In forming a company with more than one owner, a question that typically comes up is, “how do I structure my relationship with my partners?” or “What are the different forms of business ownership and organization?”
The concern is usually about making things fair when partners contribute different things in return for their stake in the company. To make things easier to understand, we can divide each partner’s ‘share’ into three basic, separate interests: 1) a Capital Interest; 2) a Profit Interest; and 3) a Control Interest. While this example uses an LLC or Partnership structure to illustrate these concepts, they can be adapted to a Corporation just as well.
1. Capital Interest – What is each partner’s share in the overall company?
Here, ‘share’ refers to the whole thing. The company name, desks, chairs, computers, equipment, software, intellectual property, cash, accounts receivable, and everything else.
The question for you to ask here is, ‘if my company is sold today, what does each partner get?’
If there are two partners, and both initially invest equal value in the company, this can easily be a 50/50 arrangement. However, if one partner invests more than the other, the capital interest can be used to ‘balance’ the relationship from the start.
2. Profit Interest – What is each partner’s share of the operating profits?
Here, ‘share’ refers to just profit (or loss). When the business makes a profit or loss from its normal operations, how should it be split among the partners?
If both partners a) invested equal value in the company; and b) actively work in the company (doing things of fairly equal value), the profit interest can also be 50/50. However, if one partner works more than the other and/or invested more than the other initially, the profit interest can also be used to balance the partners’ participation and contributions in the business.
A larger share of the profit interest can be used as an incentive for the active partner to run the company well.
3. Control Interest – How much say does each partner have in what the business does on an operational level?
This refers strictly to the ordinary business decisions made by the company, and generally not to structural and fundamental decisions or changes. There are a number of ways to modify and adapt this interest to the partners’ needs by structure or agreement. It is best to clearly define the nuances of who has control, and when, in writing.
Keep in mind that depending on what you want to accomplish, all three interests can be different to accommodate the actual relationship between you and your partner.
As an example, one partner can have a 30% capital interest in the company, a 20% profit interest for the first 4 years (and 50% thereafter), and full control in day-to-day business decisions.
Therefore, the interests in the company for you and your partner will depend on:
- What value you and your partner invest in the company
- Who will operate the business
- Who will be in charge of which day-to-day decisions
To avoid complications later, it is best to have the partners’ intent expressed clearly in an Operating Agreement for a Partnership or a Limited Liability Company (LLC), and via a Shareholder Agreement and By-Laws for a Corporation.
If you are interested in more detail related to your situation it is best to speak with an attorney.
