I have being offered 50k investment but not sure if its a good deal, advice pls :)

amn88 · 19-07-2011 02:49PM #1

Hi I have a business idea, that i am very confident in; its not a huge risk business as the stock can be easily liquidated if things werent going too well for us! I was looking for a 100k investment but one of my best friends is after offering me 50k , which is very decent of him i know but he will be no major plus to have in the business.. ie he is not a business man at all. 50k would be enough to get the business of the ground.

He wants to give me 50k which I re pay in monthly instalments over 5 years, ie €833 per month! So thats ok, i think!? Maybe I should stretch over 10years!?
Now for his return on investment, he wants 20% of all profits and play no part in the buisness, just a silent investior
OR
he is willing to put in the same amount of hours as me and get 50% of profits! I will be working on a profit only basis, i will not be paid a salary, i.e. ill either be getting 80% of profits if im working alone or 50% if there is 2 of us working together! I will need someone working with me in the business anyway and they will cost about 25k per annum, he would be able to do anything that employee would be able to do, so basically ill be saving 20k a year on salary apprx but ill be giving away 30% of profits.

Now for the projections; I project 30k profit in yr one, 50k in year 2, 70k in year 3 and 80k for yr 4 and 5.

If he is working in the busines he will be saving me 100k on salary over the 5 years and will be getting a PROJECTED 205k in the profit share system.(50% allowing the extra 100k saved on wages) I'll also get 205k over the 5years

If he comes in as a silent investor he will get (20%) of profits which is 62k and not work in the business so thats allowing for me paying 100k in wages over the 5 years to replace him.

Is this a good deal in terms of investment considering;
1/ buiness bank loan is not an option at the minute for me.
2/ im willing to work for nothing until there are profits in the business
3/ his loan repayment is the no.1 payment every month
4/ if it was my own money i wouldnt be getting paid until there were profits anyway! average 50hrs per week.
5/ there is no financial risk as i am not putting in money and also i am not leaving a job for this (i also have a decent income every week to keep me going)
6/there will be turnover from day 1 as i have customers waiting already!

What do ye think of this investment, should i grab it with both hands? If so which option is better? Or is it expensive considering the risk isnt huge?

YouBuyLocal · 19-07-2011 05:10PM

Hi,

Just a minor thing, but would you not ask him if you could postpone the loan repayments for the first year? If he is taking the risk with 50k, surely he is more interested in the latter 40k than the first 10k, but if you are only projecting 30k profit in the first year (I presume that is already counting loan repayments) then saving you 10k might improve your chances of succeeding in the long run, and thus improve his chances of getting paid back in full. Maybe I'm wrong though, maybe you are counting in all the costs already and 10k wouldn't be a big deal.

I suppose these things all come down to the cost and availability of capital. If he is your only option then you may have no choice but to offer him a better deal. But if you're clever you'll never let on that this is your motivation.

The most important thing is that you have a good working relationship. If you say he would not add to the business then I wouldn't be too quick to ask him to come in for 50% of the profits. Much more of the pressure will be on you as you are the one who knows the business and you are the one that has to take the responsibility for failure (in the worst case scenario), so any work he does will not be worth 50% in that circumstance.

You also have to be confident that when times are tough your relationship gets stronger. If it weakens or you fall out altogether then it could be very messy. These things get much messier with friends and family as reputations and mutual friends are at stake. Those things are worth more than money.

Other than that it seems a fine deal to me. He is risking his cash and needs a return. I'd be happy to double his money or more if it were offered to me & by a mate of mine.

TheCostumeShop.ie: Ronan · 19-07-2011 05:39PM

Firstly does your friend fully understand whats involved and the difference between investing and a loan? Since he's not a "business person" you need to spell out the agreement and all the possible eventualities. IE worst case scenario if it goes unbelievably wrong and you loose it all, which can happen. Can he handle the loss and will he be able to comfortably survive without the repayments; he's not taking out a loan he won't otherwise payback? Will he expect you to pay it back anyway because he see's it as a loan or is he buying equity which may be worth nothing. If he can't handle the risk dont let him take it.

