Business structure?

Question

I have been approached by a small-time industrial subcontractor who needs a money partner.  He has contacts that will provide him with steady high paying corporate work.  But they dont pay for about 30 to 60 days after invoicing.  So he needs me to provide $25,000 upfront to cover equipment costs, payroll expenses, insurance, etc before the first paycheck.  After the initial paycheck is received the operation should be able to sustain itself.  He will split the profits 50/50.  I do not know this person and still have some due diligence to complete but everything seems above board at this point.  What sort of business structure would be most suitable in this case?  What other steps should I take to secure my interest?

Bill Gulley · Answer

Sounds like this is not up your alley at all, so you need a local business attorney to guide the two of you, make sure the attorney is representing you.

I got into a steel fabrication business by providing the seed money and it was very profitable, but I ran the business side and oversight.

Your collateral is everything you can put your hands on, his personal assets and business assets. Vehicles, equipment, inventory, accounts receivables and orders, your security is accomplished with an agreement and/with UCC filings.

When doing due diligence in such an opportunity, begin with him personally, then his business history, then financials, then compliance issues that may be applicable, then employees, with employees, look at criminal records, pay being customary and work history. They all need to be trustworthy. Do OSHA regulations apply? What environmental compliance issues exist? Violations can stop a small business. Who are the competitors and where are they in the niche of this business? Each of these aspects can lead to other aspects for investigation. Where did these orders come from and can they perform? Just some of the concerns.

It took me about 45 days to wade through an existing business to invest in, it's not accomplished properly in 3 days or from any forum.

Investors in business are business people, they invest in what they know or what they can easily understand. They must be able to take charge and run the business or get those who can if things blow up to protect the investment. Just because you are approached on some deal and you think it's an opportunity isn't enough, you need the resources and knowledge to take charge.

See an attorney who has put small partnerships for manufacturing ventures together.  It might be a great deal!  :)

Bill Gulley · Answer

Sorry, all of that and I failed to mention the structure. It may depend on the existing structure that he has. He has some blue sky as he has orders so restructuring under a new name may not be a good idea. You can buy in to any existing structure. That's why I suggest you see an attorney. Your security will depend on how the deal is structured, stock, operating agreement, note from the business to your capital account, whatever.

However, you do not want to act as an outside lender and take an equity position or have control or undue influence over the borrower.  If you are taking the 50/50, don't act as a lender. That does not mean the company can't pay you back for contributions as a partner. Again, see an attorney. Good luck!

Michael Lauther · Answer

Larry Flanagan, Jon and Bill as usual offer substantive suggestions. My negative view is because wile the legal safe guards are important the only real asset here are the contracts and you need to evaluate them as well as the ability to perform. The reason I lost money is because the business failed not because the structure was wrong.

Michael Lauther · Answer

Larry Flanagan I have been involved with several of these "opportunities" they never end well. 50% of no profit is still zero and you will have a difficult time recouping. There is usually a good reason that a businessman is in this position and unless you are willing to risk that much capital for an unspecified return at an unspecified date to a person you do not know well I would look to other investments.

Jon Holdman · Answer

This would be an incredibly risky investment.  There's no security at all.  If you don't know this person, why would you even consider this investment?

If you want to consider this, I would suggest refactoring his receivables.  Seems like he has a cash flow problem with customers that pay slowly when he needs cash now.  So, you buy his receivables from him, at a discount.  He gets cash now and you get the larger cash later when his customer pay.  Not clear to me, though, that he actually has and customers or receivables right now.

An alternative would be for you to make an equity investment in his company.  The two of you form a company (with help of a lawyer and a CPA) and you put in cash in exchange for some fraction of the ownership.  Frankly, I think that ownership fraction is quite high.  He's selling you a piece of his business.   If the business could be valued at $75K, and you put in $25K, the total value would be $100K and you should get a 25% ownership.  Given you description, I think the existing value is much closer to $0 than $75K, so your ownership should be much higher.

You could actually form the company and just hire him.  With an opportunity for him to buy you out at some point.

Another alternative would be just a straight loan.  A business startup loan.  But banks and the SBA do (or, at least did) this sort of loan.  Why isn't he talking to them?  Do they know something you don't?

Does "payroll expenses" include his paycheck?

Has he every actually run a business like this?  Its easy to be an employee of a company and think "I could do this."  But, in many cases, you think your job is the only one that matters and you don't realize what else it takes to run a company.  $25K doesn't really sound like enough to get this off the group.

Business structure?

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