Tag: partnership

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Episode 84 – A Marketing Agency’s Approach to Sharing Equity with Key Employees – Member Case with Kelsey Raymond

There are many ways to split up a partnership. And the equity split needs to evolve over time. On this episode, Kelsey Raymond, Co-Founder & Chief Executive Officer at Influence & Co., shares how she successfully replicated herself by developing a key employee into her COO, so she can run the business on her own terms.

TRANSCRIPT

Greg Alexander [00:00:15] Welcome to the Boutique with Collective 54, a podcast for founders and leaders of boutique professional services firms. For those that aren’t familiar with us, Collective 54 is the first mastermind community to help you grow, scale and exit your firm bigger and faster. My name is Greg Alexander and I’m the founder and I’ll be your host today. And on this episode, we’re going to talk about ownership, structure, the right one, how to split up equity and all of the associated challenges with that. And the reason why members should care about this topic is because converting income into wealth is how boutique founders realize their dreams. Generating a high W2 or K-1 is easy. Most of our founders are exceptional people, and generating high incomes has not been a challenge for them. However, building a large balance sheet is hard. Net worth Trump’s net income and net worth is generated from ownership. We want to make sure that our scaling activities are producing lots of personal, net worth and wealth for our founders. And sometimes that requires sharing equity with others that can help grow the pie, so to speak. So therefore, the right ownership structure is so important. So we have a role model today, Kelsey Raymond. And Kelsey is an expert on this. And she’s someone who has created wealth for herself and converted income into wealth. It’s built an amazing business. And she’s going to tell us a little bit about her journey and how she pulled this off because so many of us are trying to do it. So. Kelsey, welcome to the show and please introduce yourself. 

Kelsey Raymond [00:01:58] Thank you. Thank you for having me here. As you said, my name is Kelsey Raymond. I’m the CEO and founder of Influence and CO, which is a content marketing agency. And yeah, I have been doing it for about ten years and have learned a lot and made a lot of mistakes along the way. So hopefully others can learn from some of those. 

Various Speakers [00:02:21] Okay, great. And I wanted to talk a little bit about equity and equity splits. And as I understand it, but I’m sure there’s more to the story that you have a CEO, I believe her name is Alyssa, and she’s been pretty important to you. And and you have shared some wealth with her. As I understand it, she’s an equity owner in your firm. Tell us a little bit about how that evolved over time and and why you decided to go that route. 

Kelsey Raymond [00:02:53] Absolutely. So the first iteration of this, from the beginning of the company, since we started turning a profit, my former co-founder and I decided that it was important to align incentives with the whole team. So we from the day that we started turning a profit, we allocated 10% of the company’s profit for a profit sharing pool to pay back to the rest of the team. This was always, you know, communicated as this is at our discretion. If we have a really bad quarter, it’s not going to happen. You know, don’t count on it. Don’t go plan to, you know, put a pool in the ground or anything like that. But but so from there, that was a way that, you know, even as a small team of 12 people, we had this profit sharing pool and everyone got different amounts determined by their role, their seniority, their performance. And it was paid out on a quarterly basis. Mm hmm. Alyssa was our first ever full time employee. So she’s been here since day one. I very much consider her, you know, an unofficial co-founder from the beginning. So as that her profit sharing amount was always the highest or on the higher end of everyone else on the team. And over time, we saw that one way to really show her how much we valued her was to give her a guaranteed amount for that. So it changed from, hey, you’re going to get some percentage to, you know, we’re allocating 10% for the whole team. 2% is just for you. So, you know, every quarter you’re going to be getting 2% of the profits. But at that time, it wasn’t equity. It was really I think most people would call it phantom stock. So if she chose to leave the company, that was going to go away. So I share this is kind of a an evolution over time of both Alice’s role changing in the organization and really, you know, her stepping up more and more. I wanted to tie her in more and more as her role changed. So once she became the CEO, I really, you know, and my co-founder left. So that’s a whole other story there. But I really, really saw that it would make sense for her to have some true equity. And one of the reasons for that is that we were having conversations that we were open to the idea of selling the business at some point. And based on her, the profit sharing structure that she had, she wouldn’t have been included in any exit, any sale. And so went to her and said, you know, I really would like for you to come in as an equity partner. You know, up until this point, we’ve just we’ve given you this 2%. If you want to buy in at, you know, up to 5%. I’d like to welcome you to do that. And the way that we structured it is that we only asked her to pay 20% of that purchase price for the equity that she was buying upfront. And then the rest was paid out of the proceeds of her distributions. So that really allowed for. Her to have true equity in the company without having to come up with a bunch of money upfront, but still having some skin in the game since, you know, I had brought a lot to the table when we had got the loan and everything like that. So that’s kind of the evolution over time. And then we actually did end up selling February 4th. Melissa and I are still running the company, so it’s an interesting structure. But with that, you know, her her return on what she invested to become a true equity partner, she said, is, you know, the best investment she’s ever made. Times 1000. So it all it’s all worked out really well. And it made me really happy that, you know, that opportunity that made me more wealth worth selling that business, that she was really included in that because she’s been so key and so integral to the organization. Yeah. 