My person thoughts on things here is agree to be friends first and to value that over money. There's nothing more ugly that falling out with a friend over money.

Maths wise 310 return on 50 in 5 years seems good. It's enough to make a living off, assuming you have put in all of your expenses and budgeted to hire some staff so you aren't working 100 hour weeks indefinitely to stay afloat.

If you wouldn't hire him without his investment, don't hire him with it. He can help out at the start but this would be a concern if ongoing.

It's interesting you mentioned you were needing 100k, which implies you may need a second round of financing and to part with more equity.

Sounds like you have a good business though so best of luck with it. I reckon go for it.

AstonMartin · 19-07-2011 06:14PM

3/ his loan repayment is the no.1 payment every month

This could put your business in a lot of stress in the beginning. It might be a good idea to push back the first repayment for 6 months or a year to take some of the financial pressure off at the beginning and sell it to him as it is necessary to get the business to succeed which is in his interest.

you say its a two man operation but he is not qualified or experienced in any way so why would you place yourself in this position only to regret it when your business takes off and his offer of doing as much work as you turns out not to be the reality either because he does not want to put in the time or he just cant handle the work.

There is a big difference between 50k and 100k. How confident are you of your figures and why is this other person willing to jump in with 50k and working full time on the business?

Good Luck.

amn88 · 20-07-2011 12:55PM

ok ill make it a condition that loan repayments start after the first 6 months!
There is a lot of tedious work involved that will be time consuming so he will be able to do all that!
100k would be used forr more stock which would make us more profitable but we can start with 50k and all going well im sure he'll re invest if need be!

Actually Ronan, he does understand he can loose all, and that its not a loan to me personally but to the business and if the business cant pay him back he wont be and if it can he will be ! But what i was wondering, say if this business is worth quite a bit in a few years does he actually own 50%/20% of the business.... ie am really giving away equity by taking this funding undr this kind of agreement? Even after the 5years when he has his full 50k back plus his return/share of profits will he be entitled to a share of profits after that? will he actually own 20%/50% of the busines?

Anyway none of ye have said its not a great deal? its my first time setting up my own business and have never dealt with finance before... so this was just a repayment method we came up with ourselves... so i wasn't sure if it was a ridiculous way of doing things or not or if was really bad value!

amen · 20-07-2011 01:50PM

But what i was wondering, say if this business is worth quite a bit in a few years does he actually own 50%/20% of the business

this is what you need to nail down and get a legal agreement for.

From your post it is not clear if the your friend is
1: Providing a loan to the business (but might be you as an individual) which is then repaid each month BUT your friend also gets 20% of profits for the loan. I would not be happy with this. I would rather take the loan and pay it back at commercial rates (maybe around 10% at the moment) thus paying your friend back 60K. If you got a loan of 50K from the bank they only want their money back not their back and a % of profits

2: Providing a loan to the business and he wants equity i.e owes 20% of the business. If this is the case then I would let him have 20% but I would not be paying back the loan. The "loan" money is his capital for buying part of the business. As he owns part of the business he will get 20% of the profit..

3: Providing a loan to the business and he wants equity i.e owes 50% of the business. As above but this gets very messy. You always want to maintain control over you business. So you always want 51%.

No matter what you do you really need to speak to a solicitor and get a good agreement. You also need to specify what happens if in 2 years you are not getting on ? How you sell/recover the equity ?

What happens if your friend wants to sell his 20% ? The agreement needs to specify that you get first option. What happens if you want to bring in a third investor? Your agreement needs to specify that everyone has to sell equity to the third investor in equal dilutions.

How/Who values the company in case of dispute? This also needs to be in the document.

TheCostumeShop.ie: Ronan · 20-07-2011 02:30PM

Totally agree with Amen, you need a solicitor to draw up a shareholder agreement.

It does sound like a good deal for you but maybe its even a better deal for your friend, depending on how much risk is involved. If you intend on being the decision maker I'd strongly suggest changing it to a 51 / 49% shareholder split, there is a chasm of a difference. Also if you are bringing your skills and idea to the table, maybe the friend bring just money could mean that he's buying the equity and as such it gets paid back out of his furture share of the profits rather than pre-profit payback.

