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DJS051085
03-20-2014, 05:37 PM
Hi All - So I understand the concept of equity financing in theory but I have a few questions I'm trying to get straight. I think the best way would be to offer some scenarios and to try to get answers.

Scenario 1:
So, let's say that I take my personal savings and use it to start a business (I imagine this is the way most start-ups begin at some point). I invest $10,000 of my own money and I would record $10,000 in shareholder's equity on my balance sheet - representing 100% of my company value. The company grows substantially, netting an amazing return on equity and the company book value is now $1,000,000. However, a substantial amount of the book value of the company is in fixed assets and low cash flow is hindering company growth so I decide to sell 25% of my company.

Here is my question: As 100% owner in the company, doesn't the sale of my 25% equity represent a liquidation of MY personal portion of the company and wouldn't those funds go to MY personal account and not the corporate/company account? To raise corporate funds via equity, would I sell my personal equity portion and then write myself a payable note?


Scenario 2:
This one is less complicated in my eyes. If 4 people start a company as equal partners, so each agreeing to a 25% ownership share, and the company generates $200,000 in profits, so each person has claim to $50,000 - how is the decision made as to the portion of profits reinvested in the company? Would this be something handled at the inception of the firm in some sort of company charter - like a majority vote dictates what is reinvested in the company versus paid to partners? On that note, lets say that the company was not profitable in its first few years and more capital was needed to keep it going. If one person was in a position to contribute and others were not, would the firm write that person a payable note or perhaps that person would "buy" equity from the other partners (but then this goes to scenario 1 as to whether the buyout of other partners generates cash for the firm or the other partner...)

Thanks all.

kimoonyx
03-23-2014, 12:40 PM
Scenario 1. I assume your asking for tax purposes? Funds from the Liquidation of company assets should go into the company account, unless you want to claim the additional 250,000 in income (I would hate to have to pay that tax). when you deposit more then 9,999.00 into a personal account it is automatically reported to the IRS, and if you don't claim it when you file or provide sufficient exemption - expect an audit.

Scenario 2. four partners (nightmare!) but do-able If you are starting a business with four partners I highly advise a lawyer/accountant guided partnership agreement prior to formation. This meeting will handle the voting protocols for (if the lawyer is worth his salt) many issues that you probably wouldn't think of prior, including the scenario you have presented. I sat through a partnership agreement once (because I have never again taken a partner) and I was very thankful for the structure and the lessons gleaned. It also provides some perspective about who you are partnering with...once the questions are posed by the lawyer about how certain issues should be handled and you try to come up with an agreement on the structure of decisions, you see in real time how the other partners think and what their priorities are. Warning... that is a very high stress meeting... but at the end... if done right...its worth it.

Paul
04-24-2014, 01:18 AM
Hi All - So I understand the concept of equity financing in theory but I have a few questions I'm trying to get straight. I think the best way would be to offer some scenarios and to try to get answers.

Scenario 1:
So, let's say that I take my personal savings and use it to start a business (I imagine this is the way most start-ups begin at some point). I invest $10,000 of my own money and I would record $10,000 in shareholder's equity on my balance sheet - representing 100% of my company value. The company grows substantially, netting an amazing return on equity and the company book value is now $1,000,000. However, a substantial amount of the book value of the company is in fixed assets and low cash flow is hindering company growth so I decide to sell 25% of my company.

Here is my question: As 100% owner in the company, doesn't the sale of my 25% equity represent a liquidation of MY personal portion of the company and wouldn't those funds go to MY personal account and not the corporate/company account? To raise corporate funds via equity, would I sell my personal equity portion and then write myself a payable note?


Scenario 2:
This one is less complicated in my eyes. If 4 people start a company as equal partners, so each agreeing to a 25% ownership share, and the company generates $200,000 in profits, so each person has claim to $50,000 - how is the decision made as to the portion of profits reinvested in the company? Would this be something handled at the inception of the firm in some sort of company charter - like a majority vote dictates what is reinvested in the company versus paid to partners? On that note, lets say that the company was not profitable in its first few years and more capital was needed to keep it going. If one person was in a position to contribute and others were not, would the firm write that person a payable note or perhaps that person would "buy" equity from the other partners (but then this goes to scenario 1 as to whether the buyout of other partners generates cash for the firm or the other partner...)

Thanks all.

Depends a little on your corporate structure. If you are incorporated and shares were issued to the owners you would simply sell more shares from the compant treasury. So, if you had issued 10,000 shares to yourself you would just issue an additional 3,333 shares (25% of the new total). There is no tranactions between you and the company and the invested money creates no tax liability. Your 10,000 shares would now represent 75% of the company, so you are in fact diluted to the same extent as your first scenario. You would do a similar way with an LLC, except it's done in percentages and as "members" rather than shareholders. But in either case you are selling from the company "treasury", not your personal ownership.

Same in scenario 2. No need to have one owner sell to another and then loan the money to the company, just sell more equity.