Making an Employee a Partner: A Guide for Service Businesses
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Ever wish you had someone to help make important business decisions, contribute to revenue generation, and handle high-level tasks?
Making an employee a partner is one way to grow your service business and it can help you share ownership responsibilities and bring fresh ideas to the table.
But it’s not as simple as offering a top-tier employee a promotion. If you want to formally make an employee a partner in your business, there are legal, financial, and strategic steps you need to take to protect yourself, your prospective partner, and your business.
Learn what they are and how to apply them in this guide.
8 steps for making your employee a business partner:
1. Review your business structure
The type of business structure you have impacts whether (or not) you’re in a position to take on a partner.
If you currently have a sole proprietorship, you’ll need to incorporate your business as a limited liability company (LLC), limited liability partnership (LLP), or corporation before you can bring on a partner.
If you already have an LLC, LLP, or corporation, your business is already set up to accommodate additional owners.
2. Choose which type of partnership you want
There are three types of partnerships to choose from: equity, profit-sharing, and limited. Which you decide to move forward with depends on your business, preferences, and potential partner.
Equity partnership
An equity partnership is when the employee buys into the business in exchange for shares or a percentage of ownership. In other words, when they purchase equity in your company.
In this type of partnership, you and your partner share operational duties, responsibilities, and liability based on the percentage of the business you own.
This is a popular choice for small business owners who want to bring on a partner to share the load and contribute to business decisions.
Profit-sharing partnership
A profit-sharing partnership is when an employee receives a share of the profits without owning equity.
For example, you give them 10% of annual profits as a reward for being with your company for a long time and contributing to your success.
This type of partnership doesn’t give the employee any decision-making power, meaning you maintain full control over running your business.
This type of partnership is often used to reward loyal employees who have helped your business grow over the years. For example, those with specialized skillsets who enabled you to expand your service offerings or bring in new clients.
Because it doesn’t give up any equity, it’s a good option if you want to maintain control of your business while still encouraging your employees to contribute to your business’s growth.
Limited partnership
A limited partnership is when an employee invests in your business and receives limited responsibilities in exchange. For example, they might want to invest in your business without taking on any operational or management duties.
In a limited partnership, a partner can have as many or as few duties and responsibilities as you like, as long as you both agree. Some partners want to be left out of decision-making, while others will want to be involved in specific things, like having a say when you purchase new equipment.
If you do want them to participate in business operations, how much power they have is typically related to their financial investment.
For example, someone who invested $5,000 would have fewer responsibilities than someone who invested $200,000.
Limited partnerships work best when you need capital but want to maintain control of your business. For example, if an employee believes in your vision and supports your goals but isn’t interested in helping you make management decisions.
3. Do a business valuation
After you decide on a partnership type, you need to know how much your business is worth to set a fair price for your employee’s buy-in.
For example, if your business valuation states your business is worth $500,000, and an employee wants to invest $20,000, their equity would be 4%. If they wanted to invest $50,000, their equity would climb to 10%
Have a business valuation done by an accountant or CPA, then use this formula to calculate how much equity to give your potential business partner.
Equity percentage = (investment amount / business value) x 100
4. Determine buy-in
Once you choose which type of partnership is the best fit, you need to determine the amount the employee will pay in exchange for what percentage of your business.
For example, if you’re moving ahead with an equity partnership, you need to decide on a buy-in amount and how much of the business your new partner will own, as in, 20% of the business for a $20,000 investment.
You can also choose to allow your employee to invest based on their work instead of providing cash upfront. For example, by holding back part of their paychecks.
The same goes for a limited partnership. How much will your potential business partner pay you in exchange for what? Do you want them to have any power in your business, or do you just want them to provide capital you can use to grow in exchange for a percentage of your net profits?
The only type of partnership where you don’t need to consider buy-in is with profit-sharing since the employee won’t be purchasing equity or providing capital.
5. Outline the terms of the partnership
Decide which responsibilities and duties the employee will take on once they become your official business partner.
For example, can they make hiring decisions or operational changes, like switching suppliers? Who will have the final say, and can they make decisions on their own, or will they need your approval?
Discussing questions like these adds transparency to your business relationship from the outset, preventing disputes, confusion, and mishaps down the road.
6. Make a formal agreement
After you decide on the terms of your partnership, have your lawyer draft a formal partnership agreement or operating agreement.
