Question for people with business partners

by McStizly. Posted on Sep 14, 2020    3    14


Question on business partnership and what is fair

Hello, excuse me if this is not the right place.

Myself (Person A) and a friend and future partner (B) are purchasing a very well established business.

A is providing all capital for the business loan down payment. ( 50,000 )

B is providing no startup capital but will be running business until A retires from current job and goes full time 50/50 with B.

Loan is 500,000 x 10 years ( company is valued at 850000 but current owner is friend of both of us)

A is drafting a rough operating agreement and is curious as to how much he is entitled to return wise for the 50,000 dollar investment into the business.

I know in shark tank they say X money for X percent in company plus this or that.

Can someone lead me in the right direction?

I am leading towards 10% return on capital per year so a 5000 dollar return yearly.

I will be contributing capital to the loan in return for ownership of company but that is not my concern at the moment, the answer to my current question will guide the rest of the partnerships operating agreement.

Thanks and I will try to provide info if needed, just looking to be pointed in the right direction, not looking to be talked down or out of anything.


Comments

bluekmg 1

I won't do a 50/50 partnership again, one person needs to be in charge. Things never seem "fair" to either partner. While you're drafting the agreement, make sure you include the exit options so when one of you is ready to walk away you both know what to expect.

FreeGFabs 1

I have a similar situation to this. I had the capital. What we did was treat my capital investment as a loan at the same rate as our sba loan with a similar term. Ours is 60 months. 30k loan.

  McStizly 1

So you took the interest rate % from the business to pay yourself back? So if we get say 6% I’d take 6% of 50k a year?

FreeGFabs 1

Day 1 you each own 50% right?

So B is 50% owner and has loaned the company 50k

Or

B owns 50% plus whatever percentage 50k equals of the valuation?

  McStizly 1

B didn’t contribute

FreeGFabs 1

Ok, which of those situations is more accurate swapping in A?

  McStizly 1

Neither there’s a bank loan.. we’re under the impression I get 10% for my 10% down but if partner has no capital that’s what I’m getting at here. On paper it’s 90/10 and I’m just an investor in the beginning and wondering about my return.

FreeGFabs 1

you get 10% of the net profit if you are a partner.

If you are taking a 10% straight return regardless of profitability then you are not a partner. You are a private bank that loaned someone 50k @ 10%.

pagbot 2

I would figure out the long-term outlook first. Figure out what your equity split should look like once the loan a paid off and A & B are both full time. Then, work backwards. Let’s say you decide it will be a 50/50 split, which I think is what you were saying (aside: please don’t ever do a 50/50 split — either go 51/49 or find a third partner to give a small, tie breaking percentage to)

Next, I would decide whether B’s running the business early, before A is full time, should be considered a contribution. In my mind, it would be. Is this greater or less than the 50k contribution A is making?

If they are roughly equal, then you’re done. A contributed cash, B contributed time, both worth 50k, so you’re square.

If A’s contribution is greater, I would suggest that the profits first go to making A whole with the difference in contribution (eg if B contributed $20k in time, the first 30k in profits go to A). And vice versa.

Now, if B is salaried by the new venture, B is not contributing time, so the “difference” I’m talking about would amount to the static 50k, and so A is owed the first 50k in profits.

But this really depends on where your equity conversation lands in the first place.

hjiang1 1

Rarely do people exercise voting rights in earlier stage businesses especially without a board. I would argue that giving a controlling share to one party over another is much more detrimental than 50/50. I would advocate for a 50/50 equity split provided the contributions are generally equal.

pagbot 2

Rarely is the key word. You’re planning for the rare case, not the common case. Having no escape from deadlock puts your business in exactly that situation. I’ve seen probably a half dozen of my clients’ businesses destroyed by this. There is no benefit to not having a tie breaking mechanism. Hope for the best, plan for the worst.

  McStizly 2

I like this a lot. How would I value their time? It’ll be 2 years minimum, but with my monthly capital contribution to the loan as well. We can do the math on that though. I appreciate it.

pagbot 1

That’s a gut check and probably something you need to agree on together. Some folks view it as the loss in salary that B would’ve been making otherwise (a fair market value for their time), and some folks use the target salary at the new venture (which can be higher but is usually lower than FMV for a founder). It sounds like you’re contributing a fairly large amount here, but what it really boils down to is payback schedules. If B takes a salary, he’s getting “paid back” in real-time while you are waiting on profits. If B does not take a salary, you’re offsetting his payback by your loan contributions. Would love to hear where you land!

  McStizly 1

B will be using this as his full time only income as he already retired from previous job and we’ve been in this process since. Not leaving anything behind and a massive pay increase going off last 2 years financial statements. I will figure out the time vs capital thing and report back. Thanks!