McStartup

This question comes from Nina, who has been given the option of buying her way into some equity ownership after spending some time working at the company.  There are a number of things consider here, and perhaps most important is to gain some understand of the difference between being an investor (shareholder) and being an operator in the business (employee).

Nina writes

I have been working in a small design and strategy consultancy for the last 18 months.The company is 3 years old, good cash flow, good contracts and is also dependent on the 3 core consultants (me included). The principal has offered me an option to own some equity because I bring complimentary skills and have a strong working history and we share the same vision for the company. He is proposing that we start the business as if it was from scratch and we each put in an amount of the working capital needed. Then the proportion I put in, represents my share of ownership.

This equity gives me the shared right to business decisions, building the company, and ensuring business sustainability. What do I have to understand, what homework do I need to do to accept this offer? I am interested in equity because I want to build a company and have a role in the day to day decision making.

We the short, yet complex answer is that it will all come down to whatever agreement is reached between the two owners.  Creating a new company, and splitting the equity for this type of business is probably a wise move, as it creates a clean slate to build on, and the nature of the business is consulting. 

However, a few things to keep in mind.  First, equity ownership does not automatically equate to decision making power.  Just as I can't tell Steve Jobs what to do because I own 100 shares of Apple, one owner or the other won't necessarily have the authority to make decisions in day-to-day business operations.  That is probably obvious, but it's worth exploring a bit further, because, by the same token, I could own just one share of Apple stock and have full control over the operations of the company, provided it was the right class of stock.

As it turns out, not all stock is created equal, and different classes of stock very often have different voting rights and abilities (hence the reason for having different classes of stock).  In the structure you have described in your question, each of you should have identical classes of stock, the only difference being how much you each have.  Different classes of stock between the two of you wouldn't make any sense based on what you've said here.

Another thing to think about is that stock ownership has very little to do with day-to-day operational authority.  There are plenty of company presidents and vice-presidents who make all sorts of unilateral decisions in both public and private companies who have very little or no equity ownership at all.  The equity allows you to do is elect a board of directors, and those directors then choose a president.  That's really about it, and at some point, someone has to have the authority to make a decision one way or the other, even if the equity owners disagree on what that decision should be.  You won't disagree very often, but it does happen, and you don't want to be scratching your head as to who gets to make the call when that time comes.  Perhaps it's the person with the most equity, but that's not necessarily the answer, particularly if you might have the option to kick in some extra cash or time and boost your equity some.  What if you both had identical shares - who would make the decision then?

This decision making hierarchy is really something for the two of you to chat about outside the ownership piece, becuase they really are two different issues.  First, understand how the business will function, what your role will be, what the role of the other owner is, where you both envision things going, and so on.  THEN, once you understand the proposed business, ask yourself if you'd like to be an investor in that business, and what returns do you expect as an investor.  Will you each get a salary as employees?  How and why do your salaries differ?  Will dividends be paid out of profits?  Who decides what dividend should be paid?

I believe it's important to think about it that way, because you really are talking about having two different roles in the same business - one as a person that works in the organization, the other as an investor in the company.  Understand what authority you will have and what is expected of you as an employee, and how will you be compensated (if at all).  Then, understand what authority you will have as an investor, and how you will be compensated for that investment.

If you break it down into these two buckets, I think it will make your decision process easier to manage.  In general, my advice would be to pursue getting some ownership in the business, because right now, your are the employee without the ownership, and you have the opportunity for that to change.  However, keep in mind that if you can't reach an agreement that meets your expectations as both employee and investor, then maybe it's time to consider setting up shop on your own (and even then, you'll want to think of yourself as both employee and investor).

Best of luck!