Greg Alexander [00:07:04] Well, so first off, congratulations on your sale. We’re very proud of you. And I hope it was everything you dreamed it to be. But I will say I’m glad you’re still running the shop. And and it sounds like you’re going to go on a journey. Did you sell to a private equity firm? 

Kelsey Raymond [00:07:18] We did. We did. It’s an interesting, interesting structure, which I think is probably pretty standard. But, you know, part of the value was in cash up front, but then part of it’s in over an hour now and part of it is enrolled equity. And so that’s where, you know, Alicia is still included in that as well. So that’s, you know, rolling that into hopefully something a bigger pie in the future. 

Greg Alexander [00:07:39] Yeah. So your incentives remain to be aligned and hopefully the second bite of the apple is even bigger than the first bite of the apple, as they like to say. Okay, so I loved the story on how it evolved over time and the vision that you had from the get go of aligning incentives and setting aside this profit sharing pool. And then when you decided that this one individual was worth buying in and having real equity coming up with a creative, creative financial structure to make that happen, because sometimes when when members try to do that, they go to people and they make the offer, but the people don’t have the money. And it. Exactly. It’s prohibitive. Right. So and I did that with my firm and it worked out really well. There are some challenges with that. I’m sure you uncovered, for example, you probably had to have a partnership agreement at that point that that, you know, governed what you can and cannot do because you now have a fiduciary responsibility to it, to another party. So you had to weigh all the headache of doing this with the benefit. So what was kind of your pros and cons analysis there? 

Kelsey Raymond [00:08:43] Yeah, that’s a great question. I think the the biggest pros and cons analysis was. Replacing a. Like. I know. I think that she is absolutely capable to go out and start something of her own. Not even if it would just be a competitor. She could start any company. Yeah, she’s incredible. And so knowing that she’s going, she. She knows her value enough that even if she loves working with me and we love, you know, everything that we’re doing together, she knows that she could do something on her own. And so that was, you know, the biggest thing in the pro column is what can I do to make sure that she knows she’s valued and that, you know, she’s going to stick around for the long term. So that was the biggest thing I will share, that I had an instance with an employee that was leaving who also had a guaranteed portion of profit. This was our former CMO and she had asked when she was leaving, Hey, can I can I buy that portion like I’m leaving? And I know that that goes away, but I think the company is going to continue to do really well. So can I buy in and get that percentage? And the answer to that was no, because there wasn’t value there to me, because she wasn’t remaining on. Right. And so with Alissa, I really was looking at is this going to keep this person motivated and incentivized to stay with the company? And looking at, you know, if I knew that if we were going to sell someday, I needed her in my court on that. I needed it to be something that she was excited about as well. And so having those incentives aligned for her on a potential sale was really, really important to that as well. Yeah. 

Greg Alexander [00:10:29] What’s so great about the story is that her investment and the equity she got as a result of that materialized. Exactly. Yeah. Sometimes I hear, unfortunately with other members when investments made and you’re making an investment in illiquid private company. So everything has to go right in order for that to get liquidated and in it turn into real money, which it did in this case, which is such a great example of that. Sometimes when private equity makes an investment in a firm like yours, they want meaning the new investors want a broader set of owners. They sometimes they set aside, for example, I don’t know, maybe 10 to 20% of the equity in stock options. And they want to spread ownership across instead of just you and Alissa, maybe you, Alissa, and three or four others that that happened in this case. 

Kelsey Raymond [00:11:21] It didn’t. The conversation that we did have is that they are creating a liquidity pool, liquidity bonus pool for when the that second bite of the apple when it the entity as a whole because we’re rolled up with a few other agencies now sells again they’ve asked me to identify a few other people in the organization that I think are other other people that we really want to make sure are incentivized to stay, that they see that same vision and that they would be included in that liquidity bonus pool. That, though, is different than equity because they would have to be remaining at the organization during that time frame for that to materialize for them. 

