Crafting a profit sharing scenario that is easily unwound?


3

This stems from answers to my other question on profit/equity share when taking on a partner.

Some of the answers suggested that a profit share is suitable when taking on an employee, and equity sharing more suitable when taking on a partner. Now, for a startup, I'm not sure where the line is drawn between an initial employee and a partner, but I reckon it depends on a level or period of commitment?

When taking on a partner for a short period of time during the initial development stages (a few months), how can I craft a profit sharing scenario that is easily unwound if the partner leaves indefinitely? In this case, my potential partner is only available for 6 months per year.

It needs to be taken into account that it might take a few months for reasonable profit figures to emerge.

Partner Equity

asked Oct 5 '10 at 18:45
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Pate
306 points

3 Answers


2

Nothing prevents you from literally saying "You share in profit sharing while you're here, but if you're not here for any reason -- termination or resignation -- than you stop sharing."

If there needs to be something more sticky you can do vesting like with stock, but that's unusual for profit-sharing.

answered Oct 6 '10 at 04:34
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Jason
16,231 points
  • Your answer led me to learn a lot about vesting, which has already benefited me in one important agreement. – Pate 8 years ago

0

We issued profit sharing certificates for a certain percentage, say 1%. They can then redeem this within 0-3 years (typically wait the full 3 years) for that percentage of [profits + founder-salaries] (so that we can't just say oops we paid ourselves everything, profit is $0) for that year.

This is designed to discourage short-term profit-taking (e.g. we don't want people pushing for R&D cuts to boost short-term profits) by taking a medium-term view while avoiding long-term commitments & complexities of having more owners. You can renegotiate percentages periodically.

(Disclaimer: so far we've only tested this on friends and family who've been helping out part-time. I don't see any obvious reasons why it wouldn't work for other types of relationships though.)

answered Dec 13 '10 at 04:40
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Polemarch
301 points

0

Profit share schemes are always somewhat arbitrary. If this is going to be important for you, you just want to make some appropriate adjustments.

For example, if you've already established a profit share scheme that makes calculations and distributions annually, you could say that your partly-unavailable partner will participate pro-rata based on months worked in the year.

If you are counting current contribution as contributing to profit in multiple years, go for the same principle of simplicity and transparency. You need to define how long the profit share from current work can remain active, how and if it tapers and how this is affected by leaving (e.g. any such participation terminates a year from the last date of service for a 'good leaver' and immediately for a 'bad leaver').

I guess the most common form of profit share I've come across consists of three core elements:

  1. The basis and frequency on which profit is calculated
  2. The formula for calculating the profit share pool
  3. The formula (or schedule) for determining each individual's draw from this pool

Your short-term / part-time hire question will be part of your thinking in question 3 here. A good solution will be good for present and future hires - and in my experience can really maintain excitement in a growing team long past the point you're routinely granting or even discussing equity.

answered Oct 13 '10 at 19:01
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Jeremy Parsons
5,187 points
  • IRS also has regulations on profit sharing. Please make sure to look into them and consult a CPA. – Frank 8 years ago

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