STRUCTURING BUSINESS RELATIONSHIPS
You want to collaborate with someone on your venture, but aren't sure how to structure the relationship. This article reviews some options and their associated implications to help you find the right fit.
INDEPENDENT CONTRACTOR / EMPLOYEE
One way to structure a business relationship is to simply hire someone to work for (or with) you on one or more projects as an employee or independent contractor. This can be beneficial if you want to work with someone, but still have independence and flexibility -- especially if the business relationship doesn't work out.
If desired, you can structure the relationship so they will share in the profits of the business to help incentivize their performance. You can even structure it so they remain involved for the long term with a continued interest in the success of the venture.
The following are different ways you can pay an independent contractor or employee based on your needs and goals. Each of the payment methods can be done independently or collectively in whatever combination you want. Sometimes one payment method can be leveraged against another. For example, you could pay them a lower flat rate for a project in exchange for a share of the profits generated from the project.
A. Flat Rates / Hourly / Salary
A standard way of paying an employee or independent contractor is to simply pay them a specified amount for their work. This could be a flat rate, hourly rate, or a salary. You must ensure it i compliant with employment laws.
B. Shared Profits
Another way to to pay an employee or independent contractor is to grant them rights to share in the profits of the venture. These rights could apply to one specific project they are helping with, or it could apply to all money earned by your business.
For example, you could hire an independent contractor to help you brand one particular product and offer them a share in profits of that particular product without giving them any profit sharing rights to other products they aren't involved with.
C. Phantom Equity
Another way to give someone a vested interest in your business without actually giving them any ownership is to grant them phantom equity. Generally, this involves giving them a right to a certain percentage of profits earned by the business as a whole. It may also give them rights to share in proceeds if the business is sold.
However, because they are not an actual owner, you can prevent them from having rights to vote in the company decisions and it may be easier to remove them from the business if things don't work out.
Phantom equity can also be:
- Vesting -- Where they earn rights to profits over time. For example, if you want to give an independent contractor 20% phantom equity in your business, you could structure it so they earn 5% each year they work for you until they earn all 20% after 4 years.
- Contingent on Involvement -- If the worker quits or is terminated, you can force them to forfeit their phantom equity.
If you are comfortable enough working with someone, you can also give them an ownership interest in your business. There is a lot of flexibility as to how this is structured, but generally it means they will share in profits and decision making based on their percentage of ownership.
You can also put rules in place where they have to earn their ownership over time and you can make their ownership contingent on their continued involvement in the company (just like described above under phantom equity).
The downside to co-ownership is that it is more difficult to remove a co-owner from a business if things don't work out. You may have to buy them out to remove them from the business. However, there are rules you can put in place to avoid these issues if desired.
This article is for informational purposes only and is not legal advice.