Financial Planning for Executives: Are You Financially Ready to Become a Partner in the Business?
Making partner. It’s the dream for many executives. When you first were hired, you looked at the owners of the company and dreamed about sitting where they sit, and now your company has offered to bring you into the fold as an owner of the company. A wide range of emotions can be experienced during this period. You’re probably excited about the opportunity, possibly worried about the colossal shift in responsibility, and, of course, concerned about the financial ins and outs of the whole situation.
To get a better understanding of whether becoming a business partner makes sense for you financially, you can start by asking yourself a few questions.
What Are the Business’s Finances?
Although it may seem like the company is doing well from where you sit now, it’s time to dig a little bit deeper. If you’re planning on becoming a part owner of the business, you need to know a few things:
- What the organization’s cash flow looks like
- How much they own (or what their assets are)
- How much they owe
These three things should help give you a more comprehensive idea of whether the business is financially healthy – and whether it’s wise for you to buy in now.
What Financial Penalties Do You Face if Things Go South?
Right now, you’re not thinking about what will happen if your partnership goes badly. You’re not thinking about what will happen if the business suffers financial difficulties, or if you and the other partners have irreconcilable differences. Getting burned because you didn’t protect yourself on the front end of a new business partnership is the last thing you want.
You’ll need to read the partnership agreement and contract that your company has offered you – and pay close attention to what, if any, financial penalties you’ll incur if you choose to walk away from the partnership or if the partnership is dissolved. Is there a buy out that takes place? Who is responsible for legal fees if you and your partners take the issue to court?
Additionally, it’s important to go over how you’ll be compensated, what your responsibilities are in this new partnership, and who oversees what when it comes to day-to-day operations, big picture decisions, and more. All of these things, and documents you may have to sign, need to be reviewed by your own personal attorney.
Do You Have New Tax Obligations?
In all likelihood, your tax status will change when you make partner. As part owner of your business, you’ll need to record your share of the organization’s losses, gains, and deductions. The taxes owed on any gains you receive through the business aren’t automatically withheld for you like they are with traditional employee compensation, which means you’ll be responsible for saving and paying taxes quarterly or at year-end.
It will benefit you to reach out to a CPA to help you organize your financial life on the front end of your impending partnership. They’ll be able to guide you through the process of paying taxes as a partner, and a financial planner will be able to help you to mitigate the impact that taxes have on your income as a partner.
How Are You Buying In?
Every business has a buy in process that’s unique to them. However, you can likely expect to buy in in one of two ways:
- You’ll be expected to provide the full buy in amount up front.
- You might be able to contribute capital over time – which could help you avoid financing your new partnership.
If spreading out your contributions over a set period isn’t an option, you’ll need to consider how you want to finance your buy in. Some new partners are lucky enough to have the funds already saved. However, most people don’t have that kind of cash readily accessible. You have a few different options to finance your buy in, and it’s likely you’ll use a combination of financial resources at your disposal. These might be your personal savings, a small business loan, or a small business line of credit. Other time, the business itself might self-finance this deal by providing the loan with a competitive rate of interest. Speaking with a financial planner can help you determine what funding method will work in your favor both now and farther down the line.
What Does Your New Compensation Look Like?
Depending on the company, many partners don’t take a salary. Instead, when they become partner, they forego their salary and “employee” status, become self-employed, and invest in the business (this is your “buy in”). If the business does well, you’ll likely make much more than you did, even as a highly paid director or executive. However, if the business goes through a rough patch, you may make little to nothing. This uncertainty is daunting for many newly bought-in business partners.
For other structures, you still remain an employee but your salary drops to nothing or becomes a “draw” against future earnings. Depending on the company performs, you’ll receive compensation over-and-above the draw, or in bad times, the draw is the only compensation you’ll receive.
With a bit of forward thinking, you can plan for these “down” months and build in a back-up plan to ensure your financial security over time. Having an over-sized emergency fund is crucial for times like these. At the end of the day, you need to protect yourself – even as a partner in the business. Knowing what’s going to be expected of you financially, what you can expect out of the business’s finances in the foreseeable future, and how you can protect yourself against the financial pitfalls of partnership are all key elements of your final decision. If you’re unsure about whether this opportunity is right for you, you should consider speaking to your financial planner, tax professional, and a lawyer to get a feel for whether the agreement will benefit you in the long run.
Remember, becoming an owner is a firm is like getting “married” to all the other owners. Make sure you’ve “dated” for a suitable amount of time and understand what the relationship is like before making a big commitment. It’s often far harder to undo this agreement than it is to make it in the first place.