What do I owe my partner that just left the company?
I started an LLC. After a couple years of sputtering, I decided to get more serious about it, so I brought a partner on board. The idea was that this would always be a part time job that we did a couple nights a week, but it turned out to be much more than that.
We had a verbal agreement to get his equity stake to 25% after 4 years. It was to be 10% after year 1. This was before any money was put into the company.
As the company progressed, I put in another $25,000 - of my own money, we got another $19,000 from Kickstarter and the job started to become much more serious.
The number of hours that we worked over the following year were probably 3:1 or 4:1 in my favor. Then after about a year of him doing work, he decides that the commitment is too much and he is ready to leave.
The company is far from being profitable, yet, I still have a dream to turn things around and make it successful.
So my question is, what do I owe him?
He still thinks 10%, but I think less because I put money into the business and he didn't. But neither of us are experts on this matter.
If I continue to put more money in, it seems odd that he would own 10% right?
Your thoughts would be great. Thanks!
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Sep 6, 2013
Is the partner a friend or relative? Has he or she suggested a dollar amount? Have suggested a dollar amount?
I have mediated million dollar deals and those are always very emotional, as I would guess this is for you and your partner. I would advise you get a third party to help you walk through this together, that way you can come to a peaceful solution.
You can call me and chat if you need
Good luck and remember, relationships are important.
Jul 31, 2013
1st question – did you issue in membership shares?
2nd question – Did you have a lawyer write articles of organization?
3rd question – does the LLC have any value today?
The first thing to look to is the articles of organization. If you issued no shares then he has no title. If you want to play hardball, you owe him nothing.
If you believe he added value, or if he plans to sue you in the event he gets no compensation for his investment of time, then determine the value of the time he did contribute and pay him based on that. If no shares were issued, you could pay him and issue a Form 1099-MISC in January to report the payment as compensation for labor. You would then deduct the payment as professional services expense or outside services expense. If you are concerned that he might go to the unemployment department to start collecting unemployment, then consider paying him as a “W-2” employee.
Finally, if he owns a certain percentage of the shares issued, then you will need a valuation of the company. A certified valuation may cost you about $5,000. (I am not a certified valuation expert. I know one in Oregon if you need a referral.) If that is outside of your budget, the two of you could hire a CPA or business consultant and work on an agreement on the risk adjusted value of the future cash flows that form the basis of most valuations.
If you have any further questions, I may be reached directly at ken@kenconecpa.com.
Jul 21, 2013
Tough one if you did not have a written agreement.
This post is evidence on his behalf.
Recently broke up a 3 person Partnership for a similar reason too much work for one of the partners.
This is what I would do get a lawyer to draw up an agreement offering a sum that seems fair to you.
You can offer half of this as a cash now payment and the other half only being paid out if and when the company has become successful
(Whatever and whenever you decide that to be )
Include in this agreement Non compete and Non disclosure clauses binding him to keep your trade secrets.
The promise of some cash now and future payments if successful seems fair to me.
He knows by leaving he is making your chances of success harder by taking a large cash payout he would make it harder still.
If the company folds he gets 10% of nothing if he gives it a chance to survive he will get a payoff eventually.
Knowing that he should keep your IP to himself.
He may also be willing to consult occasionally instead of completely walking away?
Good Luck
Jul 20, 2013
I would recommend that you review the situation and any affiliated paperwork with qualified legal counsel, and not just asking the question of colleagues and online forums, or even friends who are attorneys. You want to make sure that you don't make a costly mistake in this situation. If you would like an affordable legal plan that is month-to-month with no commitment on your end (similar to an HMO, but with full-service law firms and attorneys experienced in all areas of law), contact me and I will give you more details. It's the most affordable way and still, you'd be getting the legal advice from experienced, qualified, reputable attorneys.
Jul 19, 2013
yopu owe him nothing
there is no agreement
there is a promise of 10% but 10-% of nothing is nothing
what you can do is work out the hours if he was not paid for them and that can be a basis for a payment when the company can afford it
he has broken the term of the contract by leaving early so there is no onus on the company for honouring an agreement that he is broken
Jul 18, 2013
You should have executed a partnership agreement that would state the percentage of ownership of net income for each partner and contain a formula for how that percentage would be adjusted if either partner made an investment. Without an agreement its now open to negotiation.
Jul 18, 2013
I agree with everyone who advised getting a lawyer before you do anything else.
Since he didn't put any money in the only fair way I can see to begin sorting this out is to determine revenue increases from the day he came into the partnership. If he deserves anything it would be 10% of that, minus of course, all costs incurred during the same period.
Sounds like profit sharing isn't an option as you seem to still be in the loss sharing stage. Doubtful he'll want to ante up 10% of any losses incurred during your partnership.
Be sure any agreement he signs contains a clause preventing him from coming back for more after you have turned this around and realized your dream.
Once you get this sorted out, you need to take a step back and rethink where you want to be in three years and how best to get there. Then plan for that. I'll be interested to see how you resolve this. Thanks.
