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There are two founders in a new company that does not have any profit yet and is financed out of their own pockets. One founder owns of 75% shares, and the other one - 25%. There is a need to spend a large sum of money on a risky deal that may help the company grow and start bringing profit.

Is it as simple as that the first founder pays 75% of the sum and the other one - 25? Or there are some factors involved that may influence the distribution of burden?

  • 9
    If it is structured as an LLC there is no liability beyond the initial investment unless criminal liability can be proven. – Nathan L Nov 4 '15 at 14:32
  • There are many factors as listed below. However if you and your partner agree on it, it can be as simple as following the original 75-25 split. This would be a fairly common way to handle this situation. – Myles Nov 4 '15 at 19:53
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    It's worth to note that a significant extra investment into company on any other terms is likely to mean that after the investment it won't be a 75%-25% split anymore. – Peteris Nov 4 '15 at 20:59
  • 4
    This greatly depends on the legal form of your company, and of the legal system (i.e. country). Could you add those to your question? – Paŭlo Ebermann Nov 4 '15 at 21:03
  • Think about it another way: let's say the company is worth $0. Now the 75% guy puts in $1000,- for the risky deal. But....the deal doesn't go through. Both partners decide to liquidate the company which now value at $1000,-. And they split the $1000,- fairly in a $750 and a $250 part......wait what? – Pieter B Nov 6 '15 at 8:46
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A firm is a separate legal person from its shareholders or owners (but doesn't get invited to parties much). Owners invest capital to get shares in the firm or may get shares for investing time, effort etc. but those shares are on a limited liability basis. That means that shareholders are only liable up to the value of their shares and that the firm itself is responsible for any expenses or liabilities. The firm will have working capital from its initial investors (i.e. any capital invested to get shares) and can borrow money on the bond market or issue new shares to cover outgoings. Share ownership simply entitles the owner to a proportion of the residual equity of the company and voting rights (for non-prefered equity). In a firm that I previously worked for, for example, one of the partners owned 51% of the firm but put up 100% of the firm's equity capital. The other partner owned 49% and provided 90% of the intellectual capital of the firm. They both took decisions equally.

The distribution of ownership should, therefore, have no bearing on who finances deals. The owners (or managers in larger firms) should decide together how to use the company's capital for spending because it is exactly that; the company's capital; not any one of the investor's.

Limited liability of owners is one of the major benefits of forming a company.

  • "A firm is a separate legal person from its shareholders or owners" - this depends on the local law and the form of the firm. My own "startup" is not a separate entity from me - I am an "independant entrepreneur" and I'm responsible for my business with all of my property. On the other hand, I do get some crazy perks like 2% tax. – Davor Nov 6 '15 at 15:07
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I think you're looking at the picture in an odd way. When each of you made your initial investments and determined what portions you owned, that gave the company capital that they could use to finance its operations. In return, you are entitled to the future profits of the company (in proportion to your ownership). Any future investment by either of you is at your own discretion.

Your company now faces a situation where it would like to pursue a potentially lucrative opportunity, but needs more capital than it has to do so. So, you need to raise more capital. That capital can come from one or both of you (or from an outsider). Since that investment would be discretionary, what the investor gets is a negotiation: the company negotiates with the investor how much equity (in the form of new shares) to award in exchange for the new investment (or whatever other compensation you decide on, if not equity).

9

I think your question might be coming from a misunderstanding of how corporate structures work - specifically, that a corporation is a legal entity (sort of like a person) that can have its own assets and debts. To make it clear, let's look at your example.

We have two founders, Albert and Brian, and they start a corporation called CorpTech. When they start the company, it has no assets - just like you would if you owned nothing and had no bank account. In order to do anything, CorpTech is going to need some money. So Albert and Brian give it some. They can give it as much as they want - they can give it property if they want, too. Usually, people don't just put money into a corporation without some sort of agreement in place, though. In most cases, the agreement says something like "Each member will own a fraction of the company that is in proportion to this initial investment." The way that is done varies depending on the type of corporation, but in general, if Albert ends up owning 75% and Brian ends up owning 25%, then they probably valued their contributions at 75% and 25% of the total value.

These contributions don't have to be money or property, though. They could just be general "know-how," or "connections," or "an expectation that they will do some work." The important thing is that they agree on the value of these contributions and assign ownership of the company according to that agreement. If they don't have an agreement, then the laws of the state that the company is registered in will say how the ownership is assigned.

Now, what "ownership" means can be different depending on the context. When it comes to decision-making, you could "own" one percentage of the company in terms of votes, but when it comes to shares of future profits, you could own a different amount. This is why you can have voting and non-voting versions of a company's stock, for example.

So this is a critical point - the ownership of a company is independent of the individual contributions to the company. The next part of your question is related to this: what happens when CorpTech sees an opportunity to make an investment? If it has enough cash on hand (because of the initial investment, or through financing, or reinvested profits), then the decision to make the investment is made according to Albert and Brian's ownership agreement, and they spend it. The money doesn't belong to them individually anymore, it belongs to CorpTech, and so CorpTech is spending it. They are just making the decision for CorpTech to spend it. This is why people say the owners are not financially liable beyond their initial investment. If the deal is bad, and they lose the money, the most they can lose is what they initially put in.

