It’s nearly impossible to build a profitable company completely on your own, simply because it’s impossible to have all the skills and resources necessary for a successful business. Although you may start out on your own, at some point you’ll want to utilize talent and skill sets beyond what you personally possess.
As a startup founder, however, you aren’t likely to have the cash flow necessary to pay attractive salaries. Additionally, you may need capital to invest in equipment or other essentials. While you don’t have the necessary resources, what you do have is company equity, which can be leveraged to access what you need.
But exchanging equity for talents, skills and cash comes with risks. Here are the basics of what you need to know about partnerships and equity before you consider taking on a partner.
What is an equity partnership?
First, let’s define what an equity partnership is. Although a partnership can take different forms (general partnership, limited partnership, limited liability partnership), what defines an equity partnership is that the equity partners own shares of the company and thus receive percentages of the company’s profits.
The partnership agreement will outline each party’s rights and responsibilities, describe how decisions will be made, clarify how losses will be distributed, and explain how the partnership can be dissolved if any party wishes to end it (or if a death necessitates it).
The specifics of the agreement will vary depending on what the partners negotiate. Profits may be divvied up according to the relative ownership percentages or may be allocated based on other factors, like how much new business each partner brings in or how much effort each partner is putting into the business — or a combination of these.
Pros and cons of equity partnerships
Partnerships have advantages and disadvantages. Before committing to one, you’ll want to fully consider the pros and cons.
- Pooling of resources: Partnerships are valuable because they bring people together to combine their skills, experience, ideas, business networks, and/or financial resources for the company’s greater success. In many instances, a founder wouldn’t be able to access these resources in any other way.
- More organized operations: When you’re the only one responsible for decision-making, it can be tempting to operate on the fly. In a partnership, the legal agreement outlines processes that must be followed, which will help you function in a more organized manner.
- Potential for conflict: If you haven’t outlined what will happen in each potential scenario your partnership could encounter, conflict is possible. Address all worst-case scenarios. What happens if one partner wants out? What if one partner dies? How will each partner stay motivated to fulfill his or her responsibilities? What if one partner wants to work more hours or contribute more resources?
- Liability: Without the legal structure of an LLP, partners are personally responsible for the company’s liabilities. To protect each partner’s personal assets in the case of a lawsuit or bankruptcy, be sure that you structure your partnership as an LLP.
Related: Why billionaire Warren Buffett Still Pays Less Tax Than His Secretary
Alternatives to equity partnerships
There are other ways to gain access to the resources you need as a founder besides entering equity partnerships.
These days, you have many creative options when it comes to funding. Here are a few:
- Crowdfunding: If capital is what you need, crowdfunding can be a great option. In exchange for financial contributions, you give funders perks like first access, a VIP experience, or swag like T-shirts.
- Friends and family: Loans from friends and family provide another avenue for capital. Friends and family may also have additional resources to offer, including access to their business connections.
- Barter: If your company produces something that your ideal partners would value, you could offer an exchange: their time and talent for free product or services.
Partnerships have a lot to offer startup founders, and often fuel companies to achieve far greater success than they would have experienced otherwise. But partnerships shouldn’t be entered into lightly. Choose your partners carefully and be sure you fully trust them. Think through all of the things that could go wrong and have a plan to address them.
And if you do choose a partnership, you’ll have greater peace of mind if you get advice from a legal professional