Not a Stock Question but an Investing Question

[djsamson]

I'm starting a venture capital firm with a few people. We're going to pool our money and resources together to do two things:

- Start new businesses (primarily internet companies)
- Invest in existing businesses

My question is, how do we make our profit? For example:

Say the firm buys 40% of a company - the original owner reserves his 60%. The company begins to prosper and grows a large profit. How much money do the shareholders receive?

If there's ten share holders of the firm and we all own an equal amount, who decides how much money goes to all the shareholders?

My assumption was that we would make an agreement with the company that --% of all sales went to the shareholders each -- days. That would mean if $20,000 went to the firm and ten people were in the firm, every member would recieve $2,000 for that period of time.

Thank you for your help.

[MDZ]

I guess that would mainly depend on whether you are loaning the company money in terms of debt financing or equity financing. In debt financing, you would be playing the part of a bank, and the company would pay you your loan back over time plus interest. In equity financing, you would purchase ownership in the business. Now, just because you own part of a business, it doesn't mean you will recieve money when the business has a profit. This will depend on what kind of stock you own (preferred or common) and whether the business decides to pay a dividend or reinvest its' profits back into the company.

Hope this helps,

Mark

[djsamson]

If I were to invest into a private company I would want a profit for all the firm members. Isn't it possible to pay dividends while reinvesting into the business?

We could work out a deal where 10% of the weekly profits go to the firm and 90% goes back to cover production, employee and marketing costs. I doubt these numbers are accurate but we'll use them for this example.

Then if the company is sold and the firm owned 40% of it, wouldn't that mean we get 40% of the selling price?

I assume things would be alot less complicated for start-up businesses by the firm.

[gijoe9]

In the case of a partnership it depends on the agreement. If you put up 40% of the capitol than you should get 40% of the net profit. But again that would depend on the terms of the agreement.

[stevenmac2]

I know that you are primarily focused on the percentage of share you should receive from buying into a business, but also don't forget to consider the type of legal entity this business is established as to determine what type liability you could possibly take as a owner in the company.

The various types of entity structures are C Corporation, S Corporation, LLC (Limited Liability Company), Limited Partnership, General Partnership, Sole Proprietorship.

When considering where to invest, as an owner you want to reduce your risk, so you must question the liability upfront. For C, S, and LLC's, there is no personal liability for shareholders/members. With a LP, GP, and SP - there is liability in which you could be personally held accountable (sued). But since you are operating under a legal business entity yourselves, you shouldn't have too much to worry about.

Another item to consider when buying a piece of the company is being aware whether profits or losses flow through through the entity or not to you which will impact your personal income reporting.

While this is just the tip of the iceberg, there are a lot of factors to consider when acquiring a business.

My advice is that if you are cloudy or unsure about any of this, I would seek further research by finding out this company's structure and learn the pros/cons about it. Secondly, I would build an advisory team of an CPA (with a Tax Law emphasis so you know your personal income & tax changes), a Lawyer (who specializes in creation/works with legal business entities who can help review this company structure you want to buy into and make suggestions and review over your contracts/agreements with prospective companies).

Depending on the business structure, you may want to review the Business Plan and any corporate shareholder or organizational meeting minutes to see what type of business decisions that have been made and settled in the past on whether you should invest or fund a company/business. For an LLC, some states may not require for the owners to keep record of one.

As a fan of the Rich Dad philosophy, you may gain further insight into the due diligence process for buying a business.

How to Buy and Sell a Business: How You Can Win in the Business Quadrant (Rich Dad's Advisors) and Own Your Own Corporation: Why the Rich Own Their Own Companies and Everyone Else Works for Them (Rich Dad's Advisors

Steven Mac

[djsamson]

Thank you for your assistance!

From gathering your advice, I may steer the firm towards more of a start-up VC firm. Farrah Gray went this type of route and he was quite successful. He first gathered capital to start a VC firm. Then him and his friends began about 15 ventures. Five were successful and one was sold for $1.5 Million.

By starting businesses that are completely owned by the firm we don't risk any liabilities from an outside company. We know exactly what is going on. We also can "pull the plug" when we want to and we control all business decisions.

I'd also like to ask another question:

Say one of the VC firm members proposed a business plan. He wants to start a clothing line. He states in his plan that he will be responsible for the main duties - yet he needs capital from the firm. The member only has $1,000 and let's say he needs $10,000. This would mean the firm would be funding 90% of the company.

If the member doesn't want to sell 90% of his company, can't he state in the business plan that he will account for the initial work (outside of the employees he hires in the future) and that he is the original innovator of the business concept? With these facts included, wouldn't it be possible to sell a lesser percent of the company even though in terms of dollars it may be more?

The company can also offer a higher weekly dividend for a lower overall ownership fee.

Thank You

[MDZ]

If the member doesn't want to sell 90% of his company, can't he state in the business plan that he will account for the initial work (outside of the employees he hires in the future) and that he is the original innovator of the business concept? With these facts included, wouldn't it be possible to sell a lesser percent of the company even though in terms of dollars it may be more?

I am not sure on this one. I do know that if he wants to get away from selling part of his business, he can finance the $9,000 in terms of debt. This will leave him/her with a set amount to pay back, but it will allow them to keep complete ownership of the venture to himself. Or, they can mix debt with equity and sell part of the business, and use debt to finance the rest.

I agree with Steven Mac on the importance of both a CPA and Lawyer. If funds are tight at first, they can be used just to review work that you write up. In the long run, you will be money ahead.

[djsamson]

Isn't is possible that I don't include the amount of funds I invested? Afterall, the value of the company (or potential company) can't be judged on how much funds I put in.