this post was submitted on 28 Nov 2023
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Going merely off of what you stated:
They want an equity stake in your company, you would own 95% and they would own 5%. They have also valued your company at $600,000. If you take their money you wouldn’t owe them anything but they would be part owner of your company though you would retain full control.
Do you believe your company is worth $600,000? Do you need the $30,000? If you feel your company isn’t worth $600,000 then this might be a good deal. If you need the $30,000 to help you expand then this might be a good deal.
If your company is worth more than $600,000 then it’s probably a bad deal and if you do not need the $30,000 for any reason then it is a bad deal.
Just curious, you seem to know your stuff, would the investor be entitled to profits? Would 5% stake automatically entitle them to 5% of profit?
Or does the investor only make money if the business is sold and he earns out more than he put in? This type of arrangement has always confused me for small companies like this
They are entitled to 5% of dividends. If OP owns 95% of the company, he decides whether the company pays out any dividends so finally it’s up to OP. But all of these matters should be clarified before they sign any documents.
If any owner takes a draw, all owners are entitled to a draw.
It entitles them to x% of earnings attributable to shareholders which is technically different from operating profit, assuming that is what you meant by profit.
As others have answered, yes. The investor only makes money when the business does and what I haven’t seen anyone mention is, depending on how the business is structured, partnership/llc/s-corp/c-corp the investor can share in liability should the company get sued or the company is forced to declare bankruptcy.
There’s a lot to it and it all depends on how the company is structured and operated and even how the ownership is setup assuming they have a lawyer draw up the contract.
Great comment.
Keep in mind also that if they own 5% of the company, they are entitled to 5% of the year end profits. Any owner distributions have to be split 95/5.
Just to piggy back on your answer with another question. If he does sell 5% for 30k he has no obligation to buy it back, correct?
Usually, yes.
However there could be contingencies written into a contract which could require him to buy the stake back. That’s why anyone selling a stake in their business needs to have a lawyer review any contract they are presented with.
That's what I was thinking. I had it as part of my question, but figured I'd keep it simple.
Thanks for the answer!
It’s not necessary that they would retain full control. It’s atypical but the investor could ask for a new super voting share class to be created giving them say 25 votes per share. Then the entrepreneur would keep the majority stake but lose the controlling interest. My advice: look at the term sheet Carefully! Also is your business really worth 600k given the future value of your cash flows? Make sure you get a fair deal :)
I think he is better served by hiring his own lawyer to advise him if he is given a contract drawn up the investor.
It would cost over $2k to have a lawyer review a $30k equity deal
I’m not one to get an attorney over most business matters, but selling equity is one that calls for an attorney 100% of the time.