I have an independent contractor that would like to become part owner in my company. The independent contractor has performed well and would be willing to work as a COO of the company. Is this wise? And, if so, how do I know what percentage of ownership to transfer?
Answer: It is common for entrepreneurs to bring in partners or employees to help manage and grow their businesses; however, there are a few different ways to structure these arrangements. For example, equity awards to key executives in small companies may be in the 5% to 10% range. Also, the legal structure of your business (sole proprietorship, corporation, LLC, etc), the tax status, the value of the business, and other factors will be considerations in any equity sale or award and owner/employee compensation decisions. But it is important to note that paying for equity in a business entity (corporation, LLC, etc) with sweat equity, or with services in lieu of cash, equates to a form of equity compensation. While equity compensation is common, particularly with business start-ups, it also has unique business, owner and employee income tax and cash flow considerations. Therefore, business partners generally use their local CPAs and lawyers to consider the legal and income tax implications and develop any contracts, or contract provisions, to account for and properly document their sweat equity investments.
Other than selling or awarding an ownership percentage initially, one approach would be to hire this individual as your COO with defined performance goals and expectations, including a possible partnership percentage at some point in the future (six months, for example). This approach would allow the two parties to work together for a while and then decide if a form of business partnership is in their best long-term interest. On the other hand, if this individual has the resources to buy a percentage of your business, it may be an opportunity to gain a partner with valuable business management experience and realize a working capital injection to lower your debt load.
In addition to the financial considerations, hiring an important employee like a COO typically requires a thorough background check and possible personality testing. Also, you may need an employment contract, stock buy/sell agreement, or other legal or business governance paperwork to document your business partner arrangements. To help consider the optional approaches and determine how to possibly bring this individual into your company, you can locate discussions of partnership arrangements, employee equity programs, sweat equity investments and related topics at the following example websites:
Partner considerations:
- Pick the Right Business Partner: isquare.com
- Finding the Perfect Business Partner: inc.com
- Top Ten Mistakes Businesspeople Make When Forming Partnerships: allbusiness.com
Employee equity plans:
- Phantom Stock and Stock Appreciation Rights: nceo.org
- The National Center for Employee Ownership: nceo.org
- Startup Equity for Employees: payne.org
Sweat equity investment considerations:
Common business valuation methods and businesses sale prices:
Due to the various governance, legal, and financial tax implications, business owners adding partners and considering potential business structure reorganizations generally use local professionals (CPA, lawyer, and business insurance agent) for help in reviewing their business plans and evaluating business entities, income tax, legal, and risk management issues.
Published: July 12, 2013
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