Last week we evaluated some important issues when considering the formation of a business partnership. This is a common path for many creative entrepreneurs. But it’s also common for partnerships to fail. And so considering the kind of partner you’re looking for, what their buy in costs will be, and working out how you’ll handle a possible future dissolution is critical before you make a deal. But there is one more matter to consider when it comes to equity partners in a creative practice—you see, giving someone ownership in your business does not guarantee them a job, nor does their acceptance of that equity require them to stay with your company. Having ownership in a business is not the same as an employment contract.
When creatives form business partnerships they don’t always think through all the long term implications. Too often they bring on a partner hastily, especially when they feel over their heads and the partner seems like a perfect solution to their business struggles. But while it’s easy to enter into a business partnership, it’s not nearly as easy to exit one. And if you make a mistake, you might get stuck in a relationship that doesn’t make anyone happy.
So in addition to thinking through the issues we discussed last week, you need to remember that giving someone ownership in your practice does not lock them into a guaranteed job. And unless you specify in a formal agreement some kind of pre-established basis for an equity buy back, should a partner resign or be terminated, your partner can walk out the door anytime, taking their equity with them.
Inexperienced entrepreneurs often fail to consider the distinction between equity ownership and participation in a company. At the outset this connection is often assumed by both parties. But in fact, giving someone a percentage of ownership does not inherently bind them to work for your company. All it does is give them the legal right to that percentage of profits whenever they’re distributed. And unless you give them 50% or more of your equity, the voting rights associated with ownership is a moot point—so it really only amounts to profit distributions.
So while both parties may enter into a partnership with every intention of making things work—mutually benefiting from the combination of their skills and experience—if things don’t work out, either party can start looking for another job. And unless your contract stipulates otherwise, they keep their equity. Once they’ve vested into it, it is their property, whether they work for the company or not. And if you wait to think about this reality until after a partnership is formed, you’re too late.
And so for this reason, and many others, it’s critical to work with an attorney when you form a partnership. Establishing equity buy back rules to address such eventualities is essential before you ink a deal. And keep in mind that even if you make such provisions, buying back equity will take cash. Most partners don’t pay cash to get in, more often they trade their services over time to earn the equity. But once earned, if they leave and want to be bought out—that takes cold hard cash.
Forming a partnership is a big deal. And so before you rush in, consider some alternatives. The first is simply to hire the help you need. This option is often neglected because you can’t afford the overhead, but there are alternative compensation plans that can be geared to performance, without actually giving away equity. Commision plans can be offered to a sales or marketing expert. And if they’re good at their job, good enough that you would consider a partnership, they should be confident enough to see the value in commissions.
You can also create profit sharing plans with employees, that are based on a percentage of profits, but aren’t linked to equity so that you don’t get locked into permanent profit sharing after they leave.
Creatives really can benefit from the expertise of others, and strategic partnerships can work, but be sure to consider all the issues, and weigh the alternatives before you do.
Until next week: don’t let the business of creativity overwhelm your creative business.