Equity Partnership Agreement

by | Jan 15, 2022 | Agreements

 Equity Partnership Agreement

Partnership

A partnership is a legal contract where various persons agree to pool their human and financial resources for a business venture. Every partners is apportioned the losses and profits of the business. An equity partnership agreement is a legally biding agreement between the partners and proportion of their equity in the business. Often, an equity partner in an  equity partnership agreement owns a section of the entity and is entitled to a section of the profits of the partnership. Further, an  equity partnership agreement should outline the obligations, rights, and entitlements of every partner in the partnership, equity partners included.

Essentials of an  equity partnership agreement

An  equity partnership agreement ought to outline the obligations, rights, and responsibilities of every partner. The agreement should also address the proportion of the entity’s profits that every partner will be apportioned. An  equity partnership agreement should also allocate the losses to future partners. Moreover, the  equity partnership agreement includes how the entity will make significant decisions for the running of its operations. Additionally, the partnership agreement ought to discuss how the dissolution of the company will be dealt with in case a partner exits the partnership or dies.

Aspects about being an equity partner in an equity partnership agreement

There are several aspects that are beneficial about being an equity partner in an  equity partnership agreement. They include:

  1. An equity partner normally buys into a company or partnership.
  2. The amount of buy-in results in the injection of capital into the business.
  3. The equity partner in an equity partnership agreement vests interest in the success of the business.
  4. An equity partner has competing interests.
  5. The profits in an equity partnership agreement are distributed among the partners equally.
  6. The equity partners are responsible for the debts of the business. This is outlined in the equity partnership agreement.
  7. Disputes may occur hence the equity partnership agreement should outline the dispute resolution mechanisms.

Explanation of the equity partner aspects

  1. An equity partner buys into the entity

Unlike other partnership types, an equity partner buys into the entity. Hence that income of the partners comes directly from the the profit made by the entities. This is normally a part of their salary or in form of incentive bonus. Though the partnership could be established though a partnership agreement, it is different when it comes to other partnerships. The preceding is because the partners pay a specific amount to buy into the entity. The partner then reaps the rewards mostly in form of finances. Nonetheless, is conditional on whether the business will continue growing.

  1. The buy in amount increases capital in the entity

Equity partnerships are based on investments and returns whose amounts are specified in the equity partnership agreement. If one is invited or intends to be an equity partner, the capital invested to buy in is of immense benefit to the entity. The buy in is founded on the predictions that profits will continue to make the entity grow. If this happens the entity continues to grow. However, before a partner buys in, he or she should seek advise from an experienced and competent attorney. The same should also be applied before signing an equity partnership agreement. Such allows the partner intending to buy in to weigh the benefits and risks of buying into the business. Moreover, the buy in benefits have an immediate positive impact on the entity. Contrastingly, newly admitted partners have to wait to be granted financial benefits.

  1. The equity partner vests interest in the entity’s concern

Since an equity partner buys into the business, they have both monetary stake and personal interest in enhancing the success of the business. It has been argued that such a system motivates partners to work harder for the business’ success. Nonetheless, if an entity stagnates or begins to decline, it can put pressure on the partners to reposition the business for personal monetary security.

  1. Competing interests

Though equity partners receive equal dividends, it is significant to consider various interests and individual circumstance that the different equity partners possess. An equity partner that enters the fold compared to one that intends to retire in several years, has a long-term vision for the entity. Further, their decision-making is based on the same. The the other partner focuses more on short-term profit and aims at retiring with a solid amount of capital. Though such situations do not often result in irrevokable issues in the partnership, the same should be noted in the equity partnership agreement.

  1. Distribution of profits equally among partners

As earlier mentioned, an equity partnership agreement provides for the equal distribution of profits. This is done among the equity partners. However, such may be unfavorable to a partner that bought into the business a decade ago. This is especially when they receive similar dividends to persons that joined the partnership just 6 months prior. Hence longevity is key in signing the equity partnership agreement.

Moreover, an equity partner should not expect to benefit immediately from an equity partnership agreement. Hence the reason why equity partnerships are common in accounting and law firms. The capital propels the business and the partners and employees are there for long. It is significant to note that most modern-day firms are categorized under the company structure.

  1. Responsibility for debts

Equity partners are not afforded similar protection to that of company directors. One main feature of a partnership structure is that the partners are responsible for the debts that are incurred. This should be included in the equity partnership agreement. However, this can be risky if the partnership one is buying into is not in a good financial position.

  1. Disputes

There are times that the partners may disagree on various business decisions. Hence one should pay attention to the clauses in the equity partnership agreement that deal with the resolution of disputes. This can especially  when the partnership one is buying into is not financially stable hence the increased risk of disputes.

If an equity partnership agreement lacks a dispute resolution clause for dealing with disputes among the partners, then such should be treated as a warning sign. This is because it could mean that the business is not adequately equipped to handle problems that may arise.

Terms included in the  equity partnership agreement

Startups should clearly outline the terms prior to entering into any arrangement with other  equity partners. Also, clarity regarding the contribution of every partner sets solid expectations. Some of the major terms that are considered when drafting the agreement include:

  • The vesting periods. The vesting period for the partners is normally based on their expertise and commitment to the partnership.
  • The type of equity. The allocation of the quantity and type of shares matches the vesting period of the decision. Such terms vary in the equity partnership agreement based on the expertise and value-added to the business.
  • Rates of conversion. A equity partnership agreement should also outline whether the equity will be converted every month, two months, or six months. The preceding matters if the person will gain coting rights.
  • Criteria of performance. It is not uncommon for a senior talent to have many roles. It also takes long for startups to get to a stage where special skills are hired. Therefore, while designing a equity partnership agreement, it is important to clearly define the job expectations from the potential sources.
  • Separation strategy. If not well planes, exiting agreement could be problematic for a co-founder. In the event one of the founders exits midway for unforeseen reasons, it does not discount their attempts till that time. Therefore, the agreement ought to embrace fair and reasonable exit strategies.
  • Criteria of performance. All agreements should clearly outline the responsibilities of every partner. The preceding is vital for partners that have multiple roles. It also aids in avoiding disputes over minor issues like performance or otherwise of the entity’s functions.

Conclusion

In summary, an equity partner means that there is the expectation of increased upfront capital used to buy ownership stake in a business. Further, one’s income is less derived from a salary and heavily based on the entity’s performance. If one is considering structuring a business in that manner or entering into an equity partnership, a careful perusal of the equity partnership agreement is crucial.

There is thus the need to ensure that the growth of the business’ projections reflects the capital that is injected by the equity partners. If one is considering buying into an equity partnership, one should ensure that they are in stable financial position hence can afford any amount. One should also be both mentally and financially prepared to wait for a long time to realized the expected benefits and profits.

References

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