This document should cover:
- Ownership percentages
- The buy-in amount
- The roles and responsibilities of each partner
- What profit and loss sharing will look like
- What the decision-making process will be
- How disputes will be resolved
- What the exit strategy is if one partner decides to leave
Remember, once you sign this document, it’s legally binding. Review it carefully and make sure you and your business partner understand and agree to the terms before moving forward.
7. Update your tax and business information
With a signed agreement in place, your employee is now officially your business partner. That means it’s time to update your tax and business information.
Depending on your business, state, and industry, you may want to send your partnership details to:
- Your local Secretary of State or business registrar
- The Internal Revenue Service (IRS)
- Licensing authorities if you require a license to run your business
- Your business’s bank and any lenders
- Your insurance company
You may also want to review any existing contracts you have to see whether they need to be updated based on your new partnership.
For example, if you changed your business structure from a sole proprietorship to an LLC, you may want to change your documents to reflect the change in name or structure.
Pro Tip: Review all your document templates, like invoices, quotes, and contracts, and create new versions based on any relevant information from your partnership—like your business name or contact information.
Using Jobber’s field service management software, you can easily update all your important documents to reflect updates and changes in your business. Add your business name, logo, and new policies, terms, or contact details in minutes to ensure all your future documents are correct and up-to-date.
8. Get the word out
The last step in making an employee a partner is to tell clients, staff, and business contacts about the change. For example, you may want to reach out to:
- Your other employees and independent contractors
- Your customers
- Your accountant
- Relevant business accounts, like utilities, cell phone providers, company car dealerships, etc.
- Your landlord or business mortgage company
- Suppliers or vendors
It’s especially important to communicate about your new business partner to anyone who will be directly impacted by the partnership. For example, employees who will be expected to report to them or clients whose main point of contact will change.
The pros and cons of employee owners
Making an employee into a business partner comes with potential benefits and risks. Review the legal, financial, and operational advantages and disadvantages carefully before making a decision.
Employee partner pros
1. Shared responsibilities
When you make an employee a partner, you’re sharing your duties and responsibilities. This eases your workload and helps to divide tasks more efficiently.
For example, you may be better at lead generation and want to focus your efforts there while your partner handles reducing overhead costs by negotiating new contracts.
2. Rewarding top talent
If you have a loyal and hard-working employee who’s directly impacted your business’s success, making them a partner is a great way to show your gratitude. It also keeps them committed to you and your business, preventing them from moving to a competitor or looking for another role that offers them more money or responsibilities.
3. Capital investments
Depending on the type of partnership you have, bringing on a new business partner can come with financial benefits.
For example, if they provide a buy-in, that gives you working capital you can use to grow your business.
4. Fresh ideas and perspectives
New partners come with fresh ideas and different perspectives, offering opportunities to identify new areas for growth.
For example, a new partner may have a great idea for a referral program or suggestions for developing a tiered pricing strategy.
Employee partner cons
1. Loss of ownership
If you choose an equity partner or limited partner, you may give up equity, reducing your ownership in the business. You may have to make joint decisions about the business whereas before you could make those decisions on your own.
2. Potential for disagreements
With another person involved in making business decisions, there will be more room for disagreements and disputes. Especially if you don’t see eye to eye about strategy or business operations.
3. More liability
In a partnership, your liability isn’t only based on the decisions you make. Your partner may also be able to make business decisions that negatively impact the business. Depending on the business structure and partnership you choose, you could be equally liable for their bad investments or business debts.
4. Shared profits
Because you’ll be offering your business partner a share in the profits, you could see a decrease in the amount you receive.
What are the tax implications of making an employee a partner?
The tax implications of bringing on an employee as a partner vary depending on whether you change your business structure and the type of partnership you choose.
For example, if your business goes from being a sole proprietorship to an LLC or corporation, you’ll be taxed differently.
And because partners are typically considered self-employed from a tax perspective, your employee may need to report self-employment income on their next tax return.
Talk to your accountant to understand how a partnership will impact your taxes.
Scaling your service business through a partnership
There are many ways to grow and expand your service business, and the decision to make an employee a partner shouldn’t be taken lightly.
On the one hand, making an employee a partner can make your life easier by cutting back on your duties. But on the other, it’s a legally binding change that can reduce your ownership shares.
Before taking the leap, consider how it will impact both your short- and long-term goals and the vision you have for your business.
And don’t forget to explore other ways to reduce your workload, like using field service management software like Jobber to book jobs, manage clients, and handle payments.
Originally published in May 2016. Last updated on October 29, 2024.
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