David Bowie sang Changes, a ballad about how everything evolves, though we refuse to see the changes in ourselves. Because the passing of time alters a business, it is appropriate to review your founding documents before they cause your failure. A young professional sought my counsel on the status of her partnership. As a new college graduate, a more seasoned business owner gave her the great opportunity of buying into the business where she worked. Her benefactor even provided financing for her 20% ownership stake. This was in 2007, the last year of the boom, so she bought at the height of the business’ value and has been repaying her loan with interest for 7 years. At the time, both partners were working in the business full time. Over the years, the business value has decreased. The original owner moved and the minority partner has taken on the lion’s share of the work. Still the two get paid about the same amount and there are no profits to split.
One might think that the original owner is taking advantage of the younger’s inexperience. However, that might not be true. They are each abiding by the partnership agreement that they both signed. It is a fact that things have changed, but that is only an indicator of intent. The proof will come in the willingness of the majority owner to consider how things have cha-cha changed. The first consideration is compensation for contribution. Each owner should be compensated for the value they contribute to the business. Contribution value can be tested by comparing the cost to hire someone else to do the same job. Any additional value an owner may generate by virtue of their skills or expertise should be disbursed according to ownership percent.
Using this partnership as an example, the minority owner who is working full time in the business, should be paid the salary of a manager. After all the bills are paid, and profit is calculated, the proceeds should be split 80% and 20% according to ownership percentage.
After the current debt is paid for the 20% ownership, this minority partner would like to buy more of the company. Before doing so, I advised her to have the business value appraised based on current income and not what it was worth seven years ago. A good test of value and intent is to ask the majority partner what she would pay to buy her 20%. The minority partner needs to seriously consider the benefits of other employment to effectively negotiate this new transaction. This complication of business value could have been avoided if the founding document or partnership agreement had a Buy/Sell agreement. Turn and check your founding documents, and don’t strain at the cha-cha-changes.