Starting a corporation - A few questions and advice sought

[bobsacamano]

Hi guys,

I am starting a corporation with a partner. My partner is going to be funding all the start-up costs(around 20K) and I will be taking care of day-to-day operations. The start-up funds are being loaned by a company he currently owns.

My partner wants no involvement in day to day operations, he simply wants to be a shareholder. After some discussion, we have decided that we should split the shares 50/50.

Is this a fair and common situation? It seems fair for me because there is no financial risk involved and should the company fold I don't lose anything other than my time invested.

Another issue that my partner brought up is that as our company starts generating revenue, the priority should be re-paying the initial loan that his other company made. Afterwards, I will most likely be taking a salary.

This is my first time owning and operating a company so I am a little inexperienced. He is being advised by his accountant so obviously he is being given advice that would be to his advantage. I don't have an accountant yet to provide advice to my advantage, however I will be meeting with a few in the coming weeks.

We are meeting with a lawyer tomorrow to proceed with the incorporation and shareholder agreement. What sort of issues should I bring up? Can anyone offer me any advice that would benefit me in this situation? It would certainly be very well appreciated.

Thank you very much. I've already learned a lot from the knowledgeable members of this forum and I hope to learn much more.

Cheers!

[JonnyCash]

If he is going to be doing 0 work, why is he getting his loan repaid? In my opinion you guys should split profit 50/50 (50% going to re-pay his loan, 50% going to you for wages), and at most he should have 10-20% of the shares.


Why don't you just go to a bank? It doesn't seem like this partner is giving you anything you couldn't get on your own.

[bobsacamano]

You bring up a very interesting point.

If we're going into this 50/50, then I guess his 50% is the money he's investing and my 50% is the labour. If our company pays back the loan, why is he still keeping 50% of the shares? Thanks for bringing that up, I didn't see it that way.

But the reason I'm going into this with him is because he has valuable contacts within the industry for which we'll be providing products/services. His other company will be our first client and he's also responsible for 2 other clients that we have. So, I think his contacts and PR can be considered work, right? But 50%?

[JeiJei]

I don't think there's anything wrong of repaying him the money invested.

After all, if the operation goes sour, he lose 20G while you just lost your time.

I have a venture with my uncles, they financed fully the operation (50K) and what I do is this, I draw a contract with my lawyer that specified that the money invested by my uncles is a loan that I need to start paying back when the company reaches certain net profit level (I put 10K/year), and I still gave them 49% of ownership (for me maintaining full management power)

It all really depends on how you guys have discussed. But IMO, if he is taking full responsibility on financial losses, that 50% is definitely worth his part, but you shouldn't be working for free either. Discuss with him that once the company brings a positive cash flow, you get a salary of x amount/year. That qualifies as expenses that the company has. Since after all, you can't work for free forever. After those expenses, yes, you can pay his loan back as first priority.

[bobsacamano]

I don't think there's anything wrong repaying the money invested either. But after it's repayed, I don't believe he should retain 50% of the shares. Essentially that means I just gave half the ownership of my company to someone who didn't invest any money and does barely any work.

If I would have gotten a loan from a bank, I wouldn't half to sign over 50% of the shares to them in addition to paying back my loan.

As far as financial risk, it is very minimal. Even if I maintain only one client(his other company), he would make his money back within a year on his half of the profit alone.

Another option that I thought of, is that I can let him invest(invest, not lend) the 20K and have the company just pay him dividends. I, on the other hand, would take a salary. He can still consider that as repayment of a "loan" and once he earns over 20K in dividends, it's just profit.

I don't know...I just don't want to get the short end of the stick in this deal.

[deep]

When a bank lends you money and you pay them back, how much of your business/car/house do they own?

Exactly.

If he is bringing business/ongoing sales/clients along, then THAT has value. Money is only worth itself, plus interest.

[spf1971]

When you borrow money from a bank, you start paying interest immediately. In this case not only is there no interest mentioned but nothing has to be repaid until the company starts to make money.

Lets say that the OP takes the profits as salary, what does the partner get? Sure he has 50% of a company, but it isn't paying him back anything on his investment. There has to be some sort of financial payback for his initial investment. I'm not saying repay his investment, but there has to be some sort of payout.

[spf1971]

As far as financial risk, it is very minimal. Even if I maintain only one client(his other company), he would make his money back within a year on his half of the profit alone.



If the billing from his own company would be enough to not only cover all expenses, pay you a salary and return his investment in less than 1 year, why wouldn't he just hire someone to do that same work and save all of the extra expenses? If you're so sure that this is a great money maker, you're better off going to a bank and getting a loan.

[bobsacamano]

When you borrow money from a bank, you start paying interest immediately. In this case not only is there no interest mentioned but nothing has to be repaid until the company starts to make money.

Lets say that the OP takes the profits as salary, what does the partner get? Sure he has 50% of a company, but it isn't paying him back anything on his investment. There has to be some sort of financial payback for his initial investment. I'm not saying repay his investment, but there has to be some sort of payout.

There is going to be a payout. He will be getting dividends and/or a salary based on commission for his sales.

