PRINTPosting by Ed Kopf, Ph.D., Principal at BMC Associates
“Can you help us agree on our equity split? We’ve hit a brick wall trying to work that out.” As a mediator and consultant serving business partners and family business owners, this is a question – almost a plea – that I often hear. Entrepreneurs (fully confident in their business abilities and vision as they start a new venture or revamp an existing one) are suddenly caught up short when they have to negotiate with each other over ownership. In a series of blog posts, I will explore why the discussion of equity shares can be such a daunting subject and how it can be transformed from a source of anxiety into an experience that builds a stronger partnership.
The initiation of a new business partnership can be an exciting time. Two (or more) entrepreneurs discover that they share a vision for the new enterprise, that they have complementary skills and assets to bring to the venture – and that they enjoy working with one another. In a burst of energy, they develop a business plan and enthusiastically begin to roll it out. It feels as though nothing could stop their momentum.
When it becomes clear that the dream is actually becoming reality, they recognize that the time has come for the business and partnership to be legally formalized. Suddenly the progress and good feelings may derail. The articles of incorporation or partnership agreement require, among other decisions, a division of the ownership interests in the new firm. Often, the partners have shied away from this subject lest it distract them from the work that needs to be done or even lead to a damaging disagreement. But the equity issue can no longer be deferred.
The discussion can go downhill quickly. It can become enmeshed in a web of ego, defensiveness, misunderstanding, and inflexibility. The negotiation over equity shares can become a staking out of divergent positions – with no way to bridge them other than a battle of wills. Or, to avoid this risk, it may be resolved by an arbitrary distribution of equal shares that may come home to haunt the partners later when its implications become clear. This is no way to create the goodwill, communication, and collaboration that are so badly needed among business partners.
Given these difficulties and risks, partners and their advisers have turned to, or developed, tools to help them through this equity challenge. These often involve spreadsheets that capture a basic set of contributions made by each of the prospective partners (typically, uncompensated time and cash) – and yield a division of equity by applying a simple algorithm to the data. Such methods vary in sophistication but, most often, they attempt to provide value by objectifying, automating, and minimizing the time and complexity of the equity discussion. The overriding goal is to remove the ego and emotion and replace it with math that quickly yields a seemingly authoritative division of ownership.
My colleagues at BMC Associates and I have successfully been helping partners structure their relationships for over two decades. During that time, we’ve discovered that it can indeed be very helpful to use a quantitative, spreadsheet-driven analysis to help structure the equity discussion. But simple cookie-cutter methods, in and of themselves, are inadequate. More importantly, they squander an opportunity for the partners to add critical depth and strength to their relationship. Precisely because the equity discussion may surface significant and conflicting perspectives and emotions, it is an indispensable opportunity to assure that the partnership is grounded in shared understanding and respect. Ultimately, the equity discussion provides the partners with what may be their best opportunity to probe and come to terms with the most sensitive aspects of their relationship.
Partners need to fully understand one another’s perspectives on the tangible, intangible, and personal value each brings to the venture. The discussion needs to probe their attitudes, expectations, and emotions related to one another and to ownership. It must also account for ego and emotion – in a positive and productive context. A rush to a numerical outcome leaves much unsaid that needs saying. This is why we focus our clients as much on the process of the equity discussion as on the outcome.
There is no single approach to the equity discussion that fits all circumstances perfectly, but we have developed a method that anticipates the potential pitfalls and problems of this difficult subject. It is an approach that encourages deep understanding among the partners, has great flexibility, and provides a powerful quantitative tool to support the analysis. Using the Comprehensive Contribution-based Equity Process (CCEP), the partners we have worked with have not only reached a workable outcome, they have actually used the equity discussion to enhance their mutual understanding, ability to collaborate, and their confidence that they have reached a fair and sustainable agreement on ownership and related aspects of their partnership.
The next post in this series will describe the four key premises underpinning the CCEP and the five key steps in undertaking the CCEP process.
