Fair pay for you and your partners
Not every business owner contributes equally to a company's success, but with advance planning, you can adjust salaries accordingly.
Michele Cosentini, Baltimore
I am planning to start up an LLC with three partners. We will be designing and facilitating retreats. What is the best way to figure out how much to pay each of us? We will each spend time working both individually and together, and I'm not sure how to measure how much time each of us is putting into the business so that salaries can be split fairly. Also, do we have to pay ourselves a salary and declare how much that would be up front, or can we just keep putting the money back into the business and then divide up earnings at some later point?
By Lenora Chu, CNNMoney.com contributor
To avoid trouble later on, you'll want to map out from the start a plan to allocate pay based on a measurable standard, such as each partner’s input into the business or how much his or her professional skills are worth in the marketplace.
You don't have to pay each partner equally: One partner's accounting expertise might be more valuable than another partner's administrative work. It's fine to pay partners variably based on what they bring to the business, says Jonathan Moyer, attorney at the international law firm Reed Smith, LLP.
One standard way to measure input is to pay by the hour, on a weekly or monthly basis. You can use a software program to minimize the administrative burden of tracking hours. Moyer also recommends building in checks and balances to prevent any partner from attempting to “game the system." For example, your LLC agreement might require that all paid hours be spent at a company office or that customers verify hours spent on-site.
Another option? Avoid tracking hours and make guaranteed payments at set times throughout the year, suggests CPA James Kellogg of Fullerton, Calif. The amount can vary depending upon the profits your business earned, with each partner receiving a set share.
That size of that share could be based on each individual's contribution to the company's financial success, Moyer says. For example, if one member is responsible for generating 75% of the firm's revenues during a specific time frame like a given month or quarter, he or she would be entitled to a distribution of 75% of the cash generated by the business during that time.
The allocations could be reviewed periodically and increased or decreased based on whatever performance criteria you and your partners agree upon, says Moyer.
Distributions could also be based on ownership percentages, which in turn would be structured to reflect partners' differing levels of input, says Moyer. That way, distributions from the company are more likely to be in-line with each partner's responsibilities.
For example, if it’s expected that you will put twice the time into the business that the other two partners will, the ownership could be structured so that you own 50% of the business and your two partners each own 25%.
Or, as you suggested, you can opt keep money in the business and take distributions at a later time. LLCs are generally set up so that each member has a capital account, to which contributions, profits, distributions or losses are allocated according to each member’s ownership percentages, Moyer says.
Money (or losses, if the business runs into the red) will build in each capital account and be available whenever you desire. To prevent problems down the line, you and your partners should have some frank discussions before forming an LLC about when and how you'll take distributions. Always delineate the commitments expected from each partner at the start, Moyer advises.
Equally important, Moyer says, is agreeing to the consequences if these commitments aren’t met. You should provide a written mechanism in your bylaws for dissolution of the business or removal of a member if things don’t go as planned. Confronting these issues up front can be emotionally tricky, but it often helps head off destructive legal problems down the road.
Give us your advice: Check out recent “Ask & Answer” questions.
Firing yourself: Unemployment benefits for business owners
