Dec. 5, 2018

Alliance of ideas and money: how to calculate the interest and influence of business partners

Many companies start as alliances of ideas and money used for their realization. At first, such partnerships are very productive, but in time, success and money cast doubt on the role of the partner responsible for knowledge/product/brand/skills rather than funds.

It is traditional in our society that the investor gets a larger cut, and the one who runs and and develops the business – a noticeably smaller one. Business shares determine the influence of a partner, and the managing partner is usually unable to change decisions made by the investor even if they are harmful to business and reputation.

However, in 2018, corporate legislation was changed, making share management more flexible and giving the owners of smaller shares more opportunities to protect their interests.

Can the managing partner count on a larger share?

When a new business is created, the partner that brings knowledge, brand or experience can expect 50%+ votes in the company. However, in practice, without any discussion or arguments, he/she usually gets 10-20% and becomes dependent on the other partner.

So how to calculate this intangible contribution? There are two basic methods.

  1. Multiplying the hourly wage of a person with certain qualifications by the total time he spends on this work over a certain period.
  2. Subjective assessment of the unique knowledge, experience, reputation, customer base, etc. based on the expected cash flow of the new business.

It’s the second option that is usually used in our country. The partners get together to divide shares in the company, not even thinking that they are evaluating intellectual contributions. They are simply dividing shares. For example, an investor offers a doctor 100 thousand dollars to open a clinic. The terms are: 80% for the investor (since he gave the money, without which there would be no clinic) and 20% for the doctor who will be running the clinic. Many in our country agree to these terms and even consider them beneficial, but even a simple calculation of the doctor's contribution – unique experience, knowledge and skills, reputation, personal brand and customer base – will show that his share in the business should be at least equal to that of the investor. Best case scenario, it should be 60%, 70% or more, but we still often evaluate these contributions intuitively, without any calculations. This results in underestimation of intellectual resources and short-lived businesses.

How to evaluate flexible joint business management?

Business with several owners is usually registered as a limited liability company (LLC), making the investor and the manager members of that LLC.

The interest in a business is essentially the number of votes that a member can use to support a certain business decision. Naturally, members with larger interest (majority members) can significantly complicate the life of the managing partner and damage the business itself by voting or hindering the manager’s work.

However, the new LLC law passed this year (Law of Ukraine on Limited and Additional Liability Companies) and the law on corporate contracts (No. 1984-VIII) make the relations between owners of uneven shares more flexible:

1. Mandatory approval of candidates for top management positions by all members. It is possible to provide in the charter for the approval procedure for such candidates prior to the general meeting, as well as to put a provision there that only candidates approved by all (100%) LLC members will be voted on. The latter will provide additional protection to minority members.

2. Protection mechanism for minority members put in the corporate agreement, by putting a list of issues in the agreement on which the investor will be required to vote at the general meeting as the managing partner says. These could be issues related to the appointment/dismissal of the CEO, business development, or any other. It is also possible to put in the corporate agreement provisions on who and when makes decisions in case of disputes between members (for instance, in case of a 50/50 distribution of votes).

3. Irrevocable proxy. With this document, the investor authorizes the managing partner to vote in his stead at the general meeting in case of his absence. Irrevocable proxy is convenient when the investor does not plan to interfere in the company's day-to-day activities at all, lives in another country or cannot always attend the meetings.

4. You can specify in the charter or corporate agreement the terms and procedure for a partner’s withdrawal from the business, the sale of his share, or the attracting of investors. When the withdrawal and sale procedure is described step-by-step at the start of a business, the company enjoys unprecedented protection in case of conflicts between partners. This will help your business survive where many others go down.

5. LLC governing bodies can now be customized to suit your needs by creating a supervisory board or other governing bodies and setting your own rules for the general meetings, voting and so on.

All the tools are there, and if Ukrainian entrepreneurs start using them, this will help partners maintain their reputation and contribution as well as increase the value of their business.