Jul 18, 2013
Matt, why oh why do you not have a written agreement that spells this out, including the additional capital contributions and differential hours worked? Partnership dissolutions can rip people's lives apart.
A couple of observations:
-- 10% of what? If you're not profitable, the company is worth no more than any tangible assets you could sell in dissolution. If your company is not worth anything, then he's not due anything.
-- In fact, he may owe you money! You made a capital call to the partners, and he didn't contribute.
-- Normally, the value of the departing partner's stake is discounted from what the share would otherwise be.
-- He is due no share of any future value you might create after his departure, as long as you come to agreement now.
Of course he won't see it this way. You want to diplomatically come to agreement without riling him up. Try to find some articles about how to equitably handle partnership dissolutions. What factors? What formulas? What percentages? Some concrete examples.
If I were in your shoes, I would then hire an attorney to write up a proposed settlement--not in legalese, but in plain language--that embodies the things you learned in your above research.
You want your ex to sign this agreement, which will state that the company has no value. And perhaps you'll give him $500 right then, if he signs it.
That would be such a win for you, because you don't want your life to be about fighting a former partner, or running up huge legal bills.
My question to you: What happens with the Kickstarter contributions? Is there a written agreement about what is due them?
-----------
After reading the other answers, I must reiterate my question: "10% of what?" If you do a balance sheet, what tangible value does your company have?
--
Jul 18, 2013
So many good answers already. I agree with most of them and I strongly agree that you need legal counsel at this point. And like Adrian said, at least have a legal coach working with you.
One disagreement would be with Gary Brooks. I like everything he said, and the two-class of stock idea is great, but an S Corp cannot have more than 1 class of stock. It will void the S-election.
If this is a properly formed and filed LLC, buy out your partner with a Note. The minute you buy him out, the LLC becomes a SMLLC (single-member LLC), the partnership files a final return, and you operate as a sole proprietorship for tax purposes while keeping the LLC limited liability status in place.
But your first step is come to an agreement as to the buyout.
RV
Jul 18, 2013
This is a tough one. And this is a great learning experience where verbal agreements should be followed up with written contracts so you won't be in such a position now.
I would honor the initial verbal agreement since you all did not discuss a change in the agreement since.
Or you can do what you feel since he did not get anything in writing.
Do what you feel is right but recognize that he may get sour and bring you to court so it can help you figure it out.
Jul 18, 2013
If you own an LLC then what is the ownership of the LLC, that will show his share of profits he could be due. Regardless, you could pay him now 10% of what the business is worth and it sounds like he still owes you money.
I can come at this from a few other directions and my answer would be zero. You really need an attorney for the correct answer. What anyone should learn from this is, get an attorney and get it in writing.
Jul 17, 2013
The suggestions about legal counsel are all valid. In addition, I would have your accountant prepare a final partnership return as of the latest month/quarter. Assuming that you want to treat your partner equitably (not equally) even though you have no formal agreement, your investments into the business are for the benefit of the partnership (just like obligations are joint & several regardless of the ownership interests. You should then file a final partnership return, both taking advantage of the tax benefits at rates you agree on. (90%/10% ??).
Before you contribute any additional capital to the business, form an S corp. Absorb the partnership balance sheet into the new corporation. Issue 2 classes of stock-voting common to you and non-voting class B to him amounting to 10% or less of Newco equity. Future capital investments from you will purchase voting common, continuing to dilute his interest. DO NOT PAY HIM ANYTHING NOW. YOU MUST DO WHATEVER POSSIBLE TO PRESERVE CASH to fund the business since you are not yet profitable. I assume that your kickstarter money was a gift without obligations to the contributors.
Hope this gives you some ideas. As some have already said, any time there is a "third" party involved, written agreements are mandatory.
Please call 516-496-2490 if I can help.
Regards,
Gary Brooks CMC, CTP
Jul 17, 2013
There's a big difference between 10% of the company and 10% of the shares what is your share structure??
Unless you want to pay him 1/10 of all future earnings and future enterprise value you'll need to buy him out. If he refuses to be reasonable you can do a dilutive cash call and force his position.
I'd feel more comfortable negotiating a fair deal or I can represent one side if you like
Call me at 493-630-8818
Regards, Greg Genge, MBA
Jul 17, 2013
It's too late to chide you for the verbal agreement or for that matter for engaging in a partnership without sufficient consideration. That said, I hope going forward you will not find yourself there again.
I don't see what $$ he has put into it and there is no question that lacking your sweat equity neither he nor you will get a pay back. I am with Dennis here- bring on an attorney (more than anything to protect the peace down the road). In the short run, given the information I have, I am hard pressed to say what if anything your partner deserves here.
Jul 17, 2013
Hello Matt,
Since their was never a written agreement between the two of you. Then like my professional peers are telling you. Get a Lawyer to help you 2 with this. Sweat, time and effort in the business, should be accounted for something. However the % may not be as big...also what is/was your partner sales numbers like during his/her tenure?
