How to Allocate Equity Among Partners

Source: Public Practice

When 50-50 partners don’t agree, the business can simply split into two, with each partner going his or her own way.

But when a third partner is admitted, problems escalate exponentially. It is far rarer to find three compatible partners than two. When there are three (or more) it is more likely that the firm will continue, but with one fewer partner. Then you need a process to formally deal with dismissing a partner—a process few are willing to articulate on the front end, when the hope that the new relationship will bring exceptional value is clouding all rational judgment.

What happens when the new person joining significantly oversold his or her entitlement to one-third ownership? Or even more difficult, what happens when the new partner performs much better than the others. Many firms think they will deal with this issue in the compensation plan.

Even if the firm can address the situation through compensation, it is just one issue. When a partner has voting privileges well beyond his or her contribution, you have someone who is holding the firm back.

When a founding father leaves and his or her block of stock is redistributed to partners who have been marginal performers, the latter can end up gaining disproportionate (disproportionate to the value they bring to the firm) access to voting rights that will forever change the firm’s future viability and stability.

Future articles will take a more in-depth look at issues to avoid in ownership distribution and processes to help you constantly redistribute equity so that partners are held accountable for their responsibility.

For the complete article, click here.

From Texas Society of CPAs, Public Practice, February 2009, www.tscpa.org.