“How do I negotiate an equity position in a new company”

Question: I am currently working as a Regional Director for a company and have brought a potential partnership to the table to my CEO based on my personal relationships with the other business owner. The deal would be a new company where one party provides the customers and the other party provides the management and services to the customers.

I have been sent a pro forma from my CEO to send to the other business owner, and would like to negotiate an equity position for myself going forward.

How do I ensure that my position is substantial enough over time? Should I ask for performance based incentives until we reach a certain mark where I could become an equity partner, or ask for a small position, say 1 – 10 %? I have heard that anything less than 25% is not worth having legally. I will be personally developing this business locally with special events that will drive revenue.

Pacific, Missouri

Answer: Dear Krissy: I’ve counseled and represented many people in your situation. Each situation is different, but there are three “General Rules” to follow.          

1. Are you confident your CEO and the other company are agreeable to having you as a “partner?” I don’t at all mean to discourage you, but many employees want to become “owners” or “partners” based on their contribution to their employer. From a business-owner’s perspective, the idea that the employee (a) will not contribute any investment to get the business going, (b) will not cover the costs of the business during time – perhaps years – that the new business may not be profitable, and (c) will not suffer the losses if the business is not ultimately successful, is often not taken seriously. So, first, I would suggest that, if you have not already done so, you have a very frank talk with your CEO to make sure he or she is interested or willing to have you as something of a partner with the company. That may be even more than he or she is getting out of the deal.

2. General Rule 1: If there is interest in your becoming a partial owner, the size of your initial ownership stake depends entirely on how “necessary” you are perceived to the success of the business. If the other company will definitely not go ahead with the deal without your becoming a partner, you may be in a good position to ask for a substantial piece of the company, perhaps 10% to 20%. On the other hand, if you are viewed by the two businesses as merely a person who made an introduction, and a person who would be somewhat helpful to have around, you might be lucky to get even 1% ownership.

If the new business was a baseball camp, and you were Derek Jeter, and were willing to meet each kid at the camp, I think you could even ask for 75% of the company. If the new business was a baseball camp, and you had some good ideas about how to run it, but never ran a baseball camp, chances are you would get no equity.

This is what we call “Relative Negotiating of Equity.” I wrote a newsletter about it. If you’d like to read it, just [click here]. 

I am sorry that in this space I cannot explain why “less than 25%” is a problem “legally,” but that using “General Rule 2,” below, is a way of “navigating and negotiating” around that “legal” problem.

3. General Rule 2:   The only real way to make sure your initial ownership interest stays valuable, and is not diluted or otherwise devalued, is to use what I call “No Less Favorable.” One thing you can count on is that the two “larger” partners in this company will make sure – or at least do their best – to ensure that their ownership interests are not lowered in value by anything that might happen in the future. But, of course, if a large investor is willing to invest say, $4 billion in the company, the two “larger owners” may have to give away some of their ownership interests. Likewise, if the new company needs to borrow money, it may have to pledge, as collateral for that loan, stock interests in the company.

What you need to ask for is “My equity interests will in all events be treated No Less Favorably in All Respects” than are the ownership interests of the two major partners’ interests. In this way, you’ll be treated just like they are: good, bad or indifferent, but not abused by them (or their smart lawyers.)

4. General Rule 3: Use an attorney who has done this sort of work before, as these negotiations and documents are full of “trap doors.” This type of opportunity will likely not come about often; most people never get such an opportunity. Their negotiation is delicate and tricky, as are the documents that are put together for this purpose. You should never “share” an attorney with one of the other two partners. And you should not use an attorney who has not done this sort of work a good deal. As attorneys we learn over time; that is why they call it a “practice.”

Krissy, I see that Pacific is near St. Louis. If you would like to obtain a list of experienced employment attorneys in St. Louis, simply [click here].

Also, Krissy, if you would like to obtain a short (30-40 minute) or in-depth (2-hour) consultation with our firm on this topic of concern, simply [click here]. 

What you are trying to do is very exciting, a bit daring, and surely exhilarating. I can’t say much more than “Go for it, with passion and persistence!!”

I hope this helps a bit. Thanks for writing in. Consider sharing with others our blogsite, our YouTube videos, and our Model Letters with which you can learn to navigate and negotiate for yourself at work.

Al Sklover

© 2011 Alan L. Sklover, All Rights Reserved.

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