Be aware if you ever need future investment you would then be open to loosing control if that new investor and the old partner, combine and vote you out. It's a long way down the road but always worth considering.

There are other tools you can use, preferred shares or an equity buy back clause that kicks in when the loan is repaid of you meet a certain level or the equity ratchets back down. Definitely worth investigating all options with an accountant and coming up with something fair to both sides input.

antoinolachtnai · 21-07-2011 01:38AM

Paying out '20 percent of profits' will put a lot of strain on the business.

If you buy 50,000 euros of stock on day 1, and sell half of it for 35,000 euros in the first month, you will have made a gross profit of 10,000 euros. If you do not pay yourself a salary, you will have very low overheads. Say the overheads are 2,000 euros. You will have to pay 1600 euros of this to your friend. Then, on top of that, you will have to pay him 833 euros. That's 2,433 euros at the end of the first month. The problem is that you won't actually have 2,433 euros to pay him.

Why not? Well, because the money won't have come in from creditors yet, and secondly, you will have to buy more stock to replace the stock you sold.

So you can have profits without having free cash.

All the signs are that you and your investors don't clearly understand the accounting side of the arrangement you are planning to enter. This will end up in an awful argument if you don't sort it out now.

You could give him 20 percent of the equity in return for his loan. However, that doesn't mean that he automatically gets 20 percent of the profits. It just means that he owns 20 percent of the company, gets 20 percent of the votes (which is as good as no votes at all if you own the other 80) and gets 80 percent of the dividends, if there are any.

amn88 · 21-07-2011 04:59PM

Ok I think I am going to give him 2 options;

Equity or a BUSINESS loan

Equity; he gives me 50k for 49% of the business , so he will own 49% and I will still have the decsion making in my hands. And he will also get 49% of dividends paid under this agreement aand I get 51%.

or

Loan; He loans the business 50k and I pay him back in monthly payments over 5 years starting after the 1st 6 months in business, plus 20% of profits. The loan will be to the business and not a personal loan to me, if the business goes under so will the money he is owed and this will be made clear in the agreement. And when his loan is repaid in full he will not have any part in the business and no entitlement to any further profits. Maybe this would take some pressure of repayments as he would be entitled to more profits if the loan is stretched out over 6 or 7 years. (my intensions will be to have it paid off asap if i can help it)

They seem like two pretty straight forward options. So just to complicate things, if he decides he wants to put in the same work into to this business that I do rather than just be an investor I will have to increase his return on the loan, say give him 40% of profits (which should be higher anyway bescause having him there will save me paying wages to someone else) but if we agree on an equity deal i wont be giving away anymore than 49% so if he wants to work i would just have to sell the 49% at a lesser rate or give away less equity for the 50k if he intends to no work, say 30%.

Obviously i'll have to get everything stated cleary in a legal agreement but does anyone see any major downfalls to this from an accountants perspective? I personnally think the loan would be my preferred option, a soon as i have him paid back he will no longer be entitled to a % of profits and the business will be 100% mine. I'll have to state in the agreement that at any point I can 'buy him out ' by paying back his loan, and the 20% of profits to date.

Nuttzz · 21-07-2011 06:29PM

Some good advice above

Also 20% of the profit might not be available in the company's bank account

I have seen plenty of companies make a profit, but the profit is tied up in unpaid debtors, so even though they have made 50k profit, they are owed 100k by customers so dont have the actual cashflow to pay out a dividend.

turnover is vanity
profit is sanity
cash is reality!

antoinolachtnai · 21-07-2011 10:22PM

Here's an alternative way to do it.

You say the stock can be easily liquidated.

Why not get him to buy the stock? You hold the stock on his behalf and buy the stock from him as you sell it. You give him a margin on his stock (not as big as your own margin, obviously). You buy the stock back from him over time.

This way, he minimizes his risk. Even if you go into liquidation, he still owns his stock, he doesn't even have to go to the liquidator's meeting. He can then sell the stock and get most of his money back. He effectively gets a share of the gross profit until he gets his money back.

I have being offered 50k investment but not sure if its a good deal, advice pls :)

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