It’s been a little while since I last updated you on my wife’s adventures in entrepreneurship. A long while, in fact. I think the last update was when they were looking for Business Insurance. That was almost a year ago, now. So much has happened in that time! How will I fit it all in!
I think I’ll hit the highlights. And, cover the most important change. One you’ll likely be able to guess if your familiar with the series, and you’ve read the title of this post. When my wife first started this business, it was with two other partners. Each of them brought their own specialties to the table, and made the business the success that it is. As the title implies, one of them recently left the company. This partner is technically still a owner as he hasn’t sold his shares in the company, but has stepped down from any active participation in the running of the company as an employee. Basically, he’s become a silent partner.
Without letting too many of the details slip, let’s just say that over the last year or so, he had grown unhappy with his role at the company and felt that leaving an active role in the company would solve those problems. Whether it will or not is up for debate. In any case, there was lots of discussion over how this was going to take place. Much of that discussion revolved around how the control of the company would evolve and change once he was gone. My wife and the other partner had some very valid concerns about the structure of the company, it’s board of directors, and it’s shareholders. In particular, there was some confusion on what rights the shareholders held.
As a part of any corporation, the shareholders are technically part owners in the company. It gets a lot more muddled when you’re a shareholder in a large corporation like Microsoft, or Apple, but in a small company where there are only three shareholders, it’s a bit easier to see. If there are X number of total shares issued, and Y is the number of shares a shareholder owns, then their ownership of the company is Y/X. In a situation like Apple, someone who owns 1 share owns 1/924,755,000th of the company. In the case of my wife’s company, each of the owners owns 100/300th of the company, or 1/3rd. Much like a larger corporation, my wife’s company is required to have an annual shareholders meeting where the board of directors are elected and other similar things are voted on. Generally, it will just be the election of the board. So, the more direct answer is that the third, now silent, partner has a 1/3rd say in who is elected to the board of directors. Should he disagree with the selections, he could vote against it, but wouldn’t be able to overcome the 2/3rd majority that the other two partners have. So, based on that, he really has no realistic say in how the company is run.
Another bit of contention is that fact that if the company were to pay a dividend to the shareholders, as they did this last year, that he would get 1/3rd of that dividend without having done any of the work that the other two partners had done. Unfortunately, that’s just the way it is. He still owns 1/3rd the outstanding shares, so he’s entitled to 1/3rd the dividend. There are several ways around this. The most obvious of which would be if he were to sell his shares to the remaining partners and completely exit from any involvement with the company. The other method would be to take the 2700 shares that the company is able to issue and give them to the remaining two partners as an annual bonus of some sort and in effect, dilute the third partners shares. Everyone involved feels this is a somewhat backhanded way to deal with it and it will likely not happen. Short of that, it would also be possible to increase the remaining partners salaries such that the issuing of a dividend would not be reasonable. This also isn’t a great solution as both the partners and the company would pay the higher payroll tax rate on the money rather than the dividend rate. In the end, it’s probably best that they just leave it as is, and merely acknowledge that the third partner put in a years worth of work and helped build the company so is entitled to that bit of ownership that he has.
I think there are a couple of very important lessons here. The first is that starting a business is no small thing. The people that you choose to partner with may not always be of the same mindset, and they may decide that the partnership isn’t working. You’ve got to be able to live with the consequences of joining into the partnership, especially if the partnership fails for any of the partners. The second lesson is that you’ve got to keep a level head when dealing with situations like this. It would have been easy for any of the three partners to overreact and cause it to be a much more difficult situation that it was. Playing nice isn’t just for the playground, folks.
Are there any other specifics that I haven’t covered in this or other posts in the series that you would like to hear about? I’ll share what I can.
photo credit: homesbythomas
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A good example of what can happen when a partnership is formed though its sounds like your situation is being handled appropriately. I can’t image that is always the case. Make me think its a good idea to come up with an agreement before the business is formed in what would happen if one of the parties decides to leave.
It sounds like everyone has been able to behave professionally and keep the lines of communication open. I always think that’s the most important thing to think of when forming partnerships. Sure its cool to create a company with your friends, but when things get tough, will you be able to keep it professional?
At the same time, situations like this are why anytime we consider starting our own business, we would form an LLC.
Interesting post. Working through people issues is always the most complex part of any business, large or small.
How does that third silent partner view his/her role? Does s/he know that the other two partners feel the situation is somewhat unfair?
Any chance that the person would be willing to simply sell out his shares to your wife and her partner? This would seem to be a logical solution if the 3rd partner is not happy with being outvoted all the time. If they are not willing to do this, then I would just tell them to shut up!
@shanendoah It wasn’t a perfect resolution, but it served the purpose. It did degrade to a less than professional status a few times, but it managed to stay above the belt for most of it.
@Marie The other partner pretty much doesn’t want anything to do with the running of the business but hasn’t expressed any willingness to sell his portion of the company.
@My University Money See my response to Marie above. I don’t think he’ll have any problem with being outvoted. In fact, I don’t think he’ll show up to the shareholder meetings and instead choose to either vote by proxy, or to vote with the board rather than show up. So far, he’s kept to the silent part of it at least, and it seems to be rather peaceable now.
Interesting situation. You don’t often hear about the dynamics of a small company under the Corporation umbrella. I’ll be interested to hear how this all shakes out.
It is so difficult to be an entrepreneur these days. You need time and money to build your business, but you can’t have both if you work full time. I respect anyone that can just say “hey, I’m outta here” and give entrepreneurship a shot.
Thanks for the detailed breakdown. Two questions, looking back, would the two remaining partners have been better off without the silent partner from the beginning? How is the remaining 2700 shares available to be issued determined?
@Buck The third partner was one of the major catalysts for creating the company in the first place. Without him, the company likely wouldn’t exist. Which is part of why nobody is pushing him to get out. At the moment, there is no set plan on how the 2700 shares are to be issued.
This post raises some excellent points about things to consider before jumping into self-employment, especially if you’re entering into a partnership with others. Probably more so than a large company, a small company is subject to changes in the goals and direction of its founders. If there are only three people involved, the actions of one have a HUGE impact on the other two!
As I lean more toward the possibility of eventual self-employment, posts like these remind me to take my time and consider all possibilities. Thanks!
I tried partnering with someone I barely knew and it ended up I did all the work. We had a lot of enthusiasm at first, and I tried to keep it up, but he just fell away and didn’t do anything. It’s really important to bang out all the terms and conditions ahead of time. Because I did the whole “casual” or “good ‘ol boy” agreement, I just ended up wasting a lot of time. Lesson learned!