Greg Alexander [00:12:07] Okay, I see. So they are aligning incentives and doing it with a liquidity bonus pool as opposed to the stock option, which sometimes happens. But I’m glad to hear that they did that. You know, you mentioned something about your CMO and her wanting to buy her phantom stock, but then leave and you had the wisdom not to do that. When I see people doing that, they create this thing called debt equity. And debt equity is when somebody owns a piece of your firm, but they don’t work there. So they’re really not creating an equity. And when you go to sell the firm down the road, it becomes a real problem because somebody says, okay, I’m paying this amount of money for this piece of equity, but there’s not there’s no one behind it. Yep. Did you get lucky there? Did somebody give you that advice? Have you you know, how did you know enough not to do that? 

Kelsey Raymond [00:12:55] Yeah. I’m trying to think. I think the biggest thing for me because this I respect the heck out of this for this woman that asked. The biggest thing for me, though, was also kind of creating a precedent for if I said yes to that, we had other people that were involved in profit sharing that may also want to buy in. I’d have to have a really good reason to tell them no if they were still with the company. And I let someone buy in who’s not with the company. So I think that was a big case of it is thinking through, you know, doing this for one person on our leadership team, anything that has anything to do around compensation, equity ownership, I assume that everyone else knows everyone else’s business. Yeah, because I think that’s the only way you can make smart decisions is if I assume that if I tell her yes, she’s going. You go tell every single other person on the team, which she wouldn’t have. But if I make that assumption, then I can make the decision through that framework of what I be willing to do this for every person that asks. And if the answer is no, then I need to be really careful about setting that precedent. Where was Alyssa? She was the first employee on the team. I think many people probably assumed she was an owner even when she wasn’t. And so telling the team the why behind Alyssa is the only one that was given that opportunity was a very easy explanation and something that I knew I could stand behind. 

Greg Alexander [00:14:22] Yeah. And they were probably happy for. 

Kelsey Raymond [00:14:25] Absolutely. They were excited because I think, you know, they also saw that as great a loss is not going anywhere. We don’t want her to. 

Greg Alexander [00:14:31] Yeah, exactly. When you weren’t selling the equity to Alyssa, how did you put a price on it? 

Kelsey Raymond [00:14:38] Yeah. So this is going to be I’m going to try to sell the short version, but interest. What made this even more interesting is that I started the company with two founders back in 2011. Two other co-founders. One of the co-founders owned a. Basically what turned into a private equity firm. It wasn’t a private equity firm at the time. It was kind of like an incubator. It was very unique model. And so he brought all of the money to the table. And myself and the other cofounder were the ones executing. That was in 2011. I had a very, very small percentage of the company over time, seeing that this other co-founder brought the money to the table, wasn’t involved in operations at all. My other co-founder wanted to do something different. It seemed like the timing was right for me to buy both of them out. So I bought both of them out in 2018. Alissa bought in in 2020. So what we were able to do is I said, you know, I would feel comfortable giving you the same deal that I got. So let’s look at the multiple that I bought it on of EBITA and apply that to our last trailing 12 months EBITA and use that same multiple. So we both agreed that was a fair way to do it because it was basically the same that I bought in at as far as the multiple. And she thought it was a really fair deal as well. 

Greg Alexander [00:16:02] Yeah, very good. So you had the good fortune there of having precedent, you know, and you were generous enough to give her the deal that you got instead of trying to mark up her deal. Yeah. Which is fantastic. And the proper way to handle that. So. Well, listen, I could talk to you about this forever, but we’re. We’re at our time limit here. I do look forward to the member Q&A, which we’ll do here in a few weeks. But, you know, the way that these collectives work is people like you deposit knowledge into the collective body of wisdom, and we all benefit from that. And every time a smart person does that, the whole membership benefits. So. So Kelsey, I literally on behalf of the membership, your story is fantastic. It’s inspirational, it’s educational. And I just wanted to thank you for contributing today. 

Kelsey Raymond [00:16:44] Absolutely. It’s fun to get to talk about these things. And like I said, I’ve learned a lot. So anytime other people can learn from the things I’ve learned along the way, I appreciate it. 


Greg Alexander [00:16:52] Okay. Fair. Fantastic. Okay. And for those that are listening, if you want to know more about this subject and others like it, pick up a copy of the book, The Boutique How to Start Scale and Sell a Pro Serv Firm. And if you’re not a member and you’re listening to this and you want to meet brilliant people like Kelsey and hear these types of stories, consider joining our mastermind community as you can find out, collective54.com. Thanks again. Have a good rest of your day.

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Episode 44: The Boutique: How to Split Up the Pie in a Professional Service Firm

Splitting the equity in a partnership is difficult. However, there is a proper way to do it that results in lots of wealth being created. Learn how to fix broken legacy partnership agreements as you grow, scale, and exit.

