new business investor into pre-existing business. need advice on structure/percentage

Discussion in 'Starting a Business' started by protrax, Feb 26, 2013.

  1. protrax

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    Feb 26, 2013
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    I am looking for some advice as far as how to structure our business arrangement...

    My friend has been running his rental business for 10+ years. We recently decided to go into business together and purchased some expensive equipment (50/50) ~$225K for his business which he was previously renting through a third party. We now need to decide how to structure the business. He does have some equity already in the business but nothing close to this new purchase. I am coming into this business initially as an investor but will also be taking on additional roles as well (physical labor for jobs, accounting and handling the financial ends of things). So I will be putting money as well as my time and labor into this business now. Essentially all of the clients come through my friend, as he has built this up over the years. I will bring in bring new clients over time, but the vast majority of the business, will come through his already existing accounts.

    So we are now faced with what is a fair way to structure the business. If I wasn't going to be involved in the day to day operations, I would say, that it only make senses for me to be paid based on the money made from the inventory I purchased with him. Since that is not the case though I think it should be more though.

    Also on the inventory we purchased together, should he be taking a percentage off the top of every job, for it being his already existing client?

    There are lots of clients that he can handle himself, so should he give up anything for those jobs?

    Do we go 50/50? Should he get a higher percentage? These are all questions wetrying to get the best and most fair solutions for
  2. Rocky

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    Nov 3, 2012
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    As your partner/friend was already running this business there must be some investment made by him. And additionally you invest more capital. Depending upon the percentage of your investment in the business you both can divide the profits.

    As far as the work you put in is concerned, since this is as good as your own business you give your time to it and so does your friend so the profit you earn can be shared accordingly and so is the case with losses god forbid if there be any.
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  3. ArcSine

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    Jun 2, 2010
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    These situations always involve idiosyncratic particulars (e.g., the personalities involved and what their motivations and hot buttons happen to be, the nature of your friendship, the specifics of the business itself, and so on) and hence there's no one-size-fits-all answer. The structure that's ideal for Partnership ABC might be all wrong for Partnership XYZ, and vice-versa, even if ABC and XYZ are in similar lines of business.

    That said, there are certain fundamentals I see used in practice with success in many cases; while not representing detailed advice they might be basic concepts you could try building your arrangement around.

    For one, think of the labor component as separate and distinct from the capital investment component. Put another way, think of yourself as two different people, one an investor and one an employee (ditto for your partner), and each should be compensated separately. This makes it easier to fine-tune each partner's overall share of the pie, in accordance with the value each partner brings to the party both as an investor and as an employee.

    Starting with the total net profit (after all operating expenses have been paid), first carve a slice off the top to each partner that reasonably provides compensation for labor services rendered. You mentioned specific tasks you'll be eventually undertaking (such as accounting and physical labor), so make a reasonable estimation of the going market rate for all such "employee" hats you and your partner will be wearing day to day.

    That particular slice comes off the top of the net profit pie, since employees are customarily paid before investors; that is, investors bear the risk of how large or small the remaining pie might be, after all the worker bees have received their fixed salary checks.

    Whatever remains of the net profit after the "labor" slice is the return to you and your partner as capital investors. To divvy up that piece, recognize that part of the return is attributable to the equipment investment itself (in which you and your partner have nearly equal amounts tied up), and partly attributable to the existence of the customers. For this latter factor, your post suggests that your partner, at least initially, brings the greater amount of value to the equation in the form of a pre-existing customer base.

    So how you slice up the "investment return" portion of the profit pie is whatever manner you both deem fair, but do give serious weight to the fact that what typically generates investment returns is a combination of capital investment and a pool of customers / clients. Neither one by itself is sufficient. You guys are roughly equal in terms of the former, whereas he's out front with respect to the latter (although it sounds as if the relative mix may change over time, as you bring new customers in the door yourself, so take that into account as well). Thus the percentages for the investment return piece would likely run in his favor by some degree---whether that be 55/45, 60/40, or some other split. The actual split you both deem fair will depend somewhat on the relative importance of the two components (capital investment, customer pool) in generating returns.

    Obviously, the first piece (the labor / salary component) can be expressed in some fixed dollar terms, whereas the investment return piece would necessarily be expressed as percentages of the remaining net profit pie.

    Again, these are just simple concepts you might use to build up an actual arrangement from, with appropriate tweaks to account for facts and circumstances. Just as an example of such a tweak, note that for certain businesses, attractive net returns depend not only the three legs I've already mentioned (daily labor, capital investment, and customer base), but also pretty heavily on skilled executive long-run management of these three legs. (Indeed, in certain industries one can observe that all the players have approximately the same capital assets and very similar customer bases, yet one or two of those players always produce returns that leave the industry's averages far behind; one then has to figure it's superior upper management making the diff.) If this describes your industry, you might then also include a "co-CEO" salary component in your arrangement, in addition to the two pieces I discussed previously.
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