Profit-sharing for blind/absent investors

[hermie13]

Hi everyone,

I'm hoping to get some advice regarding profit-sharing for blind/absent investors. My friend and I(two founders) are starting a yogurt store. We just graduated from college so we needed to look for investors to help us chip in for the starting capital. We put in 10% ourselves and found around 6 others to invest the other 90% we decided to raise.

Could you please advise me on how the profit-sharing plan typically works? My friend and I are planning to allocate a small managerial salary while we're working and managing the store, while the other investors will only be called upon for major decisions.

Originally, we were thinking of having the profit breakdown as: 25% founders, 25% expansion (goes back into the company funds for company expansion uses), 50% investors (proportionate to how much they invested). However, recently one of them mentioned they wanted it all in terms of shares. Although us founders could be given more shares at first for our technical knowledge, my primary concern is that our share could be diluted if our company requires more funding in the future and more shares are given out (we are hoping to franchise eventually).

Any advice, or suggested/example breakdowns would be greatly appreciated! Thanks!

[xvampyricx]

I'm assuming it'd work somewhat like stock shares?

[JLeezer]

Unless your investors are very kind family members, I would expect that if you have chipped in only 10% of the funding, you will likely only receive 10% or slightly more of the profit. That is generally how any kind of company operates. Of course, you can negotiate a higher percentage with the investors, but I wouldn't expect much more.

Of course, you are entitled to a fair wage for your services performed in an operational capacity as manager or otherwise. Also, any expenses you have incurred during the process of establishing the company should be reimbursed by the company or considered invested capital and converted into an appropriate number of shares of stock (or % of partnership).

And to your last concern (share dilution): you are sacrificing your ownership of the company because you don't have the funds available to finance the entire business. You can negotiate a first-right deal with the other owners that says that if anyone wishes to sell their shares, they must first offer them to the other owners (equally to all interested owners), then to the company (stock buy to decrease outstanding shares), and then to outside parties...in that order.

Good luck with your venture. Please let me know if I can be of any help on other corporate structure or taxation questions.

[hermie13]

Yes, that is what one of the investors are proposing xvamp.

Does this mean that my technical knowledge and efforts don't count for anything when it comes to profit sharing? I'm just curious because it seems unfair that if an investor and myself each put in 10% of the total funding, we get the same share of the profit even though I was the one who put together the company (while they are a blind/absent investor). Is this what typically happens?

Thanks for the responses More suggestions/comments are greatly appreciated!

[JLeezer]

Yes, that is what one of the investors are proposing xvamp.

Does this mean that my technical knowledge and efforts don't count for anything when it comes to profit sharing? I'm just curious because it seems unfair that if an investor and myself each put in 10% of the total funding, we get the same share of the profit even though I was the one who put together the company (while they are a blind/absent investor). Is this what typically happens?

Thanks for the responses More suggestions/comments are greatly appreciated!

I think you absolutely should be compensated for your talents, education, effort, etc., but that compensation is going to need to be negotiated with the investors and a conclusion reached prior to undertaking the venture. You may want to propose stock options for yourself vested over the course of several years, or possibly an annual compensation plan for yourself which includes additional shares of stock. While either of these may dilute the existing shares, it will provide you with more ownership over time.

Keep in mind, though, while you feel confident in your abilities and feel you should be compensated for your effort, your investors are taking a risk in you that they could be taking somewhere else, possibly at a better risk/return ratio. Your sacrifice for starting this business with a substantially lower personal investment is that of control. If you do not believe you are being rewarded with a fair amount in terms of pay and ownership, you should wait until you have more money to invest. Don't blame the investors for wanting to protect themselves...after all, you are the reason there are investors in the first place.

[paul2145r]

I would probably handle all of this with a lawyer. You'll have to have an agreement drawn up that will protect you in the case that the investors decide to sell the business out from under you. If one of them has majority shares, or they band together to form a majority, you may be in trouble.

Another option for you to consider is setting up a holding company that will own x amount of shares. This holding company is then split between the owners. It will add an extra layer of security for them, since they will now be free from any incurred liability.

[rogercbryan]

Here is how I've set-up a few of my companies. This seems to work best for smaller companies:

Situation: You need investment money to get started and you are anticipating that you will need more funds for growth in the future (this is good planning). You want to retain as much ownership as possible but at the same time want to keep your investors happy.

You need to use a 'investor repayment plan with an annual dividend".

How does this work?

First you calculate the amount of money that you have borrowed from each investor. You then figure out how long it will take to pay them back 100% of the invested money. You should be sending the first payment with in 90-365 days after you open your doors. You should then try to have them 100% paid back with in 1-2 years after your first payment.

What this does is it creates a flow of monies so that they will see their investment returned. Setting this up from day one is a good idea. It instills confidence in your investors.

The second part of this is an annual dividend. This is the long term value for your investors. The divided should be on NET income after all expenses including growth investments. The reason that you want to pay back the money you received from your investors is so that you can justify a lower divided. This will give you more control over your company.

Example:
Amount borrowed: $60,000
First Payment: 90 days after start
Amount Paid/Time: $2500 a month for 24 months
Divided: 2.5% to 5% annually

If you didn't do the repayment your investor would expect a MUCH higher divided to justify the risk associated with the investment.

Using my formula will also allow you to negotiate future investments by offering to increase your divided.

You do not have to do this with everyone. You may have borrowed from your parents who are in no hurry to get paid back.

You also want to make sure that your investors have absolutely no voting rights when it comes to operations and management. With that many people involved you will be done in a few months. All decisions need to be made by you and your partner.

This has worked for five different companies I've started... Best of Luck!

[wowgold]

wow,it is cool...