Partner Salary Agreement: 4 Questions to Avoid Partnership Failure (Your Partnership Will Fail – Part 3)

In the early days of a startup, enthusiasm and optimism create a sense of harmony among founders. Everyone’s excited, aligned, and eager to build something great. The shared values that brought you and your partner together may lead one to believe that salaries should be equal – this is where a lot of partnerships go wrong.

Part 1 – Sweat Equity: How Defining Roles & Responsibilities Can Protect Your Startup

Part 2 – 4 Essential Tips for Safeguarding Your Startup

As time goes on, the demands on each partner will inevitably shift. Some partners may lose interest, pursue other projects, or feel satisfied with the level the business has made it to thus far. Others may pour in more energy and time, feeling the weight of sustaining the business. Yet, if salaries remain equal despite unequal contributions, resentment can grow, and tensions can escalate.

This sense of injustice is one of the leading causes of partnership breakdowns. The good news? It’s avoidable. By addressing partner salaries upfront and creating a clear Partner Salary Agreement, you can preempt many of these conflicts and build a foundation for long-term success.

4 Key Questions to Guide Your Partner Salary Agreement

1. Should the partners receive a salary at all?

In most cases, the answer is “yes,” since many partners play active roles in daily operations. However, it’s helpful to divide a partner’s salary into two components:

Ownership Salary (entitlement wages): Compensation tied to being a founder or owner.
Employee Salary (earned wages): Compensation for work done as an employee of the company.

This distinction helps separate financial entitlements from operational contributions, setting the stage for fairer discussions.

2. Should the partners receive an Ownership Salary (entitlement wages)?

An Ownership Salary is a base amount paid to partners simply for their role as founders. There are pros and cons to this approach:

Pros:

Allows participation in company benefits (e.g., health insurance, retirement plans).
Acknowledges the legacy of the founding team.

Cons:

May deter outside investors who see it as an unnecessary expense.
Increases the company’s payroll tax obligations.
Partners may take home less due to taxes compared to distributions.

If you opt for an Ownership Salary, keep it minimal to avoid overburdening your startup. Alternatively, you might decide to eliminate it altogether and focus on profit distributions as a more flexible and tax-efficient way to reward partners. Either way, document the decision clearly to prevent misunderstandings.

3. Should the partners receive an Employee Salary (earned wages)?

An Employee Salary compensates partners for their active roles in daily operations. To decide if a partner should receive one, ask:

If this partner left, would we need to hire someone to replace them?

If yes, the partner is filling an operational role and should receive an Employee Salary.
If no, the partner’s contributions don’t warrant an Employee Salary.

This question clarifies whether the partner is functioning as an employee or simply as an owner.

4. What should a partner’s Employee Salary be?

Determining the right amount requires research and thoughtful consideration. Start by asking:

What does the market pay for a similar position?
How experienced is the partner in this role?
Is the partner effective in their responsibilities?
How easy would it be to replace them if they left?

Use these factors to calculate a fair and reasonable salary. While the number may vary, the goal is to ensure partners are compensated in line with their contributions and the market value of their work.

Why a Partner Salary Agreement Matters

The answers to these questions will form the basis of your Partner Salary Agreement. Whether you formalize it in writing or not, having the conversation is what matters most. Addressing salary expectations upfront can prevent resentment, foster trust, and protect your partnership from unnecessary conflict.

Final Thoughts

Don’t let salary disputes derail your business. During the formation of your startup, take the time to discuss and document how partner salaries will be handled. A little effort now can save you significant trouble down the road.

Stay tuned for part 4 of “Your Partnership Will Fail,” where we’ll explore more strategies to navigate the challenges of business partnerships and build a foundation for lasting success!