equity partner is immediately expected to pay the firm a substantial amount from their salary, even though they have just joined the firm. Unless these policies continue to change and do so more rapidly, it actually makes more sense for a new partner to enjoy a temporary period. They would not be required to invest their capital earnings but would be eligible for bonuses and receive guaranteed compensation. This would mean that the new addition to the firm is not an equity partner yet, but it would also provide a chance to adjust to the new firm, integrate with the culture, and decide if it is a fit for them. Then, in due time, the individual would be able to decide if he or she would like to invest long-term in the firm with a substantial amount of capital, therefore becoming an equity partner.
The point here is that historically, equity partners were required to contribute a lot of money up-front without knowing if they fit in with the firm or if the firm felt their skills were a worthy addition. So it may make sense to hold off on becoming an equity partner and, in the interim, figure out if you made the right choice while saving money.
At-Will Employment for Everyone
In the past, business partners in equity had a lot in common with tenure-track university professors: once they made it past the dotted line, they gained strong job security. However, once again, the industry is changing. Firms are beginning to change over to a more corporate template and experiment with personnel and unique systems of measurement. Individuals who may have different corporate backgrounds are being brought into management positions, and new individual metrics are being utilized.
What does this mean for equity partners? It means, basically, that everyone at the firm is an at-will employee. While some firms are more empathetic and concerned for employee well-being than others, even the companies that have long-since based themselves on resilient, long-term relationships with their employees, managers, supervisors, and partners are welcoming new partners from all experience levels. These firms hope that choosing new partners from diverse backgrounds will generate new business relationships and new revenue streams.
Giving Equity Partners a Breather
The majority of firms expect great things from equity partners. This has been true for generations, and it is still true today. Although this means that there is increased pressure placed on these new partners, they also typically have to deal with a transitional period, during which they adjust to the new firm’s culture and way of doing things. Especially with less-experienced business partners, this ramping-up period can pose a challenge to meeting goals, making deals, and their overall progress. While many partners bring past business prospects with them and think that they will start out immediately “on a roll,” this is not generally the case.
The pressure to perform can be troubling, and some companies are choosing to provide a different path to becoming an equity partners. They are doing this by using a transitional or interim period. This idea can help contribute to the success of a new partner, therefore increasing both the value of the partner and his or her business dealings and the overall value of the firm. These days, some businesses have a policy that stipulates a 1-2 year time period of transition for new partners. During this time, the partner can get to know his or her peers, understand how the firm’s systems, rules, and policies work in real-time, and also bring their own clients smoothly into the business. At the end of this interim period, if both the firm and the new partner feel good about everything, then the discussion about equity begins.
While this new policy may seem slow-paced, it can reduce the overall pressure that new partners feel and lead to stronger relationships within the firm and greater productivity. Instead of “slow-paced,” think “strategically patient.”
Compensation Structure that Partners Prefer
If you haven’t seen the changes taking place within the business world over the last decade or so, you simply have not been looking hard enough. Presently, few companies still enforce strict retirement guidelines that ask partners to give up all or part of their equity. Instead, compensation is a more fluid concept, and managers have more freedom to adjust payments, utilize metrics and indicators, and change things like individuals’ careers blossom and grow.
In fact, bonuses have also become more common and have even grown more extensive, as draws have been lowered and compensation has been back-ended for partners. This gives management more authority and increased discretion. Usually, income partners, non-share partners, and non-equity partners get most of their payments through a fixed draw, received monthly. However, top performances are awarded—if they are quality—through bonuses, some of which can be quite high.
So, if a partner waits to become an equity partner, they are still able to receive bonuses on top of their draws, some of which can be very rewarding.
Hybrid Partnerships
Another significant trend we have noticed in partnership structures is the idea of “hybrid partners.” When non-equity partners or income partners are known as “hybrids,” a slice of their pay, usually 10-30%, is based on overall firm performance. So, in a system set to 10/90, 90% of pay is assured, and 10% is based on the business’s annual revenue. Some splits are set to 20/80; some are set to 30/70; this depends on the firm.
While this may not seem precisely partner-friendly, new partners can still collect some benefits. If the business exceeds its target number for profits or growth, there might be a financial upside for the partner. However, this advantage is lessened by the fact that the partner will have to contribute some capital to the business.
You may have heard of the term “one-tier” partnership, and some companies actually market themselves this way. However, the term is misleading since these firms would not be included in the yearly reported statistic of profits per equity partner (PPP). Research tells us that equity partners are defined as partners who get 50% or more compensation as equity and that anyone who receives less is considered non-equity and is known as simply a salaried employee.
The fine print here is for prospective partners to always be sure they have read and understood the operating agreement. When an individual is debating becoming a partner or equity partner in a business, it is a wise idea to contact a licensed business attorney for help with this task.
How an Equity Partner is Paid: The Conclusion
Essentially, an equity partnership is becoming a more malleable concept these days, but its focus is still on performance. If the partners and managers who already make up the firm share the correct resources with the new partner and their collective strategy and vision for the firm, then the rest is up to the partner.
While a partner’s initial and sustained performance at the firm is vital, more consideration is now given to the idea of an adjustment period. It used to be that all partners sought equity immediately upon signing up with the business, but now that is not the case. Many businesses now allow for a period of adjustment time, though there are exceptions that usually focus on older partners who bring in not only clients but experience and a proven track record.
In 2022, an intelligent and driven business person should look forward to being an equity partner and being compensated as such. However, they should also be sure to check in with their new firm beforehand regarding the compensation structure and recognized interim period. Obviously, this goes along with carefully studying the firm’s operating agreement before signing anything. Being cognizant of the business’s expectations is crucial for entrepreneurs and prospective partners in all areas of business.
Contact a Skilled, Licensed Business Attorney Today
At Nakase Wade, our California business lawyers and corporate attorneys have helped many aspiring partners go over their new firm’s operating agreements. Our lawyers also are on-hand to help prospective equity partners with their decisions and answer any questions they may have about the process of joining a new business as a partner. We offer free consultations and look forward to speaking with you, so contact us today.