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When 50/50 Ownership Splits Just Don't Work

Sometimes, divvying up everything equally in a business isn't in everyone's best interests.
May 5, 2003
URL: http://www.entrepreneur.com/article/61474

What is the ideal way to divvy up the equity in a startup? When in doubt, most folks divide everything equally. Sometimes, though, that isn't a good idea. Here are some of this week's questions on this topic:

Q: My husband and I formed a limited liability company a year ago with a dear friend of ours. We agreed verbally that the three of us would split everything equally, and each of us contributed $10,000 to the LLC's capital. My husband and our friend have recently had a falling out, and now the friend wants 50 percent of the business with a veto power over major business decisions. We have no written agreement. What can we do?

A:Unfortunately, by taking your friend's $10,000, you have made her your business partner. The good news is that since each of you put in the same amount (and can prove it with canceled checks and bank statements), there is strong evidence that you intended equal ownership of the LLC. So your friend should not have any legal claim to a bigger piece of the pie.

Assuming your business is still in start-up mode and doesn't have significant revenue, you should offer to buy your friend's LLC interest for the $10,000 she put in. If that doesn't work, you should consider dissolving this LLC (which you should be able to do legally, even if your friend dissents), and starting a new LLC without your friend. Keep in mind, though, that your friend will have a one-third interest in any assets that the LLC owns prior to the dissolution. You will have to hire an independent appraiser to value these assets and pay your friend one-third of the appraised value.

Q: I am planning to buy a franchise. Initially, I will be doing all the work. My daughter, who is currently unemployed, has agreed to help me in the business, but I don't know if she will stay for the long term. She may want to return to a corporate job if the economy improves. If she stays, I intend to make her my partner and leave the business to her in my will. If she doesn't, I don't want her to be liable for any of the franchise obligations. How should we structure the ownership of this business?

A:There are two possible ways to go here. Under the first, you can be the sole owner of the business and make your daughter an employee "at will." That way, either of you can terminate the employment relationship at any time, and your daughter will not be liable as an "owner" of the business under the franchise agreement. You will have to pay federal and state payroll, withholding and unemployment compensation taxes on your daughter's compensation.

The second alternative is to give your daughter a small amount of equity--say, 1 or 2 percent--so she won't be considered an employee for tax purposes. You can then enter into an "earnout" agreement with her, so that your daughter's equity will increase in regular increments as the business grows (for example, you could offer her "an additional 5 percent for each $50,000 increase in gross sales"). Before doing this, you should look at your franchise agreement, which likely requires anyone owning more than a small percentage (usually 5 or 10 percent) of your business to personally guarantee the franchise obligations. See if the franchise will waive this requirement for your daughter, or increase the required percentage so that she will not be required to "sign on the dotted line" until she is ready to make this business her life's work.

Q: My wife and I are getting ready to form an LLC for a plumbing business. I will be doing the work, while my wife will keep the books and run the office. We plan to split everything 50/50, but I'm wondering, is there any advantage in giving my wife 51 percent so we will qualify as a woman-owned business?

A: The short answer is, not for this type of business. It might be helpful to become certified as a woman-owned business if you were providing services to large corporations and government contractors, which are required by law to give a certain amount of their business to minority and women-owned contractors. A number of organizations, such as the Women's Business Enterprise National Council, provide this certification for a small annual fee.

Since most of your customers will be homeowners or small businesses, there is really no need for your plumbing business to be "woman-owned." Even if your wife owns 51 percent or more of the LLC, your business probably won't be certified as long as you retain control over the day-to-day operations. To qualify for certification, you will have to demonstrate that your wife is really the boss, that she decides what work will be done, for whom and when, and that she controls and directs your daily activities.


Cliff Ennico is host of the PBS television series MoneyHunt and a leading expert on managing growing companies. His advice for small businesses regularly appears on the "Protecting Your Business" channel on the Small Business Television Network at www.sbtv.com. E-mail him at cennico@legalcareer.com.