You Bring the Money, I Bring the Knowhow
What's it all worth if we call the whole thing off?
Q: I'm starting an exporting firm where I bring the business knowledge and
contacts to the table and my partner brings the finances and flagship
product. I plan to run the company, and he will share in the profits. How do
we value our contributions when we split up ownership in the company?
--S.C., Hoboken, N.J.
A: First rule when structuring partnerships: There are no
hard-and-fast rules. Some partners apply the feel-good method and split
everything 50-50. Others buy into capitalism's bottom line -- the gold rules.
Throw 10% to 20% to the service partner for sweat equity, but base majority
interest strictly on the financial contributions of the money partners.
Neither approach is ideal, experts say. What starts out as feel-good turns
into feel-bad when the money partner's return on investment bogs down. When the
good times roll, the service partner pouts because his or her contribution gets
short shrift. "Even if they have the best intentions, partners can either be overly
selfish or not selfish enough" at the startup stage, says William V. May, president
of Seattle-based Stonemark Investment Bankers.
Better to sit down with your lawyer and CPA and draw up a list of the
assets that each partner brings to the deal. Don't limit it to cash or
financing. Add things like patents, customer lists, and entrepreneurial
experience. Do you have vendor contacts in an industry where suppliers give
the cold shoulder to new companies? Can you secure a fantastic lease on a great
location? You're putting something of value on the table.
Put some numbers behind your knowhow, says Tom Cain of Wheat First Union, a
regional brokerage and affiliate of First Union Corp. based in Richmond, Va. How much
would a commercial real estate agent charge to secure that lease? How long
would it take to build relationships with vendors? Once you've calculated the
market value of the services each partner provides, you can split up the equity
Watch out for a tax-related booby trap that some do-it-yourself diehards
fall into: If you don't structure the deal correctly, the service partner
could get stuck having to declare the value of the equity interest in the
company as income -- a potentially very expensive mistake for someone who may barely
be drawing a salary. "This is a disaster that's best avoided by going to a
lawyer who's familiar with the creation of new businesses," says Joel Luber,
an attorney with Caplan & Luber LLP of Paoli, Pa. A specialist can also
suggest flexible business structures and constructive approaches to divvying up shares.
Another bit of wisdom from May to keep in mind: "There are a lot more people
with money willing to fund a business than there are great entrepreneurs with
great products, management knowhow, and great ideas." Translating that view into
equity is the entrepreneur's challenge.
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