• Member Dashboard
  • Courses
  • E-Books
  • Consultations
  • Templates
  • Webinars
  • Ask a Question
  • Forums
  • Member Support
  • Login

Legal to English

Protect Your Business for Growth

  • About
  • Guides to Help You Better Understand Legal
    • Guide to Intellectual Property
    • Guide to Understanding Contracts
  • Podcast
You are here: Home / Articles / Funding / Equal Equity, Unequal Investment – Bootstrapping Options

Equal Equity, Unequal Investment – Bootstrapping Options

We have covered a lot over the past several days. We have talked about Limited Liability, Compliance Programs, the Different Types of Entities, and some funding basics for starting your entity. Now, we are going to look at the starting of a company. Today, we will talk about self-funding a business and how it might work with the owners.

Listen to the podcast episode on Bootstrapping!

When you are dealing with a startup, you have to know what you are trying to accomplish by owning the business. This affects so many of your decisions. Today, we are going to talk about funding a business. Today, we are going to take a slightly different approach than you normally see when reading about entrepreneurs and small businesses. We are going to talk about self-funding a business. What we discuss today can help you whether you are bootstrapping a business until you get to a place where you seek funding or if you are looking to get your business off the ground with a partner and you never plan to seek funding.

Often with small service businesses, you will see a strong desire by the founders to not take any investment (if they ever even consider that as an option). The problem that often happens is you do not have owners in equal personal financial positions. This is one of the most common issues I see with small businesses getting started.

For today, we are going to discuss a business that needs to raise about $60,000. This number covers all of the necessary startup expenses with an estimated cash reserve of approximately $18,000. In the grand scheme of things, this is not that much money for the starting of a business. Let’s say we have two partners. They are both doctors. One is a bit further in his career (so he has more money) and the other is young, but has BIG ideas. In this case, both partners need each other. Because of this, the partners are insistent that they split everything 50/50. The younger partner only has $10,000 he can possibly invest in the business. The older partner easily has enough money to make his $30,000 investment plus the $20,000 shortfall created by the younger partner.  So, what do you do to make sure the partners are equal?

The first thing to do is say that the partners each invest $10,000 for an equal share of the company. These will be the common shares. That will be the 50/50 side of the partnership. With this structure, the owners will share everything equally.

That gets us to $20,000 invested in the company. What about the other $40,000? In this case, we do not need to look for investors because we have the money among the partners. We are simply looking to decide how that money is invested. For the older partner, he becomes both a partner and an investor in the business. He is part of the business and he is investing money in the business for which he will expect a return. Because he is investing more money than his younger counterpart, he needs to receive a return on that initial investment. The difference is that the investment of $40,000 does not come with any of the rights of the partnership. It is a passive investment. Remember, the owners want to split everything 50/50.

The two options that may be used for this investment are debt and equity.

If the partners chose an an S-Corporation as their legal entity, there is no way to give any more equity away and keep the partners equal. With a C-Corporation or an LLC, it is possible to give away preferred shares of equity that do not have voting rights and only receive a benefit in the form of some type of special dividend or extra payment on the sale of the business. The issue with that is that, with a small operation, that is a lot of complexity just to make it work. I point this out to highlight this limitation of the S-Corporation. With the C-Corporation, this would also create some tax issues with the double taxation on the special dividends as well as the regular dividends. This would also overly complicate the books of what should otherwise be a simple operation. Then, you would have an added expense of employing a bookkeeper with the understanding of how the dividend structure was designed to work and make sure everything worked properly.

There must be a simpler way.

Debt. There are a couple of different ways to structure a deal like this from a debt standpoint. Either the older partner could loan the $20,000 to the younger partner who then invests that money into the business. Then each partner invests $30,000 into the business, but the younger partner personally has a loan for $20,000 to the older partner.  That would keep the business books clean and the younger partner would simply pay the older partner just as if he had borrowed the money from the equity on his home.

