Need advice on partnering deal

[N/A N/A]

Sorry this isn't directly related to RE, but I know there's folks on here that will have some good insites on my situation. An opportunity recently presented itself to partner with another couple to open a restaurant in a leased property. They have tons of experience in the industry but no money. We have no food/beverage industry experience but believe the restaurant has a good chance of being successful and are able to supply the capital to get the doors open. The deal they are suggesting calls for a repayment of our capital out of net profits and then a percentage of net profits thereafter. They would handle the day-to-day operations and have controling interest.

I don't yet know what type of business entity/structure we would use and would appreciate suggestions. Protection of my personal assets and excellent credit is critical. For the sake of this post, I will use an LLC (is it possible for the members of an LLC to have unequal interests in the company?).

To fund the company, I'm thinking that we would form the LLC and I would loan the start-up capital to the LLC with the other couple siging a personal guarantee. Truthfully, I don't have much hope of recovering my capital if the business fails, but the personal guarantee would, presumably, allow me to get a judgement against them and possibly collect at some point.

One of them would work full time running the restaurant (and be paid wages). The other three of us would work part-time. One of my biggest concerns is that since they have controlling interest, they could manipulate their pay and reduce or eliminate net profit. Additionally, they don't really have any skin in the game to keep them from just walking away if things turn sour. Does anybody have any suggestions on how to best address these concerns? I welcome any comments or suggestions since this completely new territory for me.

Additional info: business is located in TN, start-up capital is relatively small (~30k), and a previous restaurant at the location reportedly had gross sales in excess of $1M but failed due to poor management.

[Jon Holdman]

My sister did a deal like this. Four partners, all couples who were friends before this venture. All contributed cash and labor into the restaurant. Her and her husband and one other couple ended up having to sue the other two couples because they were skimming cash out of the restaurant. The restaurant is still alive and well, some 15 years later.

So, go into this expecting to 1) lose your money, and 2) lose your friends. If you're OK with those, read on.

I see two ways to do it. One is as a loan, one as an equity investor.

As a loan this is totally unsecured. Credit cards charge 15%. Hard money loans secured by real estate charge 15%. That would be the LEAST I would want. And I would want monthly payments starting as soon as the loan were made. That's how loans work! Or, if you're willing to defer it until, say, opening day or six months, whichever is LESS, then add accured interest to the balance due on a monthly basis. If there is any way possible to get a lien on anything (their house, for instance), do it.

No way in h*ll would I hand over any cash! I run the checkbook and pay the bills. They personally get NOTHING from the money. All money goes directly to expenses - materials, suppliers, rent, other people's labor, etc. That works better for them, because they only take the money as needed. So the interest is lower at first.

If they need money for living expenses, they really aren't prepared to go into this business.

The other alternative is to be an equity investor. An LLC is formed to operate the restaurant. You invest your cash into it. They contribute their labor. You will need to agree on some profit/loss split. Capital account wise, you own 100% because you're the only one with cash into the deal. That means you get all the profits and, arguably, own the restaurant. They're really just employees.

Now, they will undoubtedly want some share of the ownership. So, you have to do a "Shark Tank" style valuation. If you invest $X and they want 50% ownership, that means the business, on day 1, is worth $2X. Does that seem realistic? I highly doubt it, since at that point the business consists of your cash and their idea. Truly, that idea is probably worth only slightly more than $0. Their experience is worth something. But is there experience as waiters at some similar restaurate? Its worth very little. Or, have they started from scratch and opened a similar restaurant? That would really be worth something. Or, have they at least been the GENERAL manager at a similar restaurant? By that I mean the person who actually manages the books of the restaurant. Not just the guy who decides who works when and which section they get. This is going to be the biggest sticking point. You say they will have a "controlling interest". Really? Why? There really better be a really, really, really good reason why they can put in no money at all and retain a controlling interest. They may be the managers (I probably wouldn't agree to them having 100% control), but they certainly don't deserve a controlling interest in the company. Perhaps they manage the restaurant, but you manage the LLC and control the pursestrings.

Members can certainly have different ownership shares. The IRS has three splits: capital accounts, profit, and loss. All can be different.

If you're an equity partner, you have that FOREVER. If your share of the profits is 50%, you get that forever. If they want to stop paying you, they would buy you out. That means putting a value on the company, then they pay you based on your share of ownership, typically based on your share of the capital accounts.

They will argue this is unfair and that without them you have nothing. Wrong. There are plenty of ways to invest that cash. Hard money loans to rehabbers will earn you double digit returns and your loans are secured by real estate. Your risk of a complete loss in a hard money loan is very, very low. Your risk of a complete loss in this investment is quite high. I would say a complete loss is the most likely outcome. Their risk, OTOH, is minimal. If the deal fails, they walk away. If you're letting they have living expenses, they're actually getting a job for a while, even if the deal fails.