Complicated Partnership - Advice needed

[Keltik]

Hello all, I'm new to this forum but I've been long time reader. My situation is complicated so here I've included some background information - sorry for the long first post.

I'm an IT guy working for a small law firm, I do some moonlighting on the side and have done ok doing so. Recently I've decided to go all out and really get my side business going. So, I decided to ask a friend, John(alias) who happens to be my bosses bother in law (he owns his own Dental IT company) for some business advice. As we spoke about my situation and how I wanted to grow my business, he was surprised, because he felt the same way and wanted the same. So he offered me to be a partner in his company, Dental Solutions Inc. (alias), I would become a partner and create an IT legal side to Dental Solutions Inc. (DSI). The first hurdle was to get the approval of my current boss, because I didn't want bad blood in the family, plus I wanted to make the law firm I'm currently at my first client.
When the news reached my current boss about the idea, he didn't take it too well, but quickly got over it and understood my circumstance. He agreed to becoming a client of DSI and letting me keep my current office for free as long as I would be the person in charge of their IT infrastructure. With that said it was insinuated by both my boss and I that my pay would be the same, just that my status from employee would be changed to consultant and we would do the change at the end of the year.
At the same time this is going on, John coincidently gets a referral to service a legal company. We figured that this was a good opportunity to get to know each other professionally before making the partnership official at the end of the year, and therefore went forward with this project together. We had decided that the profit of any new projects that we both worked on would be split 50/50, and so it has.
So with all that said we are still confused on how this partnership will work financially because I am not it a position financially to contribute capital to DSI.
So my questions are:

• What are ways for me to gain equity in the DSI without a financial investment?
• It was agreed that any projects we worked we would split 50/50. He needs help with his existing Dental clients, but won't ask me for help because he feels he would have to give me 50%. How can I help him with his existing clients fairly? Is there any ideas on how to meet halfway with the profit if I were to help him with an existing client, and vice versa?
• Does this partnership sound like a good idea?

[jamesray50]

Have you already formed your partnership with the state? Does it state that you will split everything 50/50? The only way to get equity in a company is to invest money or from the profits of the company. I'm a little confused about the clients you already have. The law firm you have is already a client of your new company? But they are going to pay you as an independent contractor? And you are not going to split that 50/50? Why? What kind of help does he need with his existing clients? Is it recurring help? If you are not going to split your existing client 50/50, why should he split his existing client 50/50?

I'm not a tax accountant or attorney so maybe they can chime in on this, but I wouldn't want to be a partner with someone who agreed to split everything with me 50/50 and then I didn't get 50% of the income they brought in, especially if they didn't contribute any equity to the business.

[vangogh]

First welcome to the forum and no need to apologize about the length of your post.

I'm hardly an expert on the legality of forming partnerships, but I did have a few thoughts reading through your post. From what you described I think a partnership could make sense, but it's sounding like you and "John" are going about this the wrong way. If you two become partners in one company than neither of you has clients anymore. The company does. You shouldn't be looking at one specific client and thinking is it fair to share 50 percent of that client with John. And he can't be thinking the same thing about the clients he's brought to the business.

With your current boss he should no longer be writing you a check. He should be writing it to DSI or whatever the company name is or becomes. Personally I wouldn't take him up on his office deal. I think that will leave you working for him rather than him being a client of yours. Even if you technically set it up that way he's always going to see you as employee and that's how he'll treat you. When the day comes where you have to choose between working on something for him or another client you'll never have the option to work for the other client.

If you and John want to form a partnership talk more to each other about how it should work and what would be fair to each of you. You both have to realize that it's no longer you as individuals having clients, but you together as a company that has clients. If over the next year 90 percent of your clients only need the dental side of things then you would both be expected to work on that side of things and still split the company profits. That might sound unfair to John at first, but it's how it is. If the next year 90 percent of the clients come from the legal side then you still both do the work and both share the profits.

I would think IT is pretty much similar for either industry. Obviously there are differences, but I assume either of you could do the work for each. If that's not the case and only you can really do the legal thing and only John can really do the dental thing then your partnership isn't going to work unless you each bring in a similar share of revenue.

What I would think should happen is John brings you on as partner. He brings you up to speed on his current clients and anything you need to know to handle their IT infrastructure. You do the same with any clients you bring in to the partnership. At that point either of you might be doing the work for any client. The money has to come into the partnership (not to either of you specifically) and then is shared between the two of you based on whatever split you both think fair.

[Harold Mansfield]

Sounds pretty simple to me. Do the work on the past clients as a way to "pay" your way into a full partnership of all clients. Or, do it for additional compensation on the next few partnered clients.

