Sonja and Tarsha are co-owners of S&T Test Prep, an LLP they established together. They each own a 50 percent equity share (i.e., half of the business).

At first, their business is devoted to tutoring students, and Sonja and Tarsha do all the tutoring themselves. Pretty quickly, because they are good at what they do, Sonja and Tarsha have more clients than they can serve on their own. They bring on some 1099 contractors to handle the extra clients, and initially this proves to be a good way to expand their customer base and revenue without taking on the expense of hiring a W-2 employee.

However, they fairly quickly realize that the contractor model has limitations. Turnover is quite high, and the quality of work delivered is uneven. They try to address these problems by devoting some of their time to training the contractors, but they don’t get much of a payoff for their investments because the turnover rate remains high.

Sonja and Tarsha decide they need to hire some w-2 employees to keep their business healthy and growing. Their first full-time employee is Prashanth. They offer Prashanth a 1-year contract that will cost them $60,000 when you add together his salary, employment taxes, workers comp, insurance, and all the other expenses that bringing him on will incur. To cover this cost, the owners each make a $15,000 dollar contribution to the business and they take out a $30,000 loan.

It takes almost 2 years for Prashanth to “break even,” meaning that the money he has brought into the business is sufficient for Sonja and Tarsha to repay themselves their $15,000 contribution and also pay off the loan along with all interest and servicing charges. Once Prashanth breaks even, the money he brings in each month is sufficient to cover all the costs associated with having him as an employee plus some left over that can be booked as profit.

A few years later, Prashanth is an invaluable part of the team, booking considerable revenue and also managing and training newer employees. Recognizing the gap between what he brings in and what he is paid, and also feeling like he has earned the right to be an owner, Prashanth asks to be made a Partner, and Sonja and Tarsha agree.

In practical terms, what this means is that Sonja and Tarsha will need to sell some of their equity shares to Prashanth. To do that, they must answer two questions. First, what should the distribution of equity be once Prashanth has been made a Partner. Second, what should the shares cost?

For a quick overview of some of the ways Partnerships determine what their equity shares are worth, select the Next Unit button below.