How much equity for silent partner

[ChrisG]

I am in the planning stages of starting a new company. I have been in talks with someone who would invest the initial capitol needed, $30,000. He will not have any day to day involvement once everything is up and running. He will offer consultation and fairly valuable industry and market insight. I will do all the work on a piecework wage and commission on the sales. How much equity would be fair for each party. Thanks in advance.

[Freelancier]

You left out a piece of info. This is his $30K, so my guess is that he also stated how much equity he wanted. How much was that and what was the payoff terms (if any) for the $30K?

[ChrisG]

He will be borrowing the money so the payback will be his loan payment + 7%. He has not said how much equity he wants. He has said to think about what I think is fair and we will discuss it. The business would still go ahead without him or his money, it would just be a slower start with far less spent on marketing.

[Freelancier]

Then he's viewing it as a term loan + equity to cover his risk. 7% is not a high percentage for a loan, so that's not where he's valuing his risk, so that tells you that he wants his risk premium as equity. Unless the terms of the loan are that it's also covered by assets in case of default (like a car loan). You see how not simple this becomes?

Then there's the valuation of the rest of the business to consider. When you give someone X%, you're giving them X% of all the assets and valuation of the business. If you're getting a $30K loan for a business that would reasonably be valued at $1M, then you don't want to give them 15% equity stake for that $30K that you'll likely pay back. But if the business has a reasonable valuation of $100K, then 10% might make sense.

[Paul]

Always a tough question that depends on many variables.
I think you have to determine the value of the investment in terms of accelerating the business. What will it mean as it relates to your commission income? Will the $ 30,000 marketing money add $ 10,000, $ 50,000 or $ 100,000 to your income?

The increase in your compensation may easily outweigh any profit share you will have to payout because you are paid first before profit is determined.

As Freelancier said ,his interest percentage is very low considering there is some risk.

What we have done in the past in very similar situations is give a generous payback/buyback with a cap. It is typically secured with a significant equity position that is dissolved when a certain amount is paid back. Alternatively a predetermined buyback amount. If you feel the investment will signifcantly accelerate the business you can make the payback/buyback generous.

[ChrisG]

Thank you for all the detailed responses. It is a lot to think about. Most of the business side of things are over my head right now so that is where he will be valuable. What exactly is the buyback? Is that an option for me to buyback some of the company? He has requested a 50/50 split. Does that sound fair? The business will not be worth very much but should generate about 400000 in sales in the second year.

[Freelancier]

50% of a company for a 30K investment may be good or it may be nuts. My view is that 50/50 is always nuts, because if there's conflict, no decision can legally be made. What you should do is structure it so that as he gets his money back, you can buy back the rest of his shares for some additional money.

[Kyle Johnston]

It really depends on how much you are willing to take the long road (without his investment). If you are ok doing things the long way then you can offer him a lower percentage and hope he goes for it. If you really want to get the ball rolling, then you may need to offer him a higher percentage. Be sure to know your boundaries on both the high and low ends.