OR

Each partner invests $10,000 and the older partner loans $40,000 to the business. Then that money would be subject to a promissory note (of whatever kind you work out – we only have so much time today, so we will leave it at that). That means you would need to go back to the cash flow and add in the payments (monthly, quarterly, yearly) to the cash flow. The debt service then becomes a liability of the business. At this point, I will also point out the benefit of creating a credit line with the older partner instead of borrowing the $40,000 up front. Basically, there would be a credit line of $40,000 and you would only use what you needed. Based on our example the money sought include cash reserves of $18,000, so the business may not need all of the $40,000. Using a credit line allows the older partner to keep his money earning some kind of interest, but keeps the business from paying on money it didn’t need. That will help to keep your expenses low.

This scenario is possible with S-Corporations, C-Corporations, and LLCs. See how the decision to select an entity can hinge on more than one factor?

Of course, this is not the only way to handle this kind of investment. Do you have any thoughts on other options to invest the money? I would love to hear them. Hit reply and let me know!

I will talk to you next week, unless you talk to me first 😉

Josh

Helping You Sleep at Night Knowing Your Business is Protected. Legally.

Even if you have been in business for years and everything has been fine. It can all change. Fast. And you could lose it all. If you don’t know how to protect yourself.

After working with entrepreneurs for years, I realized that many entrepreneurs have the same legal questions. And the same problems. Many entrepreneurs, though they understand that legal is an important part of protecting your business, just put it off. You always think you can do it later. Until there isn’t a later.

Want to know a better way to do legal?

Join Today for Free

Take the Conversation Further

Let's continue the conversation! Join me on Twitter or Facebook to join the conversation now!

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

About Josh

I am a business lawyer who helps small business owners and entrepreneurs develop a clear legal plan to protect their business as it grows. I podcast, blog, and spend my time giving entrepreneurs a clear path to legal protection. Growing your business can only happen if you have a firm foundation.

If you want to know more about how to build a business while laying your legal foundation of protection, you are in the right place. Read More…

Looking for Something?

Free Membership

Are you plagued by legal questions? Do you want to know how to protect your money, but don't want to spend the time (or money) trying to find a lawyer to ask a simple question?

Are you tired of "It Depends"?
 
Learn more about getting clear answers in an "it depends" world. Discover a Better Way to Do Legal.
 
Join Today for Free

Let’s Connect!

  • Facebook
  • Twitter

Legal to English Podcast

Entrepreneur Interviews

8 episodes

Legal to English

52 episodes

Don’t Miss Anything

Free Legal. Right to Your Inbox

Free Legal. No Spam. Unsubscribe Anytime.

Check Out Some Other Articles

Legal to English Dictionary: Sole Proprietorship

Legal A business in which one person owns all the assets, owes all the liabilities, and operates in his or her personal capacity. English This is the most basic form of business. It is a lemonade stand. A kid’s lawn cutting business. If you are doing business by yourself and keeping all of the money […]

Business Values

I have  talked a lot over the past several months about the vision, mission, and values of your business. About being intentional and focused in your growth and creating systems to help you grow. Today, let’s talk about some business values  I hold as essential. Hopefully, we can talk more about it. Maybe, this can […]

Legal to English Dictionary: Defined Term

Legal In legal drafting, a word or phrase given a specific meaning for purposes of the document in which it appears; a definiendum. English This is a phrase heard more often in conversation about a legal document than in a document itself. Defined terms are the terms throughout contracts that are capitalized (sometimes bolded or […]

Conversion

This week’s podcast episode with Tony Summerville was all about the why of converting an LLC to a Corporation. Tony gives us a behind-the-scenes look of his process of making the decision of conversion. As an exclusive for you, I wanted to make our conversation this week about the how of that conversion. I would […]

Privacy Policy Lesson 1 – Getting Started

If you are planning to capture email addresses, or use analytics to track traffic on your website, you need to have a privacy policy. You need to tell people: what information you collect who you share it with how users can change the information how you will notify users of the changes to your policy […]

  • Fees and Credits
  • Privacy Policy
  • User Agreement
  • FAQs
  • Terms of Use

© 2013-2016, The Outsourced Associate LLC, Some Rights Reserved

Privacy Policy

This website or its third-party tools use cookies which are necessary to its functioning and required to improve your experience. By clicking the consent button, you agree to allow the site to use, collect and/or store cookies.
Please click the consent button to view this website.
I accept
Deny cookies Go Back