In our last post, we mentioned the challenge of how partners should potentially split equity in a new business – one created from two other successful ventures that the partners ran independent of one another. If two businesses are merging, after all, shouldn’t the split be 50/50? Well, that’s a complicated question and the answer is even harder.
We’re discussing service businesses, so the assets may not play into the ownership equation. After all, if a digital marketing company and an SEO company merge, the only real assets the companies may have is software directly purchased by the respective owners. Not the same as a company with a fleet of truck, tools, and equipment or a physical office building. As a rule of thumb, if both small businesses bring large amounts of assets, not intellectual property, to a merger, then the initial split may need to be based purely on the value of those assets.
There’s actually a lot of logic in not splitting any partnership 50/50 if you think about it – any action requires a 100% majority and what is important to one partner may be far down on the list for the other. The decision ends up a dead heat and no action is taken or the partnership blows up and dissolves at the first sign of trouble. Of course, the other side of the coin in this scenario is that if both partners are truly aligned in their goals, then the company can move forward quickly with the action that is necessary for growth.
Personally, 50/50 makes the most sense, because the business needs to be tested to make sure that the partners can work together. This is why due diligence in the merger process is so critical.
By taking the time to understand what a potential partner’s goals are, both parties can see if the alignment is there. Are your growth goals compatible? Is one partner looking for retirement in 5 years, at which time they would sell their half of the business to the other founder? Are they simply happy being successfully self-employed and have no desire for growth? When you understand the possible objections to growth or strategy, you can plan business growth and projections and that 50/50 ownership is not an impediment – it is actually powerful team builder.
Of course, if the partnership is not in alignment, then the business can simply turn into a bad marriage and will, ultimately, fail.
In the end, any equity split needs to be explored based on what the respective partners are bringing to the table – if one brings half a million in assets, then the other should be responsible for half a million in capital. (Of course, money seems to disappear faster than trucks and offices, so this could be a sticking point – understand who retains the ownership of the assets in this case!) In either case, ownership and stock certificates rely on an understood value for what a business is actually worth, and while the above referenced business has one million in total “value”, the true value of the business could be much more or much less when you approach the next round of funding in the lifecycle of the business. Growing that number is our next subject, and we’ll look at that with a more critical eye since it involves everybody’s favorite thing – money.