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A partner and I (both working partners) are starting an internet based  business and have found an investor who will contribute $10k as the start-up costs. At this point he is looking for 7.5% net profit participation for eleven years, 30% vote and a life of participation of 11 years. Does this seem reasonable?

First of all, the way you structured the deal is a little atypical. Is this investor requesting equity in your company or is it a loan with a maturity of 11 years?

I’m assuming that the scale of your business is rather limited, so let’s work with an assumption that you will generate revenues of $100,000/per year. Since it’s web-based, we’ll be looking at a gross margin probably in the 60% range, meaning you will expend around $40,000/year to build/manufacture/provide your product or service. Your cost overhead is probably another $1,500/month, adding a total of $18,000 to the tab. If we add a monthly salary of $1,500/month for each of you, this will take out another $36,000 – leaving you with earnings before taxes of $6,000; meaning the investor would be entitled to $465.00 or a 5% financial return on his investment this year.

The crux of the matter is that if you incorporated as a C-Corp., state and federal income taxes would take another big bite out of your gross profits, roughly 30% to be exact. If you incorporated as a LLC, sharing your profits with the investor as outlined won’t make much sense either because he would be taxed based on his ownership percentage in the company, let’s say 30% (based on the 30% vote he desires) instead of the agreed upon profit split.

My numbers may be off by a mile; so I just included this simple financial model for you to have something to go by and to document that without having further insight into your corporate structure and financial projections, my guess will be as good as anybody’s.

I hope this helps.

Mark

Love the thought out response fastventures.  I will leave you with this - take the money and run!!!

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