Giving someone part of your company can be a meaningful step.
Maybe a key employee has become essential to the business. Maybe you are bringing in a new partner. Or maybe someone helped build the company and you want that person to participate in its future value.
The idea may begin simply: I want to give them 10%.
But a percentage alone does not tell you what the new ownership relationship will look like.
What rights come with that interest? Does the person receive it immediately or earn it over time? What happens if the relationship ends? How will the new ownership affect control, distributions, future financing, or an eventual sale of the company?
Giving someone equity may be exactly the right decision. But before ownership changes hands, the structure should reflect what the business owner is actually trying to accomplish.
What Are You Actually Giving Them?
Suppose a business owner wants to give a key employee a 10% interest in the company. The natural first question is whether 10% is the right number.
There are other questions to answer.
What economic rights will come with the interest? Will the new owner have voting or other governance rights? How will distributions work? Will the person have a say in significant business decisions? What information rights will apply? Can the interest be transferred?
The answers will depend on the type of entity, its governing documents, applicable law, and the terms of the arrangement.
They should also reflect the business objective.
An owner who wants to share some of the company’s future economic upside may be trying to accomplish something quite different from an owner who wants to bring someone into the company’s decision-making structure.
The documents should reflect that distinction.
Should the Ownership Be Given Now or Earned Over Time?
Sometimes equity is intended to reward what someone has already contributed. Other times, part of the objective is to encourage that person to remain with the business and contribute to its future.
Those are different circumstances.
If someone receives the entire ownership interest today and leaves the company six months later, the remaining owners may find themselves in a long-term ownership relationship with someone who is no longer involved in the business.
Depending on the circumstances, ownership can instead be structured around time, performance, milestones, or other agreed conditions.
There can be significant legal and tax consequences to how those arrangements are structured. But the business question comes first:
What does the company expect the person to do in exchange for becoming an owner?
The structure should support that expectation.
What Happens If the Relationship Ends?
This is an easy question to postpone. Nobody expects the relationship to end when everyone is excited about creating it.
People leave anyway.
An employee resigns. A partner pursues something else. Someone dies or becomes unable to continue working. A relationship deteriorates. Two owners who once agreed about the company’s future begin moving in different directions.
What happens to the ownership interest then?
Can the departing owner keep it? Does the company or another owner have a right or obligation to purchase it? How is the purchase price determined? When is payment due? What happens if the parties disagree about value?
The answers can have significant financial consequences for everyone involved.
They are also considerably easier to negotiate while the relationship is good. These are the same terms business partners should decide before problems begin, and the reasoning does not change when a new owner is added later.
Planning for a departure is not an assumption that the relationship will fail. It is part of defining the ownership arrangement while everyone still has the opportunity to agree on the rules.
What Rights Will the New Owner Have?
Ownership can affect how a company makes decisions even when the new owner holds a relatively small percentage.
The precise rights will vary depending on the entity, governing documents, applicable law, and transaction. That makes it important to understand the company’s existing governance before adding another owner.
Who controls ordinary business decisions? Which decisions require owner approval? Are there voting thresholds for particularly important actions? What restrictions apply to transfers? Are there rights of first refusal or other purchase rights? What happens if the company issues additional ownership interests later?
A 10% interest in one company may have very different practical consequences from a 10% interest in another.
So the question is not simply how much of the company someone will own. It is what that ownership will mean.
How Does the New Ownership Fit With the Rest of the Business?
Adding an owner rarely affects only one document.
Existing organizational and governing documents, owner agreements, buy-sell arrangements, capitalization records, compensation arrangements, financing documents, and other contracts may need to be reviewed or updated.
Tax treatment can also materially affect how an ownership arrangement should be structured. Legal counsel and the company’s tax adviser may therefore need to coordinate before the transaction is completed.
Then there is the longer horizon.
What happens if the company later raises capital? Offers equity to another employee? Changes its management structure? Buys another business? Receives an offer to sell?
A decision intended to reward or retain one valuable person today should not unnecessarily complicate the company’s next major transaction. Those questions are worth reviewing alongside whether the company is ready for an investment or sale.
This is also where ongoing counsel can become particularly useful. Outside general counsel who already understands the company’s ownership structure, key agreements, financing, management, and longer-term objectives does not have to examine the equity decision in isolation. The question becomes how the proposed arrangement fits into the business as a whole, and what else may need attention before it is implemented.
Start With the Business Objective
Before deciding how much equity to give someone, it helps to answer a more fundamental question:
What are you trying to accomplish?
Reward past contribution? Retain a key employee? Create a genuine business partner? Bring in capital? Gradually transition ownership? Align someone’s compensation with the long-term value of the company?
Those objectives are not interchangeable, and the right structure may differ accordingly.
Once the objective is clear, legal counsel can help determine how the proposed arrangement fits with the company’s existing ownership and governance, identify issues that should be resolved before the transaction occurs, coordinate with tax and financial advisers where appropriate, and prepare the documents needed to put the arrangement into effect.
The immediate need may be a discrete ownership project. But for a growing company, the questions surrounding that project often connect to broader legal needs: governance, contracts, financing, compensation, succession, and future transactions. Where those issues recur, an outside general counsel relationship can provide continuity rather than requiring the business and its lawyer to start from scratch each time.
Giving someone equity should not become complicated merely because lawyers are involved.
But becoming an owner is consequential. A little work before ownership changes hands can help make sure the arrangement creates the relationship everyone intended.
Lovstad Law advises business owners on ownership arrangements, governance, business transactions, and ongoing outside general counsel needs. If you are considering giving an employee, executive, partner, or other person an ownership interest in your company, schedule an introductory call to discuss the structure before the ownership changes hands.
This article provides general information and does not constitute legal or tax advice. The appropriate structure and legal requirements depend on the entity, governing documents, tax circumstances, and specific transaction.
