What is a fair split of profit in this scenario?

[orthanc]

Hi everyone. I'm so glad I stumbled on this site.

I'm a creative director in a multinational advertising/design company. Throughout my 20 years in this profession, I've built a reputable portfolio and garnered lots of connections with clients and suppliers. I always believe if I start my own firm, it will eventually prosper. Unfortunately, the only thing holding me back is that I don't have the capital for it.

Recently, I've met this guy who is very interested to invest in this kind of business. He is an owner of a well established mid-size company specializing in events and exhibits. He figured, having a design business would further strengthen and retain his existing clients (since all exhibitors/events needs various marketing/advertising materials). And for me, this makes sense since I can start immediately to target his clients while going for bigger projects.

What he is proposing is that I will manage the entire operation of the business since he has 0% knowledge in advertising while he provides the capital and expenses. We haven't talked yet about the profit sharing and I'm hoping before we resume our meeting next week, I have at least some idea what is fair in this kind of arrangement.

I have a few questions:

-Am I categorized as an "industrial partner" since I wont be contributing financially but has the know-how to run the business
-What about the split of profit? Should it remain the same all throughout? Later on, what if the business gets bigger? Is it right to stipulate in our contract for a higher or possibly an equal split?
-The money that he will provide to start the business, will it be considered a loan and should be returned back in certain percentage accoding to profit? (Offhand, I think it shouldnt be the case and will only be liquidated once the business folds.)
-what else should I need to address on this arrangement?

Hope someone can help me out.

[SmallBizOrg]

Hi

I am not sure if there are hard and fast rules for situations like this, you 2 can strike a deal if both sides think will get same or more than their other alternatives. For you, the other alternatives are to stay where you are or to start on your own or to partner up with somebody else. For him the alternatives are to not do anything, to hire or partner with somebody else like you or to invest in another business.

In deciding what to aim for in terms of % of the profits, I would try to figure out what is the minimum that would be interesting for me AND would try to think of what would be a minimum that would make sense for the other person. Between the 2 minimum percentages there may be a "zone of possible agreement" which may be split through negotiation.

For this I would try to put together a simple spreadsheet with some projections on the revenues (under different scenarios) and the costs needed to generate those revenues (from marketing, people etc etc) and get an idea how much profit the firm can really make in different scenarios. You could probably use some sort of a business plan template which will ask you the most important questions and will guide your thinking. This exercise will give you:
1) an idea how much money the business needs to start up and to operate (either if you were to do it on your own or in a partnership)
2) a better feel what would be your minimum acceptable % (knowing the whole and knowing your alternatives, you can find out what % of the whole would make sense for you - that will be your minimum)
3) what could be the minimum % acceptable for the other party (knowing how much they need to invest from point 1) and knowing what will be their share in the profits you can get a feel of how profitable the investment would be for him and whether it will make sense

If you think in terms of marketing/sales and fulfilling functions of the business, unless the "fulfilling" part requires really specific skills that are rare or in high demand, I would think that the person who brings in the business has a stronger negotiation power. So consider how much of the business will come in because of you and how much because of him, short term and long term.

Other considerations are:
PRO: having a partner with general experience managing a business is important (designing is one thing but making a business out of it is a totally different animal)
CON: having partner(s) can complicate things especially if is somebody who you don't know too well and have not worked with before. Business partnerships are like marriages, require chemistry, commitment and willingness of the parties to adapt.

You 2 need to decide from the beginning what each of you will do and what exactly to expect from each other. Don't assume anything. Just try to imagine how the business will look like, how will it operate, everything that will need to be done...Discuss and decide who and how the marketing will be done? who and how will make the financial decisions? who and how will manage financial processes? who and how will decide on hiring? etc

Hope this helps a bit, there are no easy or quick answers unfortunately but it's better to think things through beforehand and know what to expect rather than be disappointed later on.

[webdesignphx]

Keep saving money and start the company yourself. Even a loan would be better than giving up a percentage of ownership in the company. If you truly believe you will be successful, this partner you are considering provides nothing but capital. Either save up until you can afford to start it on your own. Or get a credit line to help finance your project.

