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tt104
01-23-2014, 10:26 AM
I am in the process forming an LLC so I can sell a product I am developing via my LLC. I am forming the LLC with a business partner who is also developing the product with me. My partner and I have a friend who we paid a lump sum to develop a circuit board that will be used in our product. We also agreed that he will receive 1% of profits once we begin selling the product (we have this all in writing). I'm not sure what to legally consider this friend. I'm not sure if he would be considered a contractor because he is receiving some percentage of the profit. I'm also not sure if he would be considered a business partner. I don't want to run in to any legal trouble in the future by paying him a percentage. Any input as to how to deal with this would be great!

Freelancier
01-23-2014, 11:49 AM
He's a contractor/vendor. He's getting a royalty payment for the use of his device. It's not a big deal. He's not an employee, since you're not directing his moment-to-moment activities. If the agreement says he gets shares of the LLC, then he becomes an LLC "member". By the way, what happens if you use someone else to develop a different product for your LLC... would he still get 1% of that? If so, you need to consider restructuring your agreement to make it a royalty on sales of the product.

tt104
01-23-2014, 12:16 PM
He's a contractor/vendor. He's getting a royalty payment for the use of his device. It's not a big deal. He's not an employee, since you're not directing his moment-to-moment activities. If the agreement says he gets shares of the LLC, then he becomes an LLC "member". By the way, what happens if you use someone else to develop a different product for your LLC... would he still get 1% of that? If so, you need to consider restructuring your agreement to make it a royalty on sales of the product.


Ok cool. Our agreement does not say that he gets a share of the LLC. So we wouldn't have to do anything special or include him in any way when we file for an LLC? We would just consider his payment a royalty when we keep records of cash flow?

And no, if anyone else develops something for the product they would not get any royalties. We did this with him because he is a close friend and gave us a really good deal with the up front cost. He also is willing to give advice as far as finding manufacturers etc.

Thanks for your help

tt104
01-23-2014, 06:48 PM
I did some more research and I was wondering if we should consider his payment a royalty or commission? I think that a royalty is normally something paid when intellectual property is used. If we considered him an independent contractor getting paid commission based on a percentage of the income from sales, we would just file that as an expense and he would pay the taxes on it. (Correct me if I'm wrong)

Freelancier
01-23-2014, 10:21 PM
And no, if anyone else develops something for the product they would not get any royalties.

You missed what I was asking. You stated that your friend gets 1% of sales. Did you limit your agreement so that it was 1% of sales of the item he created or 1% of total sales for the company? If you didn't limit it, you'll likely need to do something about that as you start to create other products.

As for your question, royalties are expenses, but your best bet is to take your question to your accountant, so that you get everything categorized properly in whatever accounting package you are using.

tt104
01-24-2014, 06:28 AM
Ok, I understand what you're saying now. I'll talk to an accountant to figure out the details.