Bringing on board and "vesting partners"

[Shaun @ Tru6]

I've posted about this in the past and gotten good advice here, but since then things have changed and would like to reopen the discussion.

There are 3 legs to the Little Traveler stool: Design * Sales * Production

Sales: I don't need to worry about. We have great sales reps and they get a commission and that's it.

Design: similar to Sales in hiring out work, but here we introduce some folks who have consistently gone above and beyond contract help and have played the role of Partner significantly more than work-for-hire. I need to create a vesting package.

Production: Production has been the bane of the company. I have an opportunity to bring a production person onboard who will manage our production from end to end and she wants to be part of the company much more than just a paycheck.


A bit more background. My vision for running a company is to include people who go the extra distance in the company, rewarding them for their hard work and dedication to the big picture future, especially when they know the risks involved and since we are still very much a start-up, all their work has the potential to be in vane.

I feel that I need to create some type of vesting package that rewards folks for work done, and is attractive to bring this new production manager on board. This is all about opportunity, for the company and for them.

When I use the term Partners, it means that I value their input and want them to feel like they have a real piec of the action, that they are working for their future as much as mine as much as the other people on the team. Please let me know any and all thoughts, creative packages, etc. you have seen.

[lendaddy]

Is she hot?

[berettafan]

You could've just said 'i need free labor, how do i get it?'. Lot less typing

You can do profit sharing but it doesn't really have the 'oooh, aaaah' factor as lots of companies do this now and it's 'profit sharing' in name only. I would consider a partnership/LLC w/ all losses allocated to you and x% of profit allocated to the suckers, er i mean employee/owners. It is important that you understand the impact of 'limited partner' vs. 'general partner' or 'managing member' etc. Also consider SE tax and guaranteed payments and how they impact your tax picture.

Coolest setup i've seen so far was LLC where the sucker...damn i'm sorry i mean 'partner', got a very small % of gross (vs. net which can be played with) as a guaranteed payment and he also had the deduction for said gp allocated to him. Net income/loss beyond that was allocated to the real owners. He is NOT a managing member.

[berettafan]

Also, for a production person i wonder if it makes sense to tie their % w/ some factor that measures lead/production time.

Here's a set of parameters as an example:

Let's say you want 20 days average time from final design to boxes in the warehouse.

Katie (just because it's a hot name) manages a weighted (by cost) average of 18 days.

Katie's % of gross is 0.5.

20/18 gives a multiple factor of 1.1111.

Katie's adjusted % is now 0.5555% of gross.

Conversely if Katie manages a weighted average of 25 days she gets (20/25 x 0.5%) 0.4% of gross.

I'd probably consider a cap in such an deal.

[Shaun @ Tru6]

Originally Posted by lendaddy

Is she hot?

Yes. and single. and my age. and lives in LA.

All of which mean, no, there will be no office romance. besides, I have the bike for that now.

[Shaun @ Tru6]

Originally Posted by berettafan

You could've just said 'i need free labor, how do i get it?'. Lot less typing

You can do profit sharing but it doesn't really have the 'oooh, aaaah' factor as lots of companies do this now and it's 'profit sharing' in name only. I would consider a partnership/LLC w/ all losses allocated to you and x% of profit allocated to the suckers, er i mean employee/owners. It is important that you understand the impact of 'limited partner' vs. 'general partner' or 'managing member' etc. Also consider SE tax and guaranteed payments and how they impact your tax picture.

Coolest setup i've seen so far was LLC where the sucker...damn i'm sorry i mean 'partner', got a very small % of gross (vs. net which can be played with) as a guaranteed payment and he also had the deduction for said gp allocated to him. Net income/loss beyond that was allocated to the real owners. He is NOT a managing member.

We are an S corp now and follow this loss philosophy, and would need to create a class of stock with certain limits I believe.

I like your last para.

[Shaun @ Tru6]

Originally Posted by berettafan

Also, for a production person i wonder if it makes sense to tie their % w/ some factor that measures lead/production time.

Here's a set of parameters as an example:

Let's say you want 20 days average time from final design to boxes in the warehouse.

Katie (just because it's a hot name) manages a weighted (by cost) average of 18 days.

Katie's % of gross is 0.5.

20/18 gives a multiple factor of 1.1111.

Katie's adjusted % is now 0.5555% of gross.

Conversely if Katie manages a weighted average of 25 days she gets (20/25 x 0.5%) 0.4% of gross.

I'd probably consider a cap in such an deal.

Good stuff, thank you!

Any thoughts on how they can vest in an equity stake in the company?