Then when you begin to make money you are not losing a large percentage of the income. You can pay your monthly payments until the company has grown. And you never lose a percentage of ownership which is most valuable. If this man is just providing capital I would not give him a percentage of the ownership. If he just wants to be your bank then maybe.

Just my opinion. I have had many business partners and they rarely work out. Hope it works out. Good luck.

[Paul]

The percentage split should be determined based on the amount of cash and risk relative to the likely income return and the possible appreciation.
If you care to provide that info it will be easier for others to give advice.

Without knowing much else I would say that you should take any reasonable deal IF you are confident you will make at least what you are earning now.
He has the cash and is an “added value” investor because he is also bringing value to the company with an immediate customer base, probably some infrastructure and other benefits.

As for waiting to start on your own, I have to disagree. Consider how long before, if ever, you could fund it yourself. Again, I don’t know if the capital needs is $ 10,000 or $ 100,000. Obviously that will affect the calculation about waiting.

If it is a significant amount of cash required and you can’t get a majority position, cut a deal that allows you to earn increasing ownership until it becomes a majority. Try to get a deal in the event of the sale of the business regardless of your actual ownership that splits the proceeds 50/50 after paying back his original investment.

It is not an easy task to find someone to fund a start up business. He seems to be the right person at the right time. You don’t know if there will ever be another.

If you have to accept a weak deal to get started make sure it has some provision for increasing percentage or buy back/out deal.

My opinion for whatever it is worth.

[orthanc]

Thank you guys for giving such valuable insights.

@smallbizorg
The "zone of possible agreement" between minimum percentages of expected return is a very practical approach right now since we are still discussing the setup. I'm doing your suggestion of creating a spreadsheet to determine various scenarios and projections.
I understand that managing the business is different from designing but right now this is more or less the same thing I'm doing, the one who is just above me is the CEO of our agency (practically he does nothing but signs contracts and checks). In terms of securing and maintaining clients, it falls into my job responsibilities.

@webdesignphx
In an ideal situation, I won't share the profit of my talent with anyone else Saving up will be too long for my goals to materialize.
I can't help to put an analogy of my situation to a talented chef who wants to start his own restaurant but doesn't have the financial means to do so.

@paul
More or less the amount of cash to startup the business is around 200k-250k $usd (salaries of staff not included, 4-6 employees). Usually a small/mid size agency can secure at least 3-5 regular clients. From a (very)conservative estimate, the business can generate around 45-55k usd$ per month (from very simple requirements/retainer fees). My freelancing sometimes earns more than that from a single project. Advertising design is really profitable if you play your cards right and secure the proper connections.
Also I agree that he has an "added value" as an investor because I can utilize his connection to secure clients. Not to mention his existing business compliments the services I want to offer.
I was thinking exactly the same thing about cutting a deal that will increase my profit shares once the business proves to be profitable (which I believe it will be, considering the clients that have pledged to follow me once I start my own).

Well, most of my friends are saying I'm gambling my carrer to something which is very uncertain. From a practical standpoint, I have a secured job which provides my family comfortably. I know this is the harder path to take, but I have a gut feeling that if I don't try putting my own business, I will regret it. Anyway, these "big" companies will always be there if ever I wish to come back being an employee.

[SmallBizOrg]

To me you are in a great position to decide if it makes sense for you to make the jump....you know what it takes to get those high paying clients and how competitive the market is, you know how to keep the clients, you know if the clients go with the person or with the employer's brand...now, if you are that critical to your employer's business, can you not ask him for some equity, some sort of a partnership? because with another partner you would not be entirely by your own, you would have to listen to them too....do you hate it where you are?

[Blessed]

This isn't an answer to your question but I wonder if you are free to go out and do this business? Have you signed a non-compete?

Just a thought - something for you to double-check and get legal advice on before jumping ship from your current situation into the new possibility!

And I'm seconding SmallBizOrg's statement - "Designing is one thing, making a business out of it is another"

Partnerships can be good - but they can also be very tricky. I'd get all the details, contracts, future expectations into writing with the help of a lawyer before proceeding.