Ok…need some help…my husband want to open a delivery/carry out and we have an investor who wants to just give us the money and not be physically involved. We want to put a deal together with her (she will give us $100k) but are not sure how to structure it. I’m sure it will involve some type of return on her money plus % of profit. But what is feasible and fair? How should we pay back the return when we do not know what sales will do?
Some type of return on his/her investment.
I am currently in the same position.
My current plan.
2.5% of gross sales for the duration of investment loan.(up to a max of 25% of original investment)
PLUS 5.75% Interest on the loan itself.
My investor is at $38,000 (equipment supplied by outside source for 2 years …free…family member that is out of pizza business due to health.)
Max payback = 38000+25% + 5.75% over 3 years.
Basically it means I am paying back $1152 a month + 2.5% of gross sales up to a max of $9500 over the term of the loan
This worked out best for me. Others I am sure have very different investors.
His total return = $50962.43 (41462.43+9500) on 38000 invested or a little over 34%
For me I need to do 2850 weekly sales to make all monthly commitments.
First, you have to determine whether the money is a “loan” or an “investment”. The difference is whether the money is at risk or not.
If the money is a loan then it is approriate to agree on a rate of interest and for you to sign a personal guarantee of the loan. I would expect to see a rate of return in the area of 10-15% on a private loan from an unrelated person. Securing that loan with an interest in something real, like real esate should lower that rate. (but then you would go to a bank and get the money for a lot less) Paying a percentage of sales or profit in this scenario is NOT appropriate; the rate of return should be clearly established.
If the money is an investment you need to do several things:
- Decide and agree how much of the business the investor will own.
- Decide and agree how much you will be paid to operate the business BEFORE the profit is determined. It is fair that you are paid a market wage for your labor.
- Decide and agree what the repurchase terms will be. i.e. how much will you pay to buy back the investment. When is this option available?
For example, if you agree that the investor will own 49% of the business and that you will be paid $15 an hour to work there the scenario might look like this: (profit in an S corp is paid in direct proportion to ownership)
Wages for you and your spouse $15 an hour 55-65K per year
Profit from the business (after owner wages) 50K
25K each for the investor and for you.
The major difference is that in an “investment” the money is at risk. If the business does not make money there is no return. If the business fails, the money is lost.
In a loan, the money is expected to be repaid regardless of business performance. There is still risk (bankruptsy) but the repayment is not dependent upon what the business earns.
Another idea is actualy to do both:
A. 50K loan to the business but personally guaranteed. Rate of interest agreed. Expectation of repayment whether the business succeeds or not. Target rate of return about 12% (private unsecured loan from an unrelated party) The risk and return are both lower.
B. 50K investment in the business. The money is at risk but the expectation of rate of return is more like 25-30% for an investment like this. That would mean you would set the proportion of ownership at a point that you all expect will produce about 15K in annual cash return. Risk and return are both high.
You should certainly incorporate this enterprise to insulate yourself from risk, define the proportion of ownership and so the business can take on obligations distinct from your own. You will also realize a tax savings on a portion of the income from the business (fica on the portion paid as profit) Since this is not passive income an S corp is more appropriate than an LLC.
Thank you so much for taking the time to explain all that! We REALLY appreciate your input!
Good luck to you in your endeavors!!
Thanks soooo much for your input!
We really appreciate the time put into your reply!
Good luck to you in your business!
You are welcome. I do quite a bit of this kind of thing both as a consultant and as a S.C.O.R.E. counselor. There are as many ways to structure a deal like this as there are deals out there. Every situation and combination of people has a different set of needs which leads to variations on the approach.
Some important things to keep in the forfront of any deal like this are:
Clarity and agreement on the expectations of each side. What do you want out of the deal? Talk about it.
Don’t leave questions about unpleaseant possibilities unspoken. Bring them up and talk through them now while they are only possibilities and agree on how they would be handled.
If you can not reach the point where BOTH sides are getting what they need don’t be afraid to pass.
Put your agreements in writing.