[MRM]

Law firms often create a class of partnership called nonequity partner. A variation on that theme might be a good option for you. A nonequity partner shares in profits and losses and gets a proportionate vote in matters that the partnership or company puts to a vote. They are a real live partner. The only difference is that they don't have an equity interest in the company. That means they don't own an interest in the partnership property, like the building, the company name, etc. Maybe you can make them junior nonequity partners with a 5% partnership or something.

[berettafan]

Whoa there, do NOT create a separate class of stock in an S corp, you'll lose your S election.

In an S you can issue new stock or sell/gift existing. You can't allocate p/l however AND distributions (draws) have to be proportionate to ownership %. Not a good vehicle for the profit sharing thing.

[MRM]

Originally Posted by berettafan

Whoa there, do NOT create a separate class of stock in an S corp, you'll lose your S election.

In an S you can issue new stock or sell/gift existing. You can't allocate p/l however AND distributions (draws) have to be proportionate to ownership %. Not a good vehicle for the profit sharing thing.

A limited liability company would be a better vehicle for what I described. It's not hard to switch. There are some advantages to being an LLC, and others for being an S Corp. That's something you might want to look into.

[berettafan]

was referring to Shaun's post MRM, understood that you were referring to LLC or partnership.

[Don Plumley]

If you want to give her equity in your company (say that out loud - "give away equity in your company"), then first figure out what the value of the ownership stake should be in say five years. Not in terms of a percentage yet, but in terms of value based upon the additional value you expect her work to bring to your company.

For example, if by being efficient with production, quality, and freeing up your time delivers $1M additional profit (not gross) over the next five years, then is her fair share 1/2 of that? 1/3? 25%? Is is pre or post tax? Dont' forget to deduct the fully burdened cost of her salary over the same period. This is a good exercise to walk through with her to explain how you are deciding what the equity stake should be.

Then based on typical valuation metrics for your industry, figure out what your company will be worth in that same period. That helps put the percentage in perspective.

Since this is all brand new, rather than create a new class of stock today, I'd structure a contract that makes the promise of equity, based upon the company reaching certain financial metrics and her performance being at or above expectations. A percentage of the stock would vest every year with a lump at the 5 year mark. Then you create the new class of stock and issue shares. And to be fair, put in a change of control provision so that if more than 50% of the equity of the company changes ownership (i.e. you sell), then her stock vests immediately.

Just a few thoughts...

[Don Plumley]

BTW, you are using terms like Vesting and Partnership rather loosely and inconsistently. These are terms of art, and if you don't define them clearly upfront, you have the opportunity to create poor expectations.

[Shaun @ Tru6]

OK, thank you for your thoughts, clearly a bigger concept than I anticipated and it looks like a trip to a lawyer is in order.

Thanks again.

S

[Don Plumley]

With all due respect to attorneys, you should know pretty much how you want to structure the deal before you ask the attorney to draft it. I always give our attorney a deal points memo or outline and work with the other party on the key concepts before I start the clock. Otherwise you are paying the attorney to structure the deal and provide the contract - unless of course that is what you want to do.

[Shaun @ Tru6]

good advice Don, thank you. based on this thread, my own research, and goals for the folks working with me, I can put together a nice package of bullet points from which to build a good contract.

It looks like we'll go the LLC route on this and have already started looking into how that can be accomplished.

I hear you on the "give equity away" thing, but to me, I couldn't do what I am without these people, I value their contributions, and I'm one who thinks there's always enough for everyone if we are successful, and I our chances for success are greatly improved when folks have a stake in it.

[Don Plumley]

Originally Posted by Shaun 84 Targa

I hear you on the "give equity away" thing, but to me, I couldn't do what I am without these people, I value their contributions, and I'm one who thinks there's always enough for everyone if we are successful, and I our chances for success are greatly improved when folks have a stake in it.

I agree 100%. It's important that you verbalize this as too often unsophisticated entrepreneurs see giving away equity as a substitute for cheap labor - and as a result typically get what they are paying for plus dilute their own holdings without an appropriate return.

If you think of the equity as an investment you are making in your partners, then you are both more likely to be satisfied in the long run.

Good Luck!

[berettafan]

AND your accountant. tax implications here can be the difference in how something is done. most atty's have cpa's they work closely with.

[Noah930]

Originally Posted by Shaun 84 Targa

Yes. and single. and my age. and lives in LA.

I have no business (or motorcycle) advice to add. But there are more than a couple single Pelicans in the LA area. Throw your brothers a bone, man.

[MRM]

We'll need pics, too, Shaun, so we can give Noah our best advice. Helping our fellow Pelicanites. That's what this board is all about.