Chapter 2: Business Partners
Business partners can be an incredibly powerful tool for helping get your startup off the ground, depending on what exactly they are bringing to the table. It can be tempting to hand out equity to friends or people that help you out in the beginning, but remember: every business only has 100 percentage points to be distributed - there is a finite amount of equity. Equity is also forever. Once you give somebody a piece of your company, it is incredibly difficult, if not impossible, to get it back. Once that paper is signed, they’re in. Depending on terms of operating agreements, equity can often come with certain levels of control over the company, which can open the door to some uncomfortable situations down the line if equity has been distributed haphazardly.
As a general rule of thumb, you should only bring in business partners if it’s absolutely necessary, and be cautious about cutting in family or close friends. Seemingly indestructible relationships have crumbled under the pressure of startup related disputes. If you’ve ever seen the movie Social Network about Zuckerberg’s rise of Facebook and interpartner disputes, you get the idea. You might think, “my friend would never do that”, “this is different”, etc. Trust me, these disputes can, and do occur very frequently. Especially with something as important as your business on the line, always err on the side of caution.
There are two sets of circumstances where bringing in a business partner makes objective sense, provided you take all necessary precautions in the paperwork department:
Money: Loads of businesses need some level of funding to get off the ground. Obviously this can be wildly variable based on the industry, but if you don’t have the cash yourself, you’re going to need to get it from somewhere else. Bringing in investors as business partners can be a great way to jumpstart your business and get the ball rolling early. Ideally, cash investors would be integrated to the company as “silent partners”, simply there to collect a return on their investment. This is the ideal situation, since you get to run your business as you see fit, with all the money you need to get things done. Things can get a bit more complicated if an investor wants to be more directly involved, since there’s no guarantee the investor will be knowledgeable or skilled in your specific industry, and may be swayed to making counterintuitive decisions in an uninformed attempt to “protect their investment”. This type of corporate investor oversight has destroyed the ethos of many popular brands, a recent example being FaZe Clan’s IPO, improper treatment of their members, and endless meaningless brand collaborations.
An exception to the “silent investor only” rule is when an investor has an immense amount of skill, experience, network, and knowledge about your given industry. Partnering and receiving investment from a seasoned industry veteran with a proven track record can be a great way of mitigating early problems and navigating what to you might be uncharted waters. However, since in this case you’re generally dealing with somebody with more knowledge, experience, and intuition than you, it’s even more critical to ensure your interests are properly protected.
Sweat Equity: Sometimes starting a new business is just too much work for only your two hands, and it might be necessary to get some outside help. The ideal circumstance would be to hire contractors and maybe a few employees to fill the gaps, but if you don’t have funding or revenue, this option is off the table. The other option is to bring in a trusted party and offer sweat equity. Sweat equity refers to equity that is “gifted” to a party in exchange for unpaid labor in the form of physical work, mental effort, and time. This can be a great way to get extra skilled hands on your project, but be wary - first time bootstrappers tend to end up giving away chunks of equity to people who frankly, don’t deserve it. If you intend to offer sweat equity to a partner, make sure their presence is absolutely integral to your company’s success. Ensure they have a unique skillset to apply to your company, and that they’re going to be in it for the long haul.
One way to ensure you’re getting the right bang for your buck when it comes to sweat equity is by vesting. Vested equity refers to the practice of equity being delivered on a monthly basis over a pre-set period of time (typically 3-6 years), but can also be tied to certain milestones such as sales goals. The advantage of vested equity is that your employee/partner will not receive all of their equity upfront, and is required to continue working for and providing value to the company in order to continue receiving their equity. Certain vesting structures can also include a “vesting cliff”, where the employee will receive no equity for a certain period of time, say 12 months. The employee would receive no equity for the first 12 months, and at the end of the period would receive the full 12 months of vesting at once - hence the “cliff”. The vesting schedule would typically continue on a monthly basis until the employee’s full grant has vested. Cliffs can be incredible tools for founders to institute since they provide a “trial period” for the employee or partner. If things don’t work out, the company can part ways with the partner without having given them any equity. This is a fantastic way to protect your equity while also ensuring your vested equity recipients are continuously providing legitimate value to your company. Vested equity schedules are also commonly used in venture capital raises, so investors can ensure founding teams stay dedicated to the project instead of running off with their investment capital.