Shareholder Equity and Small Business

When you are starting a business, the idea of equity may not be uppermost on your mind. If your business plan does not cover company shares, then it needs to be included. One of the reasons you are in business is to make money, and as your company grows and becomes profitable you need to have a plan to determine how those profits will be dispersed. Equity is a stock or any type of security that represents an ownership interest in the company.  Investopedia says “On a company's balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as ‘shareholders' equity’.” In other words, the startup partners and/or investors in a new small business are traditionally awarded stock shares in the company that will eventually yield a financial return on their invested time and/or money.

It’s not enough, however to simply split up the stock shares in the beginning and then forget about it. Unforeseen variables can occur down the road that can become trouble spots for your business.  One of your investors could decide to leave before planned with all their company shares and this could throw off your game plan.  Business startup coach, Jeff Ready, advises that there is a simple solution to deal with this long before it could happen.

“These shares are made subject to a ‘right of repurchase in favor of the company’ which is a fancy way of saying that, if you leave, the company has the right, at its sole discretion, to buy the shares back.  These restrictions then ‘lift’ over time, meaning that as time goes on, fewer shares are subject to this repurchase agreement.” – Jeff Ready, McStartup.com

The company founders will have the benefit of their shares increasing in value over time but, as Ready goes on to describe, there are two more essential advantages why moving ahead with these restrictions in place is good for the startup investors.

1. The founder’s agreement includes the provision that the founders can vote on their shares as though not under any restriction.
2. The founder’s holding period for tax reasons begins with the official founding of the company.

The startup investors will also want to include provisions in the shareholders agreement for protection of their vested interest in the case of a liquidation or sale of the business. You can actually do this to protect your employees as well, to prevent new owners from taking over, buying the stock back for next to nothing and then dumping everyone in the company.  There is a fine line that can be crossed in several directions that will put your business at a disadvantage, so word your shareholder agreements carefully and consider the consequences.