[Keltik]

Thanks for the prompt replies.

We haven't finalized anything yet (legally) because we are still trying to work out the logistics of the partnership. The current law firm I work for will start paying me as contractor at the end of the year, I agree, I am not going to take the offer of making the law firm my office.

The problem with the 50/50 partnership is that I don't bring much to table, except for my expertise and a few clients. He on the other hand, established the business 4 years ago, has built a nice clientele and invested all the capital to start it up. So I guess my only solution to becoming a 50/50 partner would be to invest 50%?

He feels that splitting everything 50/50 without me contributing capital is not fair for him, but if I can't make that capital investment what else can I do?

eborg9, so in exchange for me helping him out I would earn equity in the business? is that what you meant?

Thanks

[Harold Mansfield]

eborg9, so in exchange for me helping him out I would earn equity in the business? is that what you meant?

Thanks

Pretty much.
I can see where he is coming from. You would have to come up with something fair. I doubt that it would be a 50/50 from previous clients, but maybe you can come to some kind of agreement so that all clients are on the same page. Or some kind of schedule of reinvestment on your behalf that would buy you additional equity on the entire business.

[Harold Mansfield]

eborg9, so in exchange for me helping him out I would earn equity in the business? is that what you meant?

Thanks

Pretty much.
I can see where he is coming from. You would have to come up with something fair. I doubt that it would be a 50/50 from previous clients, but maybe you can come to some kind of agreement so that all clients are on the same page. Or some kind of schedule of reinvestment on your behalf that would buy you additional equity on the entire business.

[vangogh]

I can understand where he's coming from. Could you work something out where in the beginning it isn't a 50/50 split and then as you bring more clients into the business your share of the split increases.

This is just off the top of my head and very rough. Say he has 9 clients and you have 1 and assume each client brings in the same amount of revenue to the company. Could you then take 10 percent of the company with him taking 90? Later he's brought in 14 clients and you've brought in 6 and now the share is 70/30. Assuming you both keep bringing in clients at a similar rate your share is going to continue to increase. Then maybe at some agreed upon point in the future when there are enough clients in genera the split becomes 50/50. Or maybe the 50/50 split kicks in once the clients you've brought in has reached some percentage though less than 50 percent.

I think for this to work for you it's going to have to be some kind of partnership and while it's understandable that the other person wouldn't see a 50/50 split as fair now, there should be ways to get to the point where it is fair either through your share of the company starting lower and slowly increasing or by some agreement as to how much capital you put into the company over time.

[phanio]

What is Dental IT? Some new form of plaque? You can form a LLC or other form of partnership where both of you contribute to the office expenses - which should be very little in the beginning (should be) and each keeps the revenue that they bring in minus some fee to the business for overall marketing and administrative expenses. Example, you bring in a client where you earn $1,000. You take $900 as your payment and put $100 into the business. Your partner does the same. In a year or two - re-evaluate your business situation and make changes as needed.
Other then that, find a way to contribute monetarily as much as your partner does and form your LLC (which I recommend) as a 50 - 50 entity with some outside factor being a tie breaker.

[Evan]

With that said it was insinuated by both my boss and I that my pay would be the same, just that my status from employee would be changed to consultant and we would do the change at the end of the year.

That's a BAD deal for you. Say you're paid $50,000 per year as an employee. The law firm pays half of your social security and medicare tax, plus an applicable insurance costs (worker's compensation, health care, etc.) and and state employer-only taxes such as disability, etc. Your total cost is probably much higher, closer to say $65,000. If you're accepting just $50,000 a year, which may have been your take home at the law firm, your take home after taxes will now be significantly less after taxes. It isn't comparable at all.


• What are ways for me to gain equity in the DSI without a financial investment?
You don't need to make a financial investment. It's possible to work for your equity in the partnership.


• It was agreed that any projects we worked we would split 50/50. He needs help with his existing Dental clients, but won't ask me for help because he feels he would have to give me 50%. How can I help him with his existing clients fairly? Is there any ideas on how to meet halfway with the profit if I were to help him with an existing client, and vice versa?
Yes. Set an hourly rate with him, and say you'll provide so many hours to assist him, and that will be considered your capital contribution to the partnership. Then, keep track of clients you each receive, and you can designate it so all revenues derived from that client belong to that partner, and that time worked by the other partner shall be billed at a certain rate. Important thing here is to keep track of time.


• Does this partnership sound like a good idea?
Seems like it could have a disadvantage, as I noted above. There can be benefits to being self-employed though.