If the billing from his own company would be enough to not only cover all expenses, pay you a salary and return his investment in less than 1 year, why wouldn't he just hire someone to do that same work and save all of the extra expenses? If you're so sure that this is a great money maker, you're better off going to a bank and getting a loan.

The thing about this business is that expenses are very minimal. There is no office to rent, no extra employees to hire and the daily expenses are essentially included in the price that we bill our clients. The initial expenses on equipment and software development are the major ones and even then, 20K, is not a large expense.

Right now he does hire someone else to do that same work. The company he hires has barely any competition, with about 90-95% of the market share. We're going into this to create competition, offer superior products/services, and cut into that company's market share. My partner's contacts in his industry will help this process along.

By going to a bank, I have to pay interest on a loan and also risk not taking advantage of my partner's contacts. I think I chose the better option here. I've also discussed this situation with my partner and we have come to an agreement that his initial investment will not be considered a loan and thus not be paid back as such.

Thanks again guys for all your feedback.

[brucemeng]

you can try renegotiating the equity split, what he essentially negotiated is a 20k loan + 50% equity stake.

The deal he has is a good deal, but it is not outrageous, imo. It seems like your lifeline will depend not only on his 20k loan, but on the contacts/relationships your partner brings. Can you survive without that? Again, you can put in some provisions to ensure you also get paid, but from you have shared with us, it is not an overly unfavourable deal to you (my opinion again).

*do a valuation of your company. map out the expected cash flows for the next 5 years... put what you understand about your company on paper, with numbers, that's the only way you can know a bit more concretely whether the deal is good or not

[slavka012]

So, let's get this right---your partner wants to bring YOU in to compete against a company he already is doing well in? What gives?

Read again -- he did not say that. He said they will compete against a company his partner EMPLOYS.

[slavka012]

Good and fair deal I think. Your partner finance and supply demand for the company's product. That absolutely costs 50%. He probably can go into business without you, and it appears you can't. So don't be too greedy when negotiating your share.

[heavyweight]

The 20k should not be a loan in this circumstance. It is an investment and capital infusion by your partner in exchange for company shares. I would consider his networks to be accompanied by his investment to equal 50%.

I would personally rarely give up a large portion of a company to an investor who did not offer networks related to the industry.

Your profits should be split 50/50, with his portion going to repay his investment (not a loan), as mentioned in an earlier reply.

If your partner is firm against this, you should most definitely fight him on it, obviously while keeping the relationship in tact. He should also appreciate and respect you for standing up against that, as you are running the business and he should feel confident that you can negotiate well.

Otherwise, if this 20k is considered a loan, I would attempt to offer 20% shares and roughly 5% annual interest on the loan. If you have to move, try to offer a slightly higher interest rate as opposed to a large percentage of shares. Ex. Going from 5% to 10% interest is only an extra one-time payment of $1000 if you can repay the loan in one-year, which you should be able to do. This may be enough to satisfy him if he is focusing on short term investment. And you keep possibly 80% for yourself!!

[spf1971]

There is going to be a payout. He will be getting dividends and/or a salary based on commission for his sales.

Which you will also be receiving.


The thing about this business is that expenses are very minimal. There is no office to rent, no extra employees to hire and the daily expenses are essentially included in the price that we bill our clients. The initial expenses on equipment and software development are the major ones and even then, 20K, is not a large expense.

Right now he does hire someone else to do that same work. The company he hires has barely any competition, with about 90-95% of the market share. We're going into this to create competition, offer superior products/services, and cut into that company's market share. My partner's contacts in his industry will help this process along.

By going to a bank, I have to pay interest on a loan and also risk not taking advantage of my partner's contacts. I think I chose the better option here. I've also discussed this situation with my partner and we have come to an agreement that his initial investment will not be considered a loan and thus not be paid back as such.

Thanks again guys for all your feedback.

So there will be no real assets or capital with this business, your partner puts up all of the money and provides the introductions. Besides a commission on his own sales and some dividends, I really don't see what he is gaining in this deal. It's not as if his share of the business will appreciate or could be sold, the business is basically you and him.

[bobsacamano]

you can try renegotiating the equity split, what he essentially negotiated is a 20k loan + 50% equity stake.

The deal he has is a good deal, but it is not outrageous, imo. It seems like your lifeline will depend not only on his 20k loan, but on the contacts/relationships your partner brings. Can you survive without that? Again, you can put in some provisions to ensure you also get paid, but from you have shared with us, it is not an overly unfavourable deal to you (my opinion again).

His 20K investment is not going to be paid back. My partner and I have already agreed to this. I can survive without him, but the company will do much better financially with the business that he will bring.


If your partner is firm against this, you should most definitely fight him on it, obviously while keeping the relationship in tact. He should also appreciate and respect you for standing up against that, as you are running the business and he should feel confident that you can negotiate well.

Otherwise, if this 20k is considered a loan, I would attempt to offer 20% shares and roughly 5% annual interest on the loan. If you have to move, try to offer a slightly higher interest rate as opposed to a large percentage of shares. Ex. Going from 5% to 10% interest is only an extra one-time payment of $1000 if you can repay the loan in one-year, which you should be able to do. This may be enough to satisfy him if he is focusing on short term investment. And you keep possibly 80% for yourself!!

