I received this very good question from a reader about share ratios when converting from a partnership to a LLC. Note I have dropped his name and changed the details a bit
Let me ask you…I am about to form an LLC for a small business that I have been running for several years. I have one major partner, and I am trying to get some advice on whether I should split the shares 50-50, or if I should retain
a majority (55-45) since I was the founder and ultimately have the largest assets into the business?
Firstly, much more than a legal issue this is a human issue. It really depends all on your relationship with the partner. The simple answer from a legal standpoint would be to retain the majority, because you don’t know what could happen in the future.
All this being rationally true it could work against
you, maybe your partner would feel cheated because of this and start
bearing a grudge. As in any relationship grudges have a way of rearing
their head at some point in the future, when you least want them to do
To sum it all up while rationally you should have more because you are the founder, you need to avoid grudges against you, but then again you also need to avoid grudges in you against your partner. It is all together better to avoid the times when you need that controlling stake, than having a remedy after the fact. Condoms over abortion!
One thing you might try is to offer a 50%/50% revenue split, but retain control. That seems like a good compromise. Stuff like that you can specify in the LLC agreement or in a separate contract.
Also remember I am no lawyer, then again this is a human subject and lawyers only ever should get involved when the human beings are past talking.
Anyway if anyone else has questions, please send them to me at email@example.com and let me know if you want to be anonymous. Of course I am no lawyer and I my answers might cause you to loose your house or worse your powerbook. Also feel free to comment with your own experiences and opinions below.
I have to admit like many people I was dumbfounded when I heard about EBay’s purchase of Skype. Having read EBay’s Skype Presentation
I think it does make a lot of sense. There is definitely a lot of shared areas that might not be entirely obvious to some of us who are snow blind in they payment area.
In particularly they mention that Skype can help reduce friction points in the sales of high value and complex items.
I remember when I sold my Landrover Discovery II (boo hoo how I miss you) 5 years ago on EBay. There was certainly a lot of calling back and forth between the buyer and me.
The real thing that worries me is if they start going conservative on Skype the same way they were with Paypal.
Have a read through Who Killed PayPal? which describes how PayPal has instituted a bunch of strange super conservative rules, that basically piss users off but please regulators.
I knew Max and Peter from PayPal back in the early days and remember their techno-libertarian enthusiasm which I still share today.
Skype is in many ways the PayPal of telecoms. It has a very Libertarian/anarchic approach to everything. I’m not sure it was intended that way or if it just happened as an accident. I really hope EBay leaves Skype to do it this way.
If you have to start confirming who you are before signing up, it would certainly kill off the growth of Skype. Eg. See David’s commentary on Flickr Signup pre and post yahoo .
The good thing is that EBay definitely is a ecommerce company and a a successful one. They are not a conservative telecom company nor a media conglomerate. They don’t need or should feel scared into doing major changes.
Bumped into (while web browsing) a very old friend of mine here in Denmark yesterday, who I haven’t seen for 15 years. It turns out that he is also a bit of a serial entrepreneur and boy did we have a lot to talk about. He’s working solo on a new venture right now for the same reasons I am. I hadn’t really formulated it well until last night.
We’ve both come out of some challenging partnerships that eventually failed. These things can tear on your morale and it is easy to get into a period with a mixture of blame and low self esteem. In many ways its exactly like a divorce.
For me to get out of this cycle it is important for me to work completely solo for now. This simplifies things and keeps the noise and bickering of a partnership out. To do this you do need to pick a relatively simple business that you can manage and pull through yourself.
All this doesn’t mean that partnering is bad. Partnering is fantastic if you have a good partner. It is also definitely the preferred way to go, but as I said there are times in your life when partnering is not right. If your new solo venture is successful you may actually want to bring someone in once you have the basics of the business operational.
Choosing a legal structure for your new venture is some thing that you do have to think about. If only for planning purposes. Having gone through the offshore companies is cool phase a long time ago, I decided that there are really two things you need to think about:
- Whats best for your business?
- Whats best for your and your partners personal economy?
Why are these separate. First of all what is good for promoting and growing your business is often transparency and flexibility. What is good for your personal economy is not necessarily that. All kinds of tax rules make the varying structures good for various kinds of people and incomes.
Whats best for your business?
First of all without your business doing well you wont have any personal income to worry about, so this should come first.
For this transparency, flexibility and simplicity is vital. When you are just in the early bootstrapping phase like I am right now, you dont want to be bogged down by bureaucracy or extra costs.
On your own
When you are just starting out and you are only in business with your self, you are already as transparent as can be. So theres not much to worry about.