[Evan]

I should say too, with the partnership type above, where you're more just independent practitioners just cost-sharing and utilizing each others expertise -- your partnership agreement may be a bit complex, but it works and prevents you from feeling like you're getting screwed. Nobody wants to see the other taking a 3 month vacation and getting 50% of the revenues that the one partner is generating entirely on his own -- especially on a service-based business.

[Reflo Ltd]

Thanks for the prompt replies.

We haven't finalized anything yet (legally) because we are still trying to work out the logistics of the partnership. The current law firm I work for will start paying me as contractor at the end of the year, I agree, I am not going to take the offer of making the law firm my office.

The problem with the 50/50 partnership is that I don't bring much to table, except for my expertise and a few clients. He on the other hand, established the business 4 years ago, has built a nice clientele and invested all the capital to start it up. So I guess my only solution to becoming a 50/50 partner would be to invest 50%?

He feels that splitting everything 50/50 without me contributing capital is not fair for him, but if I can't make that capital investment what else can I do?

eborg9, so in exchange for me helping him out I would earn equity in the business? is that what you meant?

Thanks

It sounds to me like John has a company and wants to add you as a partner, essentially. John, in all honesty, should be adding you as an employee as it doesn't sound like you bring much to the table for the business, per your own commentary on that matter.

What is in it for John? Do not go into this thinking that John wants to just be a swell guy and include you as an equal partner in his already somewhat established company. Be certain that you and John lay out the expectations and arrangements as solidly as possible before you get going.

If he wants capital and you have none, then again I do not see his edge. If he is willing to allow you contibute as you go, from your own earnings, that still makes little sense as he would be better off to hire you for a lesser fee and give up none of the company control.

I have to say, going in partners with people on various things over the years, this doesn't sound like a good plan from any angle.

My advice is always to never have a partner in business. The only time it is a benefit is if they have something that you absolutely need to operate your business and even then, I do not recommend it. It is always a difficult situation.

[ArcSine]

My advice is always to never have a partner in business. The only time it is a benefit is if they have something that you absolutely need to operate your business and even then, I do not recommend it.

You advise against it when it is beneficial :confused:

[Spider]

...My advice is always to never have a partner in business. The only time it is a benefit is if they have something that you absolutely need to operate your business and even then, I do not recommend it. It is always a difficult situation.Perhaps I should go back and re-read all that went before this comment, but it was made as an "always" comment and I felt compelled to respond. I hope I'm not taking anything out of context.

I think this is bad advice. Let's see how many businesses - successful businesses - we can think of that began as partnerships - Hewlett Packard, Microsoft, Apple, Sears, Ford, Cisco, Adobe, Forbes, Time, The New York Times, Dow Jones, Johnson and Johnson, Texaco ... need I go on?

[ArcSine]

In its recently-released Quarterly SOI (Statistics of Income) Bulletin (Fall 2010), the IRS reports that for Year 2008, based on all filings of Form 1065 (partnerships, LLCs, etc., being US-located or having US-sourced income)...

There were 3,146,006 partnerships (incl. LLCs, etc.)
These 3M+ entities had 19,300,250 partners
Their aggregate net profit for 2008 was $458.2 billion
Those reporting balance sheet data had an aggregate of $19.3 trillion of assets under management


This entity form seems to be working for at least a handful of folks...

[jamesray50]

This may not be quite the same as your situation, but the CPA firm I worked for had CPA who had been an employee for years and wanted to be made a partner. She had no equity as in cash, but she had clients and she used that as leverage to gain partnership. She has been a partner for years now, she takes a draw twice a month and a draw for quarterly estimated tax payments. The firm has 5 partners and each year after their books have been finalized the retained earnings are split amongst the 5 partners according to a formula/percentage that I'm not aware off. She has always had a negative equity amount. But she is still considered a partner.

[Evan]

She had no equity as in cash, but she had clients and she used that as leverage to gain partnership. She has been a partner for years now, she takes a draw twice a month and a draw for quarterly estimated tax payments. The firm has 5 partners and each year after their books have been finalized the retained earnings are split amongst the 5 partners according to a formula/percentage that I'm not aware off. She has always had a negative equity amount. But she is still considered a partner.

One can be a partner of a partnership by contributing solely services, and it may or may not create a taxable event. Unlike an S-Corporation, where profits/losses/capital are all based on stock ownership (and granting stock solely for services is a taxable event), a partnership may grant a profit/loss interest without giving an equity interest. Partnership agreements can become quite complex, and specific things can be allocated to specific partners as well. Partnerships yield a great amount of flexibility that is often unused.

The tax side of this equation may have been much different than the "book" side.