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Can anyone tell me if this is a legal business arrangement?

I have a contact who has an investor that wants to invest in a business with me. The contact I trust, the investor I don't. The investor wants to structure the deal like a loan of $ 450,000 with a 5% simple interest rate for a 5 year term. He also wants 20 % of the yearly profits. Does this make sense? I feel like if should either be structured like a loan or an investment but not both. What would be the correct set up for this ?

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Answers (9)
Terri Bollman-Wyzkoski
MainStreet Bank
Sr. Commercial Lender
Fairfax County, VA

It's tough to answer this question without knowing the type of industry, the annual revenues, the projected revenues and earnings, etc. BLS acts with and/or on behalf of our clients to identify the most appropriate financing for their business. Each of our consultants has been a business lender, so we have appropriate knowledge to evaluate such a transaction, as well as to identify whether it is reasonable. If we determine the structure doesn't make sense or is not in your best interest, we'll advise you of the same, as well as determine the most reasonable and fair structure & negotiate the same on your behalf.

Please contact us directly if you believe we can add value to your endeavor to obtain appropriate financing.

Terri B. Wyzkoski
Managing Member
Business Lending Solutions LLC
11654 Plaza America Drive #363
Reston, VA 20191
Twyzkoski@BusinessLendingSolutionsLLC.com
Direct: (703) 655-9939

Jul 14, 2010
Julie A. Barnes, CPA
Small Business Exchange, Inc.
Travis County, TX

Hello again, Rebecca

The fact that this business already exists and enjoys a financial history greatly simplifies determining the advisability of working with this investor. Plug in your most conservative estimate of profits less the 20% less payments on the loan. What kind of return on investment does this net represent? Also, you obviously need to think in terms of the absolute number, as well. That is, will you have enough profit left over to receive a comfortable salary and/or reinvest in the company?

Please visit my blog: http://www.AustinBusinesesForSaleBlog.com for more advice on how to buy, sell or evaluate a business.

Good Luck!
Julie A. Barnes, CPA
President, SBX, Inc.

Jul 6, 2010
Joseph DiBello
Vested Business Brokers
Career Development Officer/Broker
Suffolk County, NY

This arrangement from investor is not reasopnable. The business would have a compounded debt service that probably would leave you with little left for your efforts. You would be a slave to the investor and the business might not survive. You should consider other options that we can discuss, call me

Jul 6, 2010
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R A

Yes John, that is correct. I am trying to buy an existing business, not a start-up.

Jul 6, 2010
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she is trying to buy an existing profitable business in Palm Springs. If the numbers are correct that she has told us in the past then it is a good deal. If the numbers continue to hold up she will still make almost 20k per month during the five year term (with still giving away 20%.) After the five year term she will still make close to 30k per month even if the 20% is for life. Am I correct rebecca? (That's assuming she had the down payment in cash.)

Jul 5, 2010
Julie A. Barnes, CPA
Small Business Exchange, Inc.
Travis County, TX

Hello R A,

I agree with Kathryne - you need to create a Pro Forma that reflects your effective interest rate. Rather than depending upon subjective information about whether this deal is attractive, run a few scenarios on a spreadsheet - using various profit levels. Of course, the very act of predicting profit is subjective but assigning actual numbers always results in a more concrete appreciation of a transaction.

Furthermore, if your company is indeed a startup and the investor is willing to finance $450,000 - I'm assuming that you've already provided a business plan or some other form of financial prospectus so a Pro Forma should not present a new problem.

For more information about buying, selling, or evaluating a business, please visit: http://www.AustinBusinessesForSaleBlog.com.

Good Luck!
Julie A. Barnes, CPA
President, SBX, Inc.

Jul 5, 2010
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There is a lawyer named Robert Cutler who sometimes posts on here. You should reach out to him. In the mean time...........
As far as investments go this is actually a good deal. A lot of investors want a much higher interest rate and a bigger piece of the company. Most investors will insist that they get paid back first and you take a small management fee until the loan is paid off and then want a high fixed percentage of income.
If it was me who was investing with you I would want AT LEAST 50% of the company forever. I would let you have a "small" fee for running the place until it was paid off and THEN I would take 50% . maybe it sounds greedy but is my money and my risk not yours.
If this is accurate, this is a GREAT deal for you. 5% is nothing and 20% of the company is a small price to pay for the kind of money you are going to make. Think about it, you have someone who will put up 80% of the money you need for only a 20% fee. The more I think about it, I might take the deal if you pass on it!!!!!!
I always tell people that the American Dream isn't free and it isn't easy. If you don't have the money then you have to share the dream if you want it bad enough.
One last thing-- if it was me investing the bulk of the money with you I would insist on decision making power. In effect I would be the boss. This a good deal if you can pull it off.
Btw, did you ever watch Shark Tank on ABC? You should.

Jul 2, 2010
Kathryne Pusch
ConsultKAP Inc./Business Brokers Network
GA

It is legal to set up this kind of profit-sharing in addition to an interest rate on the loan. The BIG question is what does this COST you, and that depends on what 20% of your profits are each year. For example, if 20% of your profits is $5,000, that would only add an effective 1.1 % to your interest rate, the first year (assuming $450,000 principal). However, if your profits are $100,000, 20% will be $20,000 in interest, and this would add 4.4% to your effective Int-rate, making the cost of money quite high.

On top of this, you honestly need to look at your options. If this is a start-up and you do not have any other sources of funds, this may be your only option. Decide if you can afford it, as it makes no sense to put yourself out of business by being over-leveraged.

How to set this up? Have your atty draw up the promissory note, including the participation, and VERY carefully define how "yearly profits" is defined. The devil is in the detail on this. Profits can be easily manipulated. And I am assuming this is NET profit, VS GROSS, as most businesses will not survive giving 20% of gross profit to an investor.

Document everything clearly & in writing to avoid future misunderstandings. A good business atty will know what parameters must be covered.
Good luck with your business,
KAP

Jul 2, 2010
Paul E
Front Line Plans
Business Plans for Entrepreneurs
Westchester County, NY

Rebecca,

It's not at all unusual. In fact fairly common. It gives him a minimum fixed rate to replace other use of his money plus an upside for his risk. I know you've been looking for an investor. I assume the 20% is only for the 5 year term and no equity involved. It's probably less than you were willing to pay. Grab this one if it's real.

If I can help paul10507@yahoo.com

Jul 2, 2010

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