Hope this helps.
R/S,
Dennis
Jul 17, 2013
What are your total sales figures during the length of his tenure? What about costs incurred?
Cut him a small % of the difference, if anything. If he doesn't have 10% ownership in writing, he doesn't have 10% ownership.
Jul 16, 2013
Consider this... you and your partner contributed labor and he should get 10% of the valuation of the company after 12 months of operations.
If you made the $25K contribution during the 1st 12 months, then 10% of the valuation of the company at 12 months, less the amount by which the $25K contributed to the valuation should be factored out of your former partner's share.
How to valuate the company is a separate calculation.
As with shares where capital gain is being calculated, you have to deem to have sold the company to obtain a valuation. i.e. what would a reasonably astute person have paid for the company and what is 10% of that amount had there been no $25K infusion of capital)
In other words you buy him out based on a valuation of the company's worth as at the 1 2 month stage with a possible correction for the $25K cash input.
Since you have only a verbal agreement to remind both of you of the terms/conditions it's likely there will be two interpretations.
A clean break is the way to go.
I am providing nothing more than an opinion on what I would do under a similar scenario.
Always best to seek legal advice.
Aug 7, 2013
Forget the relative labor contributions. . . each of the parties did what they did voluntarily with the good intention of increasing the value of the venture..
The selling price for many types of organizations is 1.5 times annual revenue. But, it can vary if you have "inventions" or "patents".
Buyers often believe they can do a good job managing costs so current profitability is not usually a primary consideration in setting the value of any initiative.
Re- reading your initial post, I would still say "(selling price less $25K) x 0.10".
I would classify the $25K as a shareholder's loan.
Again, this is not advice, just an indication of what I would do under the circumstances had I been in your shoes.
Best you consult a lawyer but get agreement in writing beforehand that the cost of the legal fees is to be shared 50/50. And, the new owner takes on any current payables
Jul 16, 2013
This shows the difficulty of planning ahead! It is not clear how much money you have put, how many hours you each worked for this LLC and what is its profit level or potential. Without a profit estimate, the equity is not worth anything apart from your agreement.
And as a last shot, if you can't agree, auction it between yourselves and see what the value comes to. This will have some bearing on the potential as seen by both of you, keep costs down and part on good terms.
Jul 16, 2013
Lawyer is the only way as MA says.
If there is nothing written you could potentially get away with 'owing' nothing... but this may not be the best approach as they could cause you reputation damage if they were so inclined? (only you know if they would do that) or drag out loads of legal filings.
Ultimately you currently still 'own' the business and your investment into it is now just part of the business, did you have a written agreement for your investment to the business? if not, its now just a company donation.
SOOOO many issues and loop holes here. Maybe as MA says worth while liquidating, informing your clients of what you are looking to do and loosely why so they understand it is politic change and not company solution issues and go from there....
but.. step 1... lawyer
Jul 16, 2013
Thanks Adrian,
My partner and I are still on good terms and I would like to keep it that way. I agree I need some legal advice, but I would really prefer to avoid liquidating. We had a draft copy of an agreement that was never finalized (not signed), but he did good work for 10-12 months and I would like for him to get something for it.
Jul 16, 2013
Totally understand and thats positive that you are still on good terms. Be careful if you try to negotiation some kind of package with them (without mutual legal support) as by extending an offering could make you liable for a lot more if the wind changes and the positive relationship breaks, as at that point, you are in a discussion of how much not if... could get messy..
Jul 16, 2013
If in your shoes, I would meet with your partner and agree that to make everything smooth and to maintain a good relationship that you (both) should agree on a mutual legal support to help negotiate an agreement. at that point they may give you a settlement number that you are happy with.. then agree to it... and again... get it drawn up :) good luck.
Jul 15, 2013
First, I strongly advice you to hire a lawyer. It is worth getting this right. It's hard to give definitive advice without carefully review the matter, including any written correspondence in the absence of a written contract.
From what you have written, I would definitely not put more money into this venture until you figure out the arrangement. Do you really want to continue this partnership? Would you prefer to do it yourself or find a new partner? If so, you need to decide if it is better to just start over...and if it's possible (is there any IP or contractual restrictions). The key is to look at the long-term goal and where you see the company going. If you can build something that is highly profitable, it may be better to take a hit now rather than down the road where there is much more at stake.
Going forward it is critical to get these arrangements in writing and have legal counsel. You want to make sure that any arrangement factors into varying workloads, monetary contributions and changes in circumstances as much as possible. You might want to read Founder's Dilemma by Noam Wasserman, which does a great job talking through founder equity splits.
Sorry I cannot give you a definitive answer, but hope this helps. Best of luck!
Thanks Karl. Your answer is the way i feel about things. The key is to put a proper valuation on something that has lost money for 2 years and is still months away from making anything (and that will involve a lot of work).