What Does It Mean To Be An Equity Partner? (2020 Update)
Being an equity partner means that a partner buys into the business, in order the receive a cut of the business's profits later on.
We’ve previously covered what a partnership business structure looks like and how you can ensure that they’re run successfully. But what about the different structures within partnerships? In this article, we’ll look at what an equity partnership is, where it’s used, and its benefits. Equity partnerships are less common than other partnership structures, however they offer many benefits.
1. An equity partner ‘buys into’ the company
An equity partner, unlike other types of partnership, buys into the company. This means that the partner’s income will come directly from the profit that the company makes. This will usually be as part of their salary or an incentivised bonus. Although this partnership can be established through a partnership agreement, it is different to other partnerships. This is because the partner pays a set amount to buy into the business, and then reaps the financial rewards. However, this is conditional on whether the business continues to grow.
2. The ‘buy in’ amount injects capital into the business
Equity partnerships are based on a premise of investment and return. If you are invited, or intend to become an equity partner, the capital you invest to ‘buy in’ is beneficial to the company. This ‘buy in’ is based on predictions that profits will continue to grow for the company. If this is the case, you will see a good return on your investment. Before you buy in however, you may want to get some advice from an investment lawyer. This will allow you to weigh up the risks and benefits of buying into the business. It is accurate to say that the buy in benefits the company immediately. By contrast, a newly minted partner will have to wait to receive monetary benefits.
3. The equity partner has a vested interest in the success of the business
Because an equity partner buys into the business, they not only have a financial stake in the business, but a personal interest in driving the business forward. There are those that argue that this system motivates partners to work harder for the success of the business, however, if the company stagnates or starts to decline, this can put significant pressure on the partners to return the business to surplus for their own financial security.
4. Competing interests
Although equity partners tend to receive equal dividends, it is important to consider the very different interests and personal circumstances that different equity partners have. An equity partner who has just ‘entered the fold’, compared with one who is intending to retire in the next couple of years, will have long-term visions for the company, and their decision making will be based on that. The other partner will be more focused on short-term profit, and will aim to retire with a significant amount of capital. Although this kind of situation doesn’t often cause irrevocable problems in the partnership, it is something worth keeping in mind.
5. Profits are distributed equally amongst partners
As has been previously mentioned, profits from the company tend to be distributed equally amongst the equity partners. This may become a less-than-ideal situation for someone who bought into the partnership 10 years ago, who will find themselves receiving the same dividends as someone who entered only 6 months ago. Longevity is the key in this type of partnership. A partner cannot expect to benefit straight away from this arrangement. This is one of the reasons why equity partnerships are most common in law and accounting firms. The capital drives the business forward, and the employees (or partners) all tend to be there for the long haul. It’s important to note that many modern day firms fall under a company structure – meaning that
6. …but you’ll also be responsible for debts
Equity partners do not have the same legal protections as company directors. One key feature of a partnership structure is that partners are responsible for any debts incurred. This can be risky if the partnership you’re buying into isn’t in a good financial position.
It’s inevitable that there will be times where you’ll disagree with your fellow partners on business decisions. Pay careful attention to the clauses in the partnership agreement which cover disputes. If there’s no clause for dealing with disputes amongst partners, then take it as a warning sign that the partnership is ill-equipped to deal with problems should they arise.
If you’re considering structuring your business this way, or entering into an equity partnership, it is wise to first ensure that your business’s growth projections will reflect the capital injected by the equity partners. If you’re considering buying into an equity partnership, make sure that you’re in a financial position where you can afford the buy in amount – and that you’re both financially and mentally prepared to wait to see the benefits.
Jackie is the Content Manager at Lawpath and manages the content team. She has a Law/Arts (Politics) degree from Macquarie University and is an admitted solicitor in the Supreme Court of NSW. She's interested in how technology can help shape the future legal landscape.