How to Add the Right Equity Partners at the Right Time

Sharing the business you worked so hard to build through the addition of new equity partners can be challenging for entrepreneurs, even when the move is in the best interest of your enterprise. To have success here, you must be careful not to get in your own way. It’s easy to see the risks and to feel the acute pain of ownership dilution. What’s often more difficult to assess is the positive impacts new equity partners can bring.

Nevertheless, be cautious. Business partnerships can last a lifetime and may be harder to dissolve legally than a marriage.

Related: How Strategic Partnerships Catapulted My Business to 200% Growth — and How They Can Help You, Too.

The value-add of new equity partners

For a business owner, one’s equity is like one’s lifeblood. They’d assume not to dilute it unless given very compelling reasons for doing so. For owners who are calling the shots, the prospect of sharing or giving up control over the firm’s decisions and direction may leave stomachs a bit queasy. The trick is knowing the right time and the right reasons for letting go. Here are a few scenarios where giving up equity may make a whole lot of sense:

Expansion

Your construction firm is the best in town, but you’ve got expansion on the brain. Based on your read of the marketplace, bidding on local government contracts — power stations, sewage treatment plants, parks etc. — present excellent business opportunities. The problem is that you and your current lineup of executives have all made their bones in the private sector. Perhaps it’s time to form an equity partnership that can bring meaningful experience to your new public-sector ventures.

Recruitment (or retention)

There’s an all-star in your industry with a rolodex full of clients you desperately need. Perhaps this power player is already considering jumping ship from her current outfit and going out on her own. You never know: A partnership at your firm may be just the ticket she’s looking for, and, since teamwork makes the dream work, your combined efforts may be greater than the sum of their parts. Similarly, you may already have this person on your payroll, but, without an equity partnership on offer she’ll be going her merry way soon, and your firm will suffer for it.

Funding

Sometimes it just boils down to the almighty dollar. Your business is up to its eyeballs in debt and needs a capital infusion asap. Growth is stifled because of the high debt-to-income ratio. An interested party, maybe a current employee, wants to buy in as an equity partner. Maybe you should let him.

Succession

Everyone’s favorite topic: Who’s going to run it all when I die, ahem, retire? For the sake of your business’s enduring legacy, the expansion of equity partnerships is a must.

Related: Most Business Partnerships Fail — 5 Hacks to Make Sure Yours Stays Intact

What to consider before bringing in new partners

Most crucially, any new owners in your business need to be on the same page with you when it comes to the business’ values, direction and goals. If partners end up at loggerheads, then the firm’s day-to-day and longer-term business operations will be less effective. Make sure you and your partners-to-be will all be rowing in the same direction.

Once it’s established that the partnership is philosophically and logistically viable, it’s time to crunch some numbers. In most cases, it will help to have a valuation for your business. A valuation for your business allows you to assign a present-day valuation to the equity you’re giving away.

A CVA (Certified Valuation Analyst) is your go-to professional for business valuation. Not that your business attorney and accountant shouldn’t be involved. They too have roles to play, but the CVA is the one best equipped to put a price tag on your firm and, by extension, a price tag on whatever equity ownership percentages may be under consideration.

Make sure the value of the equity share you’re giving up is commensurate with the value you expect to gain by adding the partner. Equity, as most entrepreneurs understand, is a zero-sum proposition. If you’re in a 33-33-33 partnership and add in a fourth partner at 15%, then your personal stake is diluted by nearly five percentage points. Is the new partner worth it?

Vesting periods

Many companies use vesting periods and other means to ensure that new legal owners remain fully committed to the work of the firm. A five-year vesting period, for example, may allow a new partner to gradually buy in or be awarded equity in five phases. If the new owner is entitled to 20% ownership, then she may acquire 4% after year one, an additional 4% after year two, and so on until she’s received her full 20% by year five and has become “fully vested.”

Similarly, a new partner may prove their commitment by agreeing to work for a salary lower than their “market rate” for a fixed period of time. They may also work on a “draw,” whereby their compensation is directly attached to the revenues or profits they help procure for the business.

Alternatives to equity partnerships

A partnership may come in many forms. In the professional services sector, the trend towards non-equity partnerships is hard to ignore. Non-equity partnerships allow businesses to retain and develop talent by bestowing the title of “partner,” often accompanied by a formidable salary, without allotting them the voting rights, profit sharing and business development responsibilities typical of an equity partner.

Moreover, some of the value-add you seek in a new partner may be available elsewhere in the larger marketplace. Bear in mind that consultants and service providers will gladly cultivate years-long relationships with your firm to aid in growth or other strategic objectives without taking any of your equity.

Related: This Is the Unseen Advantage Your Small Business Might Need

Be intrepid but deliberate

When considering the dilution of your ownership stake, be careful not to discount the value brought to the table by a new partner. Just as there are risks to bringing them in, there are also risks in not doing so — 33% of a $10 million pie is worth a lot less than 25% of a $20 million pie, and for many businesses, a well-qualified new stakeholder, brimming with good ideas and the energy to execute them, is exactly what’s needed to renew and expand the vitality of the enterprise.