If you are working on this with one or more partners you need to keep things simple and transparent, no matter how good friends you are. This also has the added benefit of keeping out the lawyers and letting you yourselves decide whats best.
Transparent and short partnership agreement
Following rule 2 from my 6 simple rules for micro ventures distribute revenue early and often. This requires that each partner knows what his job is and what his share of income is.
Lets say Bob takes care of hosting and programming and his partner Mary takes care of marketing and sales.
They should according to my rules say that Bob takes care of the entire hosting and development task all costs included. In return he receives %70 of income.
Mary on the other hand has agreed to take care of the entire sales and marketing task including all costs in return for %30.
This is very simple and keeps the inevitable arguments under control.
They can always renegotiate this in the future or bring further partners in if need be.
In most partnerships you have the inevitable arguments about money, expenses, investments etc. This way you can split this out entirely.
All of this points to the best structure for your business at least in the startup phase is a partnership or variation there of.
Most countries allow you to setup partnerships just by entering an agreement between yourselves. While you are in the idea phase a verbal agreement should be fine. However it might be a good idea to write it down in clear language what each of your tasks and responsabilities are on what share you receive for this.
Once you start actually doing business above the hobby level, you probably may need to do some kind of formal registration of your partnership. Some places like Denmark it is actually beneficial to register for VAT purposes immediately, so your purchases are vat free.
Limited Liability Company
For international use (but read what I say below), say Bob is in Australia and Mary is in Norway a US Limited Liability Company (LLC) is almost certainly the way to go. Bear in mind though that this does cost a few hundred bucks to set up if all of your partners are abroad. If one or more of the partners are resident in the US it can be done cheaply and easily by yourselves. See this book for the best how to I know of:
LLC’s are great. They are transparent for tax purposes like a partnership and offers the warm comfy feeling of limited liability. They also do setup a more corporate image if you are into that sorts of thing, just remember be a business dont play a business.
I should also say that you almost certainly dont want to create your LLC until you have some income. It is a cost and there is bureaucracy involved. That is also why its good to move to a LLC from a partnership, because for tax purposes they are exactly the same, so no hassle.
If you are outside the US or just want someone else to manage it you can use a corporate services provider like this one (Disclaimer while they look sound and I am considering using them myselves, I do not have first hand experience with them):
Why not corporations?
Corporations where designed with something called the corporate veil, which essentially means its a black box. It acts and is taxed like a seperate person and has tons of rules behind it which cloud and never enhance the transparency.
This is good for dealing with investors. Venture Capitalists will amost certainly want you to be a corporation if you wanted to do the non-bootstrap route. As a bootstrapper though stay away for your business.
Remember though that you and your partners personal tax planning is an entirely different thing and each of you might find a use for them there.
Single person LLCs
As I said before, create your LLC when you have the money and time to spare to do so. While they are partnerships strictly speaking you may still incorporate them with you as the only partner in many US states.
Now why would you want to do such a thing? Well this would make it easier for you to bring further partners in later.
Google/Yahoo/IBM have offered to buy us, what next?
First of all congratulations. As you are now out of the bootstrapping phase you should convert the LLC into a real corporation at the exact share percentages as before. You should also by now have money to pay a lawyer to do this for you well.
Whats best for your and your partners personal economy?
Everyone is different and have different needs and requirements. If you are in the startup phase and are Funding through a nine to five like I am. I want to deduct all my costs and expenses against my salary. You may not be able to do this in your country, but in Denmark and the US you can. So that is my requirement.
Later on when my business starts making money, my requirements will most properly change. I will probably want to leave income in a company to reinvest later. I might even move to a place with a better tax climate than here. This should be my choice and not my business partners.
I therefore recommend that you startup just having everything as personal income/costs (US 1099). Then when you start breaking even create a personal holding company, which is just a corporation that you yourself own. This does not even have to be in your own country of residence, but do check local rules and regulations about this.
As my old Danish teacher always tought me in grade school, “you always need a conclusion Pelle!”.
Basically keep your business simple and transparent using partnerships or just as a self employed.
Your personal financial and tax strategy should be kept separate from your business.
And as always IANAL
this is just based on my own experiences and often alcohol controlled thought patterns.
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Other under Partnering
- Auren Hoffman on the Value of Soft Assets
- Question about Share Ratios for a LLC
- Dear EBay, please don't mess up Skype
- When one is greater than two
- Legal structures for bootstrappers
- 6 simple rules for micro ventures
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- Previously unreleased interview with me from Kenya about Kipochi
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