Sharing profits in a LLC operating agreement with one investor/one idea creator. Help!

[manville140]

Hi guys,

I found this form via search. So many great posts its going to take me hours to look through them all.

Im looking for some advice in the area of profit sharing for a new business I have started. Ive hired a lawyer, but she doesnt seem to have a grip on the whole idea of the startup profit sharing.

So what we need is a way to keep things fair, but also keep everyone vested in the business for 3-5 years. Obviously 60/40 stagnent only goes so far, but I do not really understand how the schedule would work to make incentives. So maybe someone can help guide me or send me to a another post!

Our Business.
Person One, Invests 100k, Runs the business books, manages the company like a CEO/CFO would, overseas the operation, decision maker.

Person Two, Invests 0, Brings in a sales person, brings in specific business skills in design, works on hiring production and coordinating factory, coordinates with former colleagues who serve as consultants.

Issues:
1. One person is bringing all the capital and business experience. One person is bringing specific skills and people.
2. Keeping person two on board and invested for 3-5 years, so as to not leave the company after they are compensated.

It was suggested to me, to start out at 75/25 until the initial investment is paid back, which would be 100k. I was not sure if that would be the initial investment of 100k and then 75/25 of the next 100k. Or just the first 100k. And if so, how could that initial investment be paid back where I wasn't responsible for 75% of the payback in my profit sharing? I was confused on this point.

Second. After that, it was suggested that 60/40 was a good number to work with. But exactly how does that keep someone invested? What is a good strategy to keep someone invested. This part of the business plan and profit sharing I do not understand how to develop. Suggestions?

Third, what about future loans on the business. Who would be responsible for those? If I take full responsibility, how should the shares be divided? Or should that be an option for both of us to accept in the future?

We both said we are not interested in getting paid until the business starts to make money. Cash flow would be the businesses main hangup, so keeping the cash in the business is the best option. Hence the need for more cash.

Any help would be appreciated!

Cheers

[PeterCPA]

Hi, for United States tax purposes an LLC has a number of benefits. First, the automatic classification for a two member LLC is a partnership. Assuming that you fall in this category, the LLC also allows you flexibility in how profit and losses are shared. More on point, there are profit, loss, and capital interests. You put up 100% of the capital, so, unless you allocate part of that capital to your partner, you would have a 100% capital interest in the company. If you choose to allocate capital to your partner, he/she will have to recognize income for the amount you allocate to him/her.

What I would recommend is that you allocate losses 100% first to you; losses in excess of capital should be split according to your agreed upon split with your partner. Profits should be allocated based on that agreed upon split as well. You should have priority in liquidation (i.e. if you liquidate the company and you have experienced $75K in losses, but sell your company for $50K, you should get $25K first ($75K losses plus $25K return = $100K invested) and the remaining $25K should be split according to agreed upon split.

To answer your questions:
1. You keep your partner invested by talking to them and finding out what motivates them; it might be periodic monetary awards, it might be having a say in the day to day operations, it might be increased ownership in the company. My point is, everyone is different and you need to tailor your compensation plan to motivate your partner.
2. If you are borrowing from a bank, they will most likely want both you and your partner to guarantee the debt. If you guarantee the debt by yourself, you would want to allocate losses to you to the extent the losses equal the debt allocated to you since you are the at risk party.

Go ahead and send me a message with your contact information if you'd like me to call you and discuss your specific situation in more detail.

[HappySpeedy]

You could do a sweat-equity agreement - make them earn their percentage. Especially since they're not contributing any capital. For every year they work give them additional ownership.