I'm a principal at a startup ad agency, working as creative lead and director of business development. My partner originally agreed—though not in writing—that I would get a 10 percent commission for finding clients. Now that I'm doing the work, he's suddenly concerned that my commission isn't fair because I'm a partner at the agency. His logic is that you're either a sales rep on commission or a partner who earns a salary. He wants an even division of monies, even though he's not doing an even division of the work. How can we resolve this fairly? —J.M.D., New York
Your question raises serious issues about the viability of your partnership, even before you've gotten your business off the ground.
The most fundamental misstep is failing to put your partnership agreement in writing. "Even if it's on a napkin, writing something down focuses attention on issues that must be discussed and crystallizes the relationship," says Los Angeles business lawyer C. Dickinson Hill. "Perfect foresight is rare, but everybody should recognize the need to address compensation issues upfront. If the partnership is to last, you should be able to discuss issues as they arise and each should be willing to do what is needed to keep the other partner involved. If not, perhaps this is not a good fit."
A second problem highlighted by your question is a misunderstanding as to how partnerships function legally and for tax purposes. For instance, business partners do not earn salaries as employees do. Salaries reduce profits and are deductible by the partnership. Partners share in the profits—and losses—of the business. If the partners need monthly income, they may take "draws" as advances on their yearend share of profits.
Talk to your partner about establishing monthly or quarterly draws. What each of you will take depends on factors such as who needs regular income and how the partnership is structured: Did you put in equal amounts of startup capital and split ownership 50-50? Are you, as the partner responsible for bringing in new business, putting in more time and effort than your partner? Did he do more at the outset?
Divisions of Labor, Responsibility
Generally speaking, both partners must expend time and effort to bring in new business, particularly at startup. Or one acts as a rainmaker and the other handles operations, employees, and so forth. "In some cases, adjustments may be appropriate, such as a commission on sales or a fee for running the day-to-day operations or providing capital, if everything else is equal," Hill says.
If you want to stay in business with this partner, you'll need to negotiate a partnership agreement that takes these issues—and many others—into account, says Karen Tegger Ward, an attorney and partner at The General Counsel in Irvine, Calif. "The two partners should sit down and hammer out an agreement, then have a lawyer draft it," she says. "You can also hire separate attorneys to review the agreement, but I don't think that's absolutely necessary. The lawyer can represent the company, rather than the individuals, so as to avoid conflict."
Erika Z. Schenk, an attorney with Bryan Cave in St. Louis, agrees: "You need to sit down and have a frank discussion concerning the business relationship and the economics of the venture. It may make sense to involve a mediator to facilitate those discussions and help you organize your thoughts. Then, with the help of a business lawyer, you can make sure the deal is documented properly."
You will eventually need an accountant to prepare your partnership tax return, Hill says, so you might as well find one now and use an initial meeting to talk through compensation as part of a discussion of partnership accounting and tax issues, which can be fairly complicated.