TRANSCRIPT

Sean Magennis [00:00:15] Welcome to The Boutique with Capital 54, a podcast for owners of professional services firms. My goal with this show is to help you grow scale and sell your firm at the right time for the right price and on the right terms. I’m Sean Magennis, CEO of Capital 54 and your host on this episode. I’ll make the case that splitting up the equity in a partnership is difficult. However, there is a proper way to do it and it results in lots of wealth being created. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s Chief Investment Officer, Greg has helped many boutique owners fix broken legacy partnership agreements. Greg, good to see you and welcome.

Greg Alexander [00:01:09] It’s good to be here, Sean and you are correct, I was just helping an owner unravel a one sided agreement. Splitting up the pie is very tricky.

Sean Magennis [00:01:16] OK, let’s start there. Share the story with us.

Greg Alexander [00:01:19] OK, so a husband and wife team started a marketing agency and early on they promoted a key employee to partner and gave them 20 percent of the equity. This was in response to the employee receiving an attractive job offer from another agency. In the beginning, everyone was happy and it seemed to be working. As time went on, the husband and wife started resenting the new partner. The new partner was not delivering the expected revenue, yet he was getting distributions from their efforts.

Greg Alexander [00:01:52] Also, the husband and wife wanted to take the agency in a new direction, but the new partner did not. He resisted and the way the operating agreement was written as he was able to stop it. The situation deteriorated and got hostile, with lawyers and others coming in, a valuation firm was hired to figure out a buyout price. Of course, no one could agree on what his 20 percent was worth and how the buyout would be paid over time. It got ugly and it looks like 20 percent of the equity is now dead equity.

Sean Magennis [00:02:26] So, Greg, what’s going to happen in this situation?

Greg Alexander [00:02:28] Well, they are still fighting and a resolution has not been agreed to yet. However, I’m glad, you know, we let off with this story because there’s a big lesson to be learned here from this example.

Sean Magennis [00:02:39] Greg, what is that lesson?

Greg Alexander [00:02:41] So equity arrangements need to be flexible. So for our listeners, the evolutionary path is a startup that becomes a growth firm, that becomes a firm at scale and then eventually becomes a firm an exit. And equity splits need to change as they move along this life cycle, for example, it is almost impossible to split equity as a startup. There are no clients, there’s no revenue, no profits. It’s also almost impossible post startup in the growth stage. Yes, there are clients and revenue, but there’s no intellectual property or intellectual capital to be valued at that time. The firm is still not worth anything because nobody would buy it. 100 percent of zero is zero. This changes in the scale stage as the firm is now worth something and it changes again in the exit stage because after exit, some partners are leaving and some are staying on. That dictates the need for a new equity split.

Sean Magennis [00:03:38] Greg, this is so key. And before we move on to scale and exit, how should a boutique owner split equity at a startup or in the growth stage?

Greg Alexander [00:03:46] So when starting the firm, I recommend valuing the equity solely based on contributed capital. So, for example, let us say it takes a startup boutique a million dollars to launch. So if you put up 300K and I put up 700K then the equity split is 30 percent you and 70 percent me. A lot of boutique owners split up equity based on sweat equity instead of contributing capital. And this is a big mistake and it leads to hardship down the road. So why is that? Well, it’s impossible to accurately assign a value to sweat equity. So, for example, what percentage of equity should go to a great rainmaker versus an average rainmaker? The questions too difficult to answer instead. Sweat equity is accounted for in salaries, not in equity. For instance, if a partner was responsible for project management, they get paid a salary that reflects the going rate for a project manager. That is the value of the role and it is set objectively in the open market. Does that make sense?

Sean Magennis [00:04:45] Yes, it does. But what happens when a partner does not have any capital to put into a firm at launch, but over time ends up contributing a lot to the firm as it scales? OK, so now you’re talking and this happens all the time and therefore equity splits need to be dynamic, not static.

Sean Magennis [00:05:02] Yes.

Greg Alexander [00:05:02] So in this case, the partners use a tool called the Buy-Sell Agreement. This is a contract that stipulates how a partners share of a business can be bought and sold. It defines that equity splits can happen under certain conditions and it defines exactly how it will happen. For example, it is common that the buy sell agreement establishes how shares in the firm will be priced, who they can be sold to, how they would be paid for, etc.. So having a buy sell agreement in place provides the needed flexibility to dynamically adjust equity splits at as circumstances change.

Sean Magennis [00:05:37] Greg, is this common?

