Running a company as a solopreneur is challenging, but loyal, skilled employees make your job easier. Indeed, you may realize that a co-worker could serve your business better as a co-owner. Business partners share the risks and rewards of ownership, and an employee-turned-partner can be key to your exit strategy.
However, before adding a partner, consider several things, from your business structure to the operating agreement. Explore the steps to take before making an employee your business partner.
Consider your business entity options
How will you offer your employee part ownership of your company? It all depends on your current business structure. If you have a corporation, you or another partner can give or sell existing stock shares. In some cases, it's also possible to issue new shares. Alternatively, you may want to convert your entity into a business partnership or a limited liability company (LLC).
Different entities impact your business, your personal taxes, and your partner's financial and tax situation. A professional advisor can weigh the pros and cons of each structure and recommend the best solution. Involve your employee to ensure that they understand the implications of each entity and have the funds to handle the purchase price and potential tax consequences.
Business partnership structures include:
- General partnership (GP).
- Limited partnership (LP).
- Limited liability partnership (LLP).
- Limited liability limited partnership (LLLP).
[Read more: What to Look for In a Partner]
Develop a business partnership or operating agreement
A contract defines your business structure and the roles of a partner in a partnership or members of an LLC. Although not legally required in all states, a partnership or operating agreement is a best practice. Without one, your state's standard statutes apply.
Forty-four states follow the Revised Uniform Partnership Act. This regulation outlines partnership liabilities and assets and governs partnership creation and partnership and partner fiduciary duties. In addition, the U.S. Small Business Administration stated, "State default rules govern LLCs without an official operating agreement."
Write a business partnership or operating agreement that addresses the following:
- Percentage of ownership.
- Rights and responsibilities.
- Profit and loss distribution.
- Financial reporting.
- Partnership withdrawal.
- Capital contributions.
- Dissolution.
Although not legally required in all states, a partnership or operating agreement is a best practice.
Update your formation documents
Depending on your business structure, you may need to revise your articles of incorporation or articles of organization. Corporations will modify the agreement to add the employee-owner’s title and shares. A limited liability company changes the articles of organization to account for the new member and may amend the operating agreement. Your state's laws may require owners to submit these forms to the appropriate agency.
Complete a business valuation
Most partners buy into a business, meaning you'll need a business valuation to determine your company's value. Generally, the valuation looks at your business liabilities and assets. But it can be complicated, which is why CPAs accredited in business valuation typically complete the valuation process.
[Read more: Forming a Business Partnership? 6 Things to Consider First]
Draft additional contracts, if required
Although other contracts may define purchase requirements, restrictions, and dissolution, stand-alone documents can clarify responsibilities. Many templates are available online, allowing you to create these documents for free or a small fee. However, consider having your lawyer review the contracts before presenting them to your potential partner.
Law 4 Small Business lists three optional agreements:
- Purchase contract: This contract defines the buy-in price based on the fair market value of your company. Additionally, an LLC will outline the ownership percentage, whereas a corporation describes the number of shares.
- Restriction agreement: This explains the limitations of ownership for your new partner. These may include a vesting schedule, permitting certain actions after a specified amount of time has passed. It can also restrict the selling or transferring of ownership.
- Buy-sell contract: This is similar to the purchase agreement, but it’s used when adding a founder or gifting ownership instead of the employee paying for their portion. It defines the terms and conditions of how your company handles the termination of the partnership.
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
CO—is committed to helping you start, run and grow your small business. Learn more about the benefits of small business membership in the U.S. Chamber of Commerce, here.