I thought about repaying with interest and offering a smaller percentage of shares, but I don't believe that will be beneficial to me in the long run. If he only has 20% shares with his 20K + interest paid back, then he might not be as motivated to obtain new clients.


So there will be no real assets or capital with this business, your partner puts up all of the money and provides the introductions. Besides a commission on his own sales and some dividends, I really don't see what he is gaining in this deal. It's not as if his share of the business will appreciate or could be sold, the business is basically you and him.

The only tangible assets in the beginning will be the equipment we are purchasing, which would be still worth about 75% of their value once used. If the company starts making serious money, then we will purchase assets with it instead of paying large amounts of tax on it.

We haven't gotten into detail yet about whether he will be getting dividends AND commission, I was just throwing that out there. Even if he only gets dividends, his initial investment will be covered within, or slightly over a year. Every subsequent year, it's money in his pocket. He also gains on the fact that he will be replacing his current supplier with a company that he owns 50% of.

Keep in mind that this is not a business in which we are looking to gain a multi-million dollar fortune on. It was created to satisfy a need in a small niche market that currently has barely any competition. It is essentially a "side-business" which will require minimal work, while still bringing in a decent amount of money. I already have a career to occupy most of my work time.

[heavyweight]

I thought about repaying with interest and offering a smaller percentage of shares, but I don't believe that will be beneficial to me in the long run. If he only has 20% shares with his 20K + interest paid back, then he might not be as motivated to obtain new clients.



If you are relying on him bringing clients in order for your business to be successful over the long-term, then you may need to rethink your marketing plan. I can certainly see why his networks would be great in the short-term to gain experience, clients, testimonials, etc., however after a certain time the company should be able to attract clients based on its own merit and standing in the market.

Whether your partner has 20% or 50%, if he is involved with the goal of creating value, then he should also not be solely relying on his networks for the lifespan of the business. Essentially, you should want to maximize your share of the company. Giving up the extra 30% for example just because you believe that he will be more motivated, can possibly be a mistake. You should think hard about this very important decision.

[slavka012]

You should think hard about this very important decision.

Often times people who think hard when they have NOTHING TO LOSE end up with just NOTHING.

[heavyweight]

Often times people who think hard when they have NOTHING TO LOSE end up with just NOTHING.

I like that statement! It applies well to this case. Thinking HARD may be to extreme at this point is his business career. The focus of the agreement should be on maintaining the relationship, however he wants to ensure that down the road, he won't look back and regret his choice. Maybe some slight to moderate thinking will suffice :lol: .

[spf1971]

We haven't gotten into detail yet about whether he will be getting dividends AND commission, I was just throwing that out there. Even if he only gets dividends, his initial investment will be covered within, or slightly over a year. Every subsequent year, it's money in his pocket. He also gains on the fact that he will be replacing his current supplier with a company that he owns 50% of.



I think you're overestimating your income potential. You believe that you will make enough to draw a salary, pay expenses and pay out roughly $40,000 in dividends per year ( assuming you both draw equal dividends). If the business is that lucrative, I can't believe someone wouldn't already be running a similar business.

[bobsacamano]

If you are relying on him bringing clients in order for your business to be successful over the long-term, then you may need to rethink your marketing plan. I can certainly see why his networks would be great in the short-term to gain experience, clients, testimonials, etc., however after a certain time the company should be able to attract clients based on its own merit and standing in the market.

Whether your partner has 20% or 50%, if he is involved with the goal of creating value, then he should also not be solely relying on his networks for the lifespan of the business. Essentially, you should want to maximize your share of the company. Giving up the extra 30% for example just because you believe that he will be more motivated, can possibly be a mistake. You should think hard about this very important decision.

This is the type of business in which we don't have to rely on marketing. There is potential for 15-20 local clients in this specific industry. We're not trying to target any companies apart from these.

I'm not too concerned with maximizing my share of this company at the moment. As I mentioned earlier, I'm still very inexperienced at running a business and my partner has lots of experience. I am learning as I go along and have chosen a partner that I've known personally for over 10 years. There is always the option to buy out my partner's shares in future if I see fit and if we come to an agreement on such.

If my decisions turn out to be mistakes, well, then I will learn from them and move on. Thankfully, I have a separate career on which I rely upon as my main source of income.

I think you're overestimating your income potential. You believe that you will make enough to draw a salary, pay expenses and pay out roughly $40,000 in dividends per year ( assuming you both draw equal dividends). If the business is that lucrative, I can't believe someone wouldn't already be running a similar business.

There is someone running a similar business. The whole point of my company is to compete with him, as he offers sub-par products and services.

Expenses, as mentioned earlier, are very minimal and in turn, are billed to the client. I will be operating this business from my home and I'm not planning on drawing a large salary as I'm already taxed well enough on that.

All my figures are calculated based on the minimum amount of revenue this business will generate. But then again, I am aware that things don't always play out as planned.

On another note, I have met with several accountants this week and I believe that I've found a good one. I will be having a series of meetings with him next week and look forward to his professional advice.

Thank you all again.