Okay, so you’ve decided to take on one or more partners, great. Now you need to decide how to divide up the ownership of your company to reflect the partner’s roles in the business. This is one of the most undocumented areas of business start ups there is. Not the “how to” but the “what to.” Before we get into the technical areas, let’s take a step back and review reality for a second.
The routine default action is to divide up all the stock evenly. Two partners 50 / 50, three partners 33 / 33 / 33. It is possible that this makes since, but when you examine the daily activities and responsibilities, this is rarely the way it pans out. Someone is taking on way more individual tasks with more hours than the other, and it is this reality that needs to be considered prior to making any offers or discussing a partnership. The best way to tackle this is by examining the roles that are needed in the company and create a stock package that matches those roles. If you approach someone with a nicely proportional package, you can avoid setting their expectations too high, which is almost impossible to adjust without losing their interest, and making them feel like you’re a conman.
To review our previous lesson, partnerships always benefit the lazy. Once a company is divided, you’ll never be able to get their stock options from them unless you create some very specific bylaws defining each role, and the measurable milestones of success. People usually don’t have the financial power or foresight to create such language when creating a partnership. Please understand that it would serve you well to postpone any signing until these documents are clearly defined. A basic document outlining roles will address the following:
- Name of the position.
- Define a list of responsibilities under that position title.
- Define the first 24 months of operation from this role.
- Define clear milestones that must be accomplished within those months.
- Define any tolerable conditions that would justify delays, such as approved strategy changes.
- Define acts of god such as health conditions, etc., that would allow a partner to be absent.
- Define exit strategies should that person need to be replaced due to any of the above circumstances prevailing over the job.
- In the event of death or divorce, conditions for buying back all stocks for a reasonable price.
Once the roles are clearly defined, communicate this to a potential partner during the discussion to ensure they see the big picture. If you plan to bring on additional roles, go over those as well so they understand why they don’t have a larger share coming their way.
Dividing the shares
Okay, so you’ve defined your roles, you’ve developed some legal language to protect the company should someone start to slip on performance, and now it’s time to divide the company into pie slices. I’ve been through this a number of times and it’s felt like a random science until this last decade where I finally gained enough practical knowledge to put a formula to the task. What you may not know is that when you create a corporation, you are free to design its internal affairs (within the constraints of your state and federal law) to your hearts content. What this means in the real world is that you create different “classes” of stocks, and this is the key to not losing control over your company to employees and perhaps partners that although provide a great service to the company, lack the years of experience related to running a company of your type. What I’m going to outline here are two different classes of stocks. We’re going to call them Class A and Class B stocks to keep it simple. These are arbitrary names, but highly recommended should you go this route.
Class A – Voting Shares
Voting shares are magical shares that give the possessors voting power within your company. The are shares that are legally defined within your corporate bylaws that are different than ownership shares. Again, I’m defining these as voting shares. You could make them “get free soda” shares, but for the sake of my recommendation, I make Class A voting shares.
Core partners that possess diplomatic skills and good experience within the areas of owning and operating businesses should be considered for voting rights. As the founder, you can always keep these for yourself and issue ONE share of voting stock exclusively for you if you prefer a dictatorship. Know that being a dictator is not like running Communist China. It just means that you don’t have a candidate up to par with corporate decision making; tough luck, but you’re not running a popularity contest, you’re running a business. Few will complain unless you make a string of bad decisions.
Class B – Ownership / Dividend Shares
This class of stock is reserved for dividing the ownership of the company. This means that an employee or partner gets proceeds from any dividends paid, or profits as a result of an eventual sale of the company. The number of these shares is usually in the thousands, and contrary to your first impression, you shouldn’t give them all away on the first day. When a corporation of any kind is created, they ask you who owns the shares. Ninety nine times out of a 100, all the shares are given to the founding partners in total. The problem this creates is that in order to allocate more shares, you need to file with the state of your residence to tell them your changing everything. This can get expensive if you have to hire an attorney for help.
The best method is to divide up a sizable share to yourself as the founder, and using your handy guide as described above, a proportional allocation to your partners, all the while leaving a chunk reserved for new employees or investors. There is nothing like promising a new employee they’re going to get stock, only to postpone them for weeks while the paperwork gets filed with the state. You can sign letters and contracts promising this, but I’ll tell you, I have a couple companies that still owe me the official documents, and I’ll probably never see them and have to sue them in court should they sell for any amount of money.
This is the overall information you need at a minimum to get started. Know that stocks are very psychological items that shouldn’t be thrown around lightly. People invest a lot of their future expectations into thinking that their time invested will result in a payout one day. The decade of the dot coms and the Enrons taught the public at large that stocks can be used as weapons of manipulation to get folks to work hard with no real chance of winning the lottery in the long run. The best thing you can tell anyone getting stocks is that there is no guarantee, but that if you meet your clearly defined goals for the company, you’ll be in best position to succeed.