Greg Alexander [00:05:39] Well, yes and no. Buy-Sell agreements are well-worn territory and are an established best practice. A boutique owner could hire an attorney and get one in place very quickly and inexpensively. However, many boutique owners do not have one in place. And you might ask why? Well, this is because founders think they do not need them. They cannot imagine a scenario where the need for one would arise. This is foolish. If you scale your firm in one day, go to sell it. There is a better than average chance someone other than the founder has equity. Founders want to keep all the equity, but I remind them that 100 percent of zero is zero. Sharing the wealth with those who earn it is a very good idea. In my experience. When the founders shares the wealth, more wealth is created for everyone. Magical things happen when employees become owners.

Sean Magennis [00:06:26] That’s excellent advice, Greg, and great examples. Thank you. And now a word from our sponsor, Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Tad McIntosh [00:06:59] Hello, my name is Tad MCIntosh, I own HumCap, a human resources consulting and recruitment forum. We help small businesses with their growth, human resources and recruitment needs. We get asked very often about how we can help you have strategic value in human resources in your growing company. We also get ask what are the risks in H.R. as I grow my company? We solve these problems by building customized H.R. and recruiting solutions for each and every one of our clients. If we can help you with your needs, with our experience and recruiting professionals, please call me at 469-484-6023 or email me at [email protected] Thank you and have a great day.

[00:07:51] If you are trying to grow scale or sell your firm and feel you would benefit from being a part of a community of peers, visit collective54.com. So, OK, this takes us to the end of the episode, let’s try to help listeners apply this. We end each show with a tool. We do so because this allows a listener to apply the lessons to his or her firm. Our preferred tool as a checklist and our style of checklist is a yes-no questionnaire. We aim to keep it simple by asking only 10 questions. In this instance, if you answer yes to eight or more of these questions, your equity splits are working for you. If you answer no too many times, your equity split is likely getting in the way of your attempts to scale. Let’s begin.

Sean Magennis [00:08:52] Number one, is your firm owned by more than one person? Number two, do the owners contribute to wealth creation in different proportions? Number three, are the owners at different stages in life?

Greg Alexander [00:09:09] Yes, so we should talk about that. So if you start your firm and someone’s in their 50s and someone’s in their 20s, you know, over time that person in their 50s is going to want to exit before the person in their 20s. So that’s the reason. That’s just an obvious example of why dynamic splits as opposed to static splits.

Sean Magennis [00:09:28] That makes a lot of sense. Number four, do the owners have different financial needs?

Greg Alexander [00:09:33] Some might need more cash, so therefore they get a higher salary. Some might be more interested in long term wealth creation. So they take a lower salary to get a higher equity split.

Sean Magennis [00:09:42] Again, makes total sense. Number five, do the owners have different visions of the future? Hence your example. Number six, have the partner contributions fluctuated over the years?

Greg Alexander [00:09:55] And again, this is another good governance seal of approval here. If the equity split is dynamic, then somebody can’t rest on their laurels just because they got, let’s say, 20 percent of the firm, you know, at year three and year ten if they’re not contributing, then they should not hold on to the 20 percent in perpetuity forever.

Sean Magennis [00:10:14] Yep. Number seven, has resentment crept into the relationships?

Greg Alexander [00:10:19] Its all the time. Business partnerships are like marriages.

Sean Magennis [00:10:22] Yep. Number eight, are you living with a legacy ownership structure that is now outdated?

Greg Alexander [00:10:28] Yep.

Sean Magennis [00:10:29] Number nine, will rising stars require equity to be retained?

Greg Alexander [00:10:34] Yeah. And the foolish owner here says, well, fine, I’m not going to give him equity. Well, those rising stars will quit. They’ll go start their own firms and now you’ll have new competitors and you’ll have a talent drain. So, you know, don’t be penny wise and pound foolish.

Sean Magennis [00:10:52] Great advice, Greg. And then to wrap us up, number ten, has the ownership structure distorted policymaking?

Greg Alexander [00:10:59] Yeah, and that’s a separate issue. Governance is separate than ownership. So you could have different classes of shares with different voting rights, but that’s a whole nother topic for another day.

Sean Magennis [00:11:07] Yep. Thank you, Greg. In summary, during the start up and growth stage of a firm development, split up the equity based on contributed capital. However, as the firm scales put a buy sell agreement in place, this converts dysfunctional static equity arrangements into healthy, dynamic ones. This will result in more wealth for everyone involved. If you enjoyed the show and want to learn more, pick up a copy of Greg Alexander’s book titled The Boutique How to Start Scale and Sell a Professional Services Firm. I’m Sean Magennis. Thank you for listening.