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Re: [newtech-1] Re: Business Question

From: Alyssa M.
Sent on: Sunday, December 9, 2012 10:28 AM

This is a very sound explication to a complex issue; adding founders or partners should never be done without a lot of forethought and consideration. Thank you.


On Sun, Dec 9, 2012 at 8:06 AM, Roman Fichman Esq. <[address removed]> wrote:

Let me bring bring a different perspective.

First, as far as your question, since employees generate a profit for their companies, does that mean that all employees should be equity holders?

The answer is no. Generally speaking, an employee is supposed to generate a profit otherwise the company will go out of business. Therefore, merely being an employee does not call for equity compensation.

Equity is typically extended as additional compensation and/or as a way to encourage employees to take personal concern with the company, since they will have their own property (the company's equity) at risk.

Speaking of risk, in my mind the main difference between you and any other person who is involved in your business, regardless how much selling they do, is RISK. I can't stress enough that taking risks is the element that separates entrepreneurs from everyone else. Essentially entrepreneurs get compensated for taking risks.

There are many types of risk. You have invested money (equity) which is a resource that is not renewable without additional investment. You have/will also invest time which is a renewable resource. The person, on the other hand, would only invest time (sweat equity).

The scarcer the resource the more valuable it is. Generally, money is scarcer than time, therefore your investment of money is more valuable than an investment of time.

To translate this into the real world of partnership agreements: equity partners are typically afforded at least one (and sometimes all) of the following: additional equity over sweat equity, preference in class of equity, greater control of the company, preferences in pay backs, public recognition (titles) etc.

Some examples of compensation appropriate for non-equity investments are:
- allocating non-voting equity or different class of equity.
- subject the equity to vesting / milestones
- salary + additional compensation (bonuses or commissions) without equity
- profit sharing without equity (does not work under some corporate structures)

An important consideration in all this are TAXES. I won't go into the complexity of sweat equity taxes, but the bottom line is that you cannot just "give" equity. Equity is either purchased or earned. If earned one may need to pay taxes before the equity is sold. Since there is no money to purchase equity and in fact your current valuation may be too high to begin with, any grant of equity needs to be properly structured (both through the company docs and through the offering made to the person) to avoid unnecessary and untimely taxes.

Your actual valuation and equity specifics would need to be worked out based on the facts.

Roman R. Fichman, Esq.  │ @TheLegalist
(212) 337 - 9837 Tel
(212) 842 - 5311 Fax
"From Start-Up to Exit"

Start-Ups * Technology, Internet & New Media * IP & Business Law * Funding * M & A * Due Diligence

Disclaimer: This post has been written for educational purposes only and was not meant to be legal advice and should not be construed as legal advice or be relied upon. No intention exists to create an attorney-client relationship or any other special relationship or privilege through this post. The post may contain errors, inaccuracies and/or omissions. You should always consult an attorney admitted to practice in your jurisdiction for specific advice. This post may be deemed as Attorney Advertising.

IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matters addressed herein.

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