I was just offered a potentially lucrative business proposition wherein I am required to invest about $250,000 per transaction with between 2% to 4% ROI. The business proposer will manage all operational duties. If I was to go ahead, how should the business be structured? What are the steps I can take to protect my investment? How should any potential net income be shared if the proposer does not invest a single penny? What are the pitfalls of such an arrangement? Any other suggestions and advice would be highly appreciated.
What you're asking is very complex and to me 2% to 4% seems like a terrible ROI. There is a lot of information that needs to be provided to determine how to structure the deal and if it's even a good deal. Are you getting equity (a part of the ownership of the company) for your investment? If yes, how much (%)? Is the company valuation realistic? Is the company established and having sales or is it just starting out?
Simple example: If you're investing 250k $ and the company has a realistic pre-money (before your money is invested in it) valuation of 1 Million $, you should be getting 25% in terms of equity. Of course things aren't that simple in reality but it's a good rule of thumb.
- If I was to go ahead, how should the business be structured?
This is hard to answer without more information. In general you should seek to have both equity and decision making power if you're investing into a business, if you want to be an equal partner you need both equal equity and power. Especially if it's in an early stage or if you're investing a significant amount of money. Which to me seems to be the case. How you'll specifically structure the business depends on the area in which the business operates in ex. software, manufacturing, sales, consulting etc.
- What are the steps I can take to protect my investment?
A lot of research and consulting into how these kinds of investments are usually done. You should obviously have a specific contract drafted by a lawyer as well which denotes the terms of investment.
- How should any potential net income be shared if the proposer does not invest a single penny?
Depends on what else is the proposer bringing to the table. Maybe other resources, machines for manufacturing, their network, blood sweat and tears, or whatever has a determinable value. Of course you need to figure out if what they're bringing to the table is of equal or more value to the money you're bringing in.
- What are the pitfalls of such an arrangement?
Also depends on the details. Some are:
-> Giving the partner all the decision making power, "Trust is a terrible criteria for investment"
-> There's always the risk of the company failing of course.
-> If you don't draft specific contracts on what you're getting for your investment chances are you'll be getting very little
I would suggest reading up/researching on investing into businesses (or start-ups), there are established procedures and contracts that are often used when investing.
It is noticeably clear from your question that you are hinting towards a broad business model because it is taking external forces like investment are taken into consideration. Major pitfalls in this model are not sufficiently focusing on the core value creating processes and it includes factors not completely controlled by the company.
Besides if you do have any questions give me a call: https://clarity.fm/joy-brotonath
First things first, you should do your assessment, due diligence of the person offering you this opportunity and the assessment of the offer and underlying business model.
Do you know this person, do you have an established trusting relationship?
Does this person have successful and verifiable business traction in the same field?
Are there any references you can check?
Also, assess what you could do alternatively with the capital that you would invest here? A comparison of the opportunities' type, risk profile, ROI etc will make it easier to decide if this is even a relevant opportunity for you or not.
My initial thoughts here is that the risk/reward payoff of between 2 and 4% seems low. In essence, this deal feels more akin to a venture capital proposition (seed capital), if the business proposer takes onboard all operational activities and doesn't invest anything. More information here would be helpful regarding this point, but under this form of deal, I'd be seeking a much higher return on my investment.
Secondly, and to the point of others on this thread, what percentage of the business does your $250k buy into? Has the proposer invested anything or provided anything of tangible value to the business (product, invention, patent, active customers, confirmed orders, etc.)? It's important here to understand what exactly your $250k (per transaction) is buying into.
Another question I'd be asking, is what will the funds be used for and what level of comfort do you have that it will be well managed and equate to growth/value.
Also, how many others (if any) will potentially also be investing (both now and into the future). The more invested, the further your return is diluted.
Knowing these aspects, one potential structure here is that you could be an equity parter with x% ownership (based on the above factors) of the business. I would however caveat this by urging caution and making sure I did a thorough assessment of all the angles presented here before progressing. There is some good general advice here so far from a few of the members and I hope these give you some good ideas on how to proceed. Feel free to reach out or to ask more questions here.
When the one partner provides the financing, the other the expertise, the best practice (depending on how the investor knows his partner) is for the investor to provide a small share (10% or even less) of the ownership to his partner and the rest of the reward for the managing partner to be performance-based. Usually both partners agree on few preset (long-term) goals, the achievement of which will trigger increase in the share of the managing partner. By the definition of the goals and of the share increase the investor should make sure that he would get the expected return on his investments and a fair share of the value increase based on the agreed parameters. Effective interim control of the operations and of the financials of the business (and of the fulfillment of the goals and managing partner commitments) by the investor is of prime importance. The funds are provided in installments based on up-to-date performance in the form of a capital increase or loans.
On the contrary, in case of underperformance and unless the investor does not decide to quit, any additional financing should be made either as equity financing or as convertible debt in order to dilute the share of the managing partner.
A partnership agreement can make or break potentially a very sound business.
Otherwise I agree, 2% - 4% ROI does not make any sense.
Below steps should give you clarity:
1. Conduct due diligence - only after having this report, you know what to plan next.
2. If the business is genuine, then develop strategies to:
a) secure your investment by implementing an Internal Control system, legal document, and business structure.
b) cash flows strategies to set payment in a secure manner.
c) implement a risk management system and contingency plans.
d) an exit strategy