Is It Time to Make Your Best Employee a Partner? Five Key Considerations

Taking on a key employee as a partner can also be a good way for business owners to plan for retirement…

There is a lot to be said for teamwork in growing a business. How better to increase the motivation of your employees than to offer an opportunity to own a piece of the business?

Taking on a key employee as a partner can also be a good way for business owners to plan for retirement. As COVID-19 has highlighted in recent months, the future is uncertain, and it’s always wise to find someone to fill your shoes before you think you’ll need them.

Questions to Ask Before Elevating an Employee to Partner

Of course, taking on a new partner is a significant legal and business decision that requires careful consideration. While it may be a wise decision, there are still many moving parts that must be thoroughly evaluated. Below are a few examples:

• Tax Implications: Before making an employee a partner, it is also important to consider the potential tax consequences. Partners and employees are treated very differently when it comes to employment taxes and many benefit plans, so it’s important to structure your agreement to avoid any unforeseen liability.
• Confidential Information: Making an employee your partner means granting them access to company records and other confidential information. Accordingly, it is advisable to have your potential partner execute a non-disclosure agreement if you don’t already have one in place.
• Control: If you are currently running the business on your own, you will have to relinquish at least some of your autonomy by taking on a partner. At the same time, having a partner can lift the load from your shoulders. When selecting a partner, make sure that the candidate will bring something to the table that will help the business grow (whether it is skills, contacts, or financial resources) and will complement your own leadership style.
• Time Commitment: Don’t try to rush the process. Even your best employee likely isn’t ready to take over today. Grooming someone to take over for you can be a long process and may require a significant time commitment.
• Flexibility: It is important to recognize that you will lose some flexibility when elevating a key employee to a partner. For instance, if the relationship isn’t working, terminating an employee is generally a straightforward process. Because partners are shareholders in the business, it is far more cumbersome and costly to remove them.

If you decide to move forward, you will need a detailed legal agreement in place. The exact terms of a partnership/employment agreement will depend on the circumstances, particularly whether you plan to make your key employee a partner in the near future or train them to take on your role over time. Assume you are planning to retire within a few years and you have a loyal productive employee who would, with some guidance from you, be capable of continuing to maintain, and perhaps even grow the business. An employment agreement can be fashioned with your key employee that provides the employee with equity interest (non-voting at first) that grows to majority interest in stages as you receive over several years the majority of the profits, and the employee grows into the CEO position.

In any case, it is essential to work with legal counsel to negotiate a legal agreement that addresses the roles, obligations and expectations of both parties. If not, the arrangement can lead to legal headaches down the road and may end up being far more trouble than its worth.

Alternatives to a Partnership

Finally, it is important to note that there are alternatives. You can motivate and reward key employees without making them partners. Other arrangements include awarding an employee a share of the company’s profits rather than an equity stake. Another incentive is to grant certain employees stock options as part of their compensation.  For those seeking to retire from the business sooner, or suddenly because of illness, a simple sale of the business with a deferred payout, secured by the business itself, may be structured with an un-moneyed employee who is deemed able to run the business.

If you have questions, please contact us

If you have any questions or if you would like to discuss these issues further,
please contact Dan Brecher or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.