Partnership Compensation Doesn’t Have to Be a Flash Point of Tension
Here are 7 important points to consider as you work out an agreement on compensation with your business partner. Above all, remember you can do anything that legal and agreeable to all partners. That means pay doesn’t have to be equal. One partner might get paid and the other not. As long as that’s agreed, you can do it. Let’s look at the 7 considerations of partnership compensation.
#1 When Should Partnership Compensation Commence?
If you or your partner(s) are beginning to experience burnout, it’s time to try to get some money paid to partners. You want to make some payments if partners need money even if the business isn’t yet profitable. Working hard and making nothing leads to burnout and that’s more destructive than the stress overreaching the point of profitability. I’m a big believer in paying partners as soon as possible for the sake of the partnership and the survival of the business. You must exercise caution and no go overboard with early compensation but even small amounts help.
#2 Pay Vs. Draw Vs. Expense Reimbursem*nt
There are different ways to get money into the hands of partners without starting a salary commitment. Let’s look at various forms of payment that might be an option in your Partnership or Partnership LLC.
Pay
This is payment for work and is generally paid as a salary. If the business can support making regular payments, you can set up a small salary agreement. The amounts can be small. Minimum wage laws do not apply to owners. Each partner might get $100 per week. That’s not much, certainly, but it might be enough to quench the fires of pending burnout. Never forget that appreciation for each other is extremely important. Initiating a small salary along with your appreciation will go a long way toward cooling tension over the subject of money.
Draw
A draw is generally an amount taken against anticipated profit distribution. Let’s say that we all agree that the business will have a profit of $100,000 this year. Each of our 3 members of our LLC can anticipate getting $33,333 since we’re equal partners. If a partner needs money now and the partners agree, we can issue the partner in need a draw of $10,000 against her distribution. Later, when the profit ends up as projected at $100,000, the draw is deducted from the distribution for that partner.
Expense Reimbursem*nt
This is often a big issue in a business in its second and third years. You and your partner both put up $50,000 to start the business. A couple of things came up this year that could be opportunities and you decide to kick in $2,500 to buy a machine at a steep discount. A few months later, the question comes up about why the extra money I put in isn’t counted. What does that $2,500 get me? Sure, the business is better off with the new equipment but should the money for that come from me alone?
My approach to things like this is to get them all on the table to get a clear and fair sense of what everyone contributed. If that is out of balance, or if there is full agreement, those little extra expense items paid by one partner should be treated as reimbursable expenses. Each partner may have some of these.
Once we have the list and everyone agrees on that list, we can treat the items as “cash calls” necessary to keep the business going or we can have each partner fill out an expense form and submit for reimbursem*nt. I like the reimbursem*nt method because it settles a lot of tension between partners when someone feels they are putting money in but not getting anything back.
There are two very important things to consider when reimbursing for expenses.
- We do not count startup money as an expense
- We want to get money issues balanced, solved, booked and eventually paid before someone starts talking about adjusting the equity. If that comes up, there is big trouble ahead.
Accountants, bookkeepers, and lawyers hate me for this approach. Partners, especially partners in LLCs love me. The problems dissolve and partners are motivated for success. Further, we eliminate ALL discussion about who has a greater stake in the business.
#3 Do You Need a Formal Agreement About Partner Compensation?
Yes. (Not really, but it’s a very good idea.) The agreement can be as simple as a partner-drafted resolution.
“Resolved, we agree that until annual sales reach $150,000, each partner will receive a salary of $300 per month.” That’s about it. If we need more definition, we can draft it. It’s not the U.S. Constitution so it can be somewhat informal so long as there is agreement. (See why lawyers hate me?!)
