Restaurant Profit Sharing & Partnership Agreements

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QUESTION FROM: Richard in SC

“I’m looking for a basic partnership or business sharing agreement for my chef. My family (in-laws, wife and I) have a thriving restaurant and bar on the waterfront with a fantastic team and the chef is largely responsible for that. We couldn’t do it without her and we want to make sure she stays on for a long long time...think the best incentive is to reward her with a share of the business.”


HH ANSWER:

This is one of the most common questions I get asked (from owners, operators and hard workers aspiring to be owners) and it’s a difficult one to answer because providing an appropriate solution requires a lot more information than anyone ever initially provides (hence the consulting gig)...but I can give you a hell of a start (and possibly all the direction you’ll need) for free:

There are so many ways to structure a share agreement... and determining the best fit really requires knowing what the expectations & needs / wants are for ALL parties involved...whether it’s between an operator and investor(s) or ownership and an employee. In the long run, no one is well served by an agreement that leaves one or both parties disillusioned. That’s why I like to speak with all parties involved (independently first and then together as a group) when helping a client navigate these waters.

It’s not uncommon for me to meet with a Chef or GM who really believed they had some form of ownership in their restaurant only to feel like they were “screwed over” when a sale or transfer occurred and offered them no cash at the closing table and no job at the end of the week.

Having open and honest conversations often result in parties realizing two things: 1) there’s no set way to split / share a business (laying out various options usually results in the ability to come up with a hybrid arrangement / something new and unique that both sides are amenable to) and 2) ownership involves a lot more administrative work and stress than most employees realize.

Some good questions to ask yourself and the other party involved before putting pen to paper:
Would you prefer a straight equity share? Are either of you expecting any return on the orig investment/pref return? Are either of you getting a portion or all of the initial investment returned? How are the funds being disbursed/made available to the business? Can anyone draw a salary? Are there salary caps based on dollars or percentages? Does salary offset profit sharing? How is the business entity created (i.e, Inc, LLC, LP, etc...)? What are the terms of any previously existing partnership agreement(s)? Will there be contingencies with regard to the use or allocation of funds? Does this split / share pertain to revenue only or ownership of the business itself and all FF&E as well? In other words… who owns the building or whose name is on the lease? Who owns the equipment? If it’s a profit only split are you talking Gross or Net or Net Net? What is the break even point or target sales & profit based on the Budget? How much money (or profit) is earmarked for labor and/or capital improvements? Who decides whether or not a capital improvement (e.g., new piece of equipment) is necessary? Who writes and approves the Budget and will the Budget’s sales projections / goals affect profit sharing? Who’s managing the books/accounting? What’s the exit plan/strategy?

If you don’t have answers to all (or most) of the questions above, I would strongly suggest having those conversations before going any further with an agreement to split profits or ownership of a business.

If you do have all the answers to the questions above I would strongly recommend obtaining some experienced independent counsel, consultant or mediator before moving forward.

Just remember: Equity does not exist in a vacuum. So if you’re the one being offered a “partnership“, you need to examine the fine print (or large print) to see whether it’s actual equity (aka ownership) or profit (aka bonus) that’s being offered.

If the “partnership” is a profit sharing partnership based on: sales, labor and other controllables - you can simply look at the last 3 years worth of P&Ls, multiply the equity percentage offered by each line item....and if you're satisfied with the potential then go for it. A common profit sharing formula used by associates is to offer ten percent (10%) of the net net profit for every quarter a chef/GM meets or exceeds the same quarter last year (PY).

It’s important for those being offered a partnership or profit sharing bonus to realize that even “Net Profit” can decrease or disappear at-will by anyone who has the authority (51% or more) to change wages, invest in a capital expenditures, buy something, rent something, lease something or pay for something that benefits the business even if it isn’t listed on the budget (including a company car or paying their significant other $100,000 to do the books).

IMHO, Regardless of whether you’re talking about an equity share or straight profit-share (more commonly referred to as a “bonus structure”); profit sharing should be tied to "Gross Sales" via percentages.

If those numbers get too big too quickly and/or you have multiple partners, a more controllable version would be to flag/offer a pre-set dollar amount like: $1,000 for beating food cost(Chef only), $1,000 for labor, $1,000 for other controllables(GM only) $1,000 for hitting sales budget and $1,000 for secret shopper scores- for a total possible bonus of $4k/quarter each or a total of $32k per year ($16k extra each).

If you are offering (or being offered) actual equity you need to look at the existing partnership agreement(s) with a lawyer to see how the company is formally incorporated and how the partners’ profits are both calculated and distributed. The existing agreement doesn’t necessarily dictate how the newest partner’s equity will be paid out, but it will provide the newest member of the team with an understanding of 1) who they’re getting into bed with, 2) who needs to agree to these new terms in order for them to be valid, 3) what’s left over to be shared 4) who’s holding the purse strings (i.e., if one party can unilaterally approve expenses without a cap… like say, a $700,000 salary for themselves as the managing partner and 5) whether or not a partner can be let go without cause / be forced to sell their shares back to the majority partners.

Most of the “partnerships” or “splits” I set up are gradual shifts from salary to full equity (for simplicity sake) where the salaried employee/manager/chef gradually sees the amount of money in their check gradually decrease while their percentage of their actual equity or “ownership” in the business gradually increases.

In the case of new relationships, I often recommend vesting the “employee” so that you don’t have a situation where a chef walks out after 120 days and owns 20% of the place.

Just remember that as long as one party has a greater percentage of ownership than another party, the party with the smaller percentage of ownership serves at the pleasure of the party with the majority interest. If both sides are ok with that / trust one another that can work. Trust in the majority shareholder / principal partners is key as at the end of the day- the minority partner will (technically and most likely legally) have little to no say in how the business actually functions (i.e., how money is spent and how profitability is measured) … or at least not have the final say.

Add to that the fact that the minority partner will often bear their full share of the liability and losses caused by the majority partner’s decisions as well (unless the agreement is carefully structured to shield the minority partner from such downsides) and you have a better argument for full ownership transfer at the mutual parties earliest convenience.

Consider these points as well:
https://www.hospitalityhelpline.com/finance/2019/1/8/5050-partnerships

Josh SapienzaComment