How can I decide whether to partner as a member with an LLC that I helped create?

Question

A business partner and I are creating a software consulting business. My role is the lead product developer (err, CTO?) that handles all technical aspects and he is the visionary interfacing with clients and community groups (err, CEO?). We get along well, and we now have the potential to make some money with the product, so he started an LLC and wants me to join as an equal member. The alternative is for me to work with him as a contractor, and I have other freelance software projects to support myself. What kinds of things should I consider when deciding to partner as a member of an LLC? We are not taking investor money or selling stock; we are providing a consulting service for a product that we developed.

I think my options are to partner as an LLC member, or have him pay me as a contractor. I believe partnering would ensure that I am credited for my work, but I'm not sure of the caveats. What criteria should I weigh in making this decision? If we partner, how can I ensure that we draft a fair and effective operations agreement?

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If interested, here are some details:

This started as a passionate volunteer project, and I've devoted ~600 hours of free time, although he has since paid me $2000 out of his pocket. We are getting grant money and just got our first paying client (~$3000 contract). He wants me to partner so that we can share the LLC's bank account and make draws instead of paying me as a contractor. We agree that I probably deserve most of the money since I contribute more time and expertise, and my contribution is necessary to grow and maintain the product. I built ~95% of the platform. His contribution is the original idea and managing the marketing and networking.

Here are some other salient points:

• I want to continue freelancing because we are not making enough to pay me full-time
• Neither of us has a full-time job or much personal income or savings
• The product is free software, licensed under GPL
• I want to protect myself and get credit for my early contributions. I want to avoid getting replaced by another engineer when/if it takes off
• My partner's main concern is to have an executive decision when it comes to product vision and bigger picture decisions
• My partner's contribution is the original idea, a website describing the product, networking, and grant writing. He has little software engineering experience.
• My partner's contribution is ~600 hours, but spread over the last 2 years. My contribution is ~600 hours too, but over the last 5 months.
• Although my contribution is ~600 hours, much of it was trial/error and learning. An experienced dev could probably do it in ~300 hours. My skillset is that of a junior software engineer (~2-3 years experience)

Answer 1

Being a partner with equity vs. an employee has several advantages and disadvantages.

The main advantages of being an employee is security. You get a fixed paycheck, no matter how well the company does. Customer A disappeared without paying? Supplier B took our money and doesn't deliver? Customer C suing for a bajillion dollars? Tough luck, shut up whining and pay me. Sure, you can get fired, but you can also quit at any time without losing any of your investment. Depending on country, being an employee can also have several social security benefits you don't have as a business owner.

On the other hand, being a co-owner means you don't just share the risks, but also the rewards. Should the company do exceptionally well, you are entitled to part of it. So should your company really take off and make a bajillon dollars, as a co-owner you get half of it while as an employee you only get your paycheck. However, don't have the illusion that this will happen. Most startups fail, and those which don't often end up as small businesses which don't generate more profit than a slightly above average wage for their owner(s). The success story of the small garage company becoming a global player in a decade is the rare exception, not the norm.

It's also a matter of control. As a co-owner you have a say in where the company is going, while an employee is paid to shut up and do what they are told. However, be aware that two people having to agree on everything can be quite paralyzing for the decision-making in a company when you have a disagreement. Also, not having to think about the strategical big picture and just being able to forget about your job the moment you clock out can also mean a much more stress-free life for you. Not everyone is cut out for the constant stress-level you have as a company owner.

In the end, this is a decision you have to make for yourself. Nobody can help you with it. However, no matter what you do, insist on a professional lawyer to draft the employment contract / company bylaws. Friendships can end quite quickly when money is involved. Having a proper contract can save both your money and your friendship when things turn ugly.

Answer 2

What criteria should I weigh in making this decision? If we partner, how can I ensure that we draft a fair and effective operations agreement?

Congratulations on your first sale! While it might not sound like much, many developers dream of something like this.

Focusing on your question, there are multiple issues here. First is the ownership of the product you are selling (code intellectual property). Considering you both have put in approximately equal effort, you should be asking for around 50% ownership. Legally and financially, the most common way to do this is sign the code over to a LLC (Limited Liability Company) you both own. The company sells the software (and incurs expenses in doing so such as sales and marketing) and the owners are either employed or draw income from the company. You have greater risks (usually you take drawings instead of a regular salary) but greater rewards.

Even if you do not form a company, you need to work out who owns the IP. If your business partner (only) owns the code, the product is successful and you sign on as a contractor, your business partner could just fire you then make a lot of money. I am not saying you should not trust your business partner. I am saying create legal and financial structures to protect both of you. Yes, this probably sounds scary and puts you out of your comfort zone (as it does many developers). However, this is easier than you think. Find an accountant or financially savvy friend or relative to help you.

Second, is the question of remuneration and direction. If you want to remain a developer and leave the broader decisions to your business partner, you can be an owner of the LLC but only assign your business partner as a director (member of the board). You still have the right to company financials and information and vote according to your share allocation.

However, I would recommend you both be directors and be involved in larger decisions. Both of you should have access to the accounts and financial records but transacting requires approval (e.g. signatures) from both. This protects both of you in case the other tries to screw the other and, if one of you "falls under a bus", the company is protected. It is also a great learning experience for both of you. Your business partner can still handle product direction and you can handle development but both should run the company.

Answer 3

What criteria should I weigh in making this decision?

• Whether you think the business will grow significantly in the future
• Whether you will share the risk as a contractor anyway (e.g. not getting paid for work done if the company runs low on money)
• How much of a say you want to have in the direction of the company
• How much paperwork you are willing to deal with in order to achieve your aims
• What ownership percentage you would be willing to accept

If we partner, how can I ensure that we draft a fair and effective operations agreement?

If you are not in a position to judge this yourself then you should find a professional or someone in your network who can. Lawyers are expensive but can save a lot of trouble down the line.