On the other hand, if CorpTech doesn't have the money, then they have to figure out a way to get it. They might decide to each put in an amount in proportion to their ownership, so that their stake doesn't change. Or, Albert might agree to finance the deal 100% in exchange for a larger share of ownership. Or, he could agree to fund all of it without a larger stake, because Brian is the one who set the deal up. Or, they might take out a loan, and not need to invest any new money. Or, they might find an investor who agrees to put in the needed money in exchange for a a 51% share, in which case Albert and Brian will have to figure out how to split the remaining 49% if they agree to the deal.

The details of how all of this would work depend on the structure (LLC, LLP, C-corp, S-corp, etc), but in general, the idea is that the company has assets and debts, and the owners can have voting rights, equity rights, and rights to future profits in any type of split that they want, regardless of what the companies assets and debts are, or what their initial investment was.

  • Great, detailed answer. – MegaMatt Jul 18 '17 at 13:54
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Together the founders represent 100% of the outstanding stock, so they can do it however they like.

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    While this answer is technically correct, I don't think it helps the OP much... – a CVn Nov 5 '15 at 19:40
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You can look at the company separately from the ownership. The company needs money that it doesn't have, therefore it needs to borrow money from somewhere or go bankrupt.

And if they can't get money from their bank, then they can of course ask people related to the company, like the two shareholders, for a loan. It's a loan, like every other loan, that needs to be repaid. How big the loan is doesn't depend on the ownership, but on how much money each one is willing and capable of giving. The loan doesn't give them any rights in the company, except the right to get their money back with interest in the future.

Alternatively, such a company might have 200 shares, and might have given 75 to one owner and 25 to the other owner, keeping 100 shares back. In that case, the shareholders can decide to sell some of these 100 shares. I might buy 10 shares for $1,000 each, so the company has now $10,000 cash, and I have some ownership of the company (about 9.09%, and the 75% and 25% shares have gone down, because now they own 75 out of 110 or 25 out of 110 shares). I won't get the $10,000 back, ever; it's not a loan but the purchase of part of the company.

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    When you say, in the last paragraph "the shareholders can decide to sell some of these 100 shares" did you mean "the company/directors can decide to sell some of these 100 shares"? – AndyT Nov 4 '15 at 16:34
  • Well, they are the same people in this case :-) – gnasher729 Nov 4 '15 at 21:42
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It depends on the business entity.

If the entity is a sole proprietorship or a general partnership, the individual are considered to be the business. There are no shares, and so yes, the owner would have to take on 75% of the expenses. For example, in the event of a lawsuit, if the claimant were awarded $1,000,000, the 75% partner would be personally liable for $750,000.

In the event of a corporation, there are shares, so the responsibility is on the management of the company, not the owners, to come up with money for the expenses of the business. That money can come from the business' capital, which is the money owners have put in.

Basically, for a corporate entity, the owner is not responsible for 75% of expenses, for a partnership, yes, they are.

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Another way to decide would be to do a fair valuation of the company agreeable to both the partners. Lets assume when you started the company it was worth $10,000 and to acquire 75%, you must have put $7,500 worth of money and effort. Similarly, the other partner must have put $2,500 worth of time and money.

Now say after 2 years, you both agree that company is worth $50,000. And say now the company needs $10,000 worth of investment. Whoever invests that money should get 20% (10k/50k) of the company. Or each $1,000 will buy 2% in the company. Post this investment the equity division would be

First investor (you) 75% of 80% = 60 % Second investor (your partner) 25% of 80% = 20% Third (new) investor = 20%

Now, if you alone decide to put all the money you stake will be 60 + 20 = 80% and your partner will be reduced to 20%.

If you guys want to maintain equity as it was (75-25), you need to put money in the same ratio ($7500 and $2500). If you do that-

First investor 60% + 15% (for $7,500) = 75% Second investor 20% + 5% (for $2,500) = 25%.

Please know for IP-centric company valuation is very subjective. But, do make an effort to do the valuation at every stage of the company so that you can put a number in terms of equity for each investment.

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From your question, it seems your problem is that you have a company that wants to make a deal, but does not currently have enough money to go through with it. Therefore it needs to raise capital. Assuming that you cannot get a loan from a bank and you do not want to seek funding from other sources, the two owners must provide the funds themselves somehow.

Option A: The easiest and fairest way to do this is for the two shareholders to provide 75%, and 25% of the funding as a loan to the company. They will provide this loan knowing it may not be paid back if the company goes under. Note that it would not be fair for one of the shareholders to provide more, as that shareholder would be taking all the risk, while the other still reaps the rewards (although you could add a large interest rate to account for this).

Option B: But say one of the shareholders cannot provide additional funds. In that case, the company should issue new shares, and each shareholder can purchase however many of the new shares he/she wants (each shareholder is entitled to purchase at least 75% or 25% respectively, but does not have to). The result of this may be that company ownership percentages have changed after the capital raising. This is more complex as it require valuing the company accurately to be fair, and probably requires reporting to a government (depending on the jurisdiction).

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Typically, no. Unless you have a detailed agreement spelling out the apportioning of costs, all operating expenses are deducted from gross income first, with the division of the proceeds coming out of net profit, in accordance with the type and % of shares you own, and per the terms of the shareholders agreement. This is a simplified answer, and does not address other methods of extraction, such as wages paid, loans to shareholders, interest paid on loans from shareholders, etc..

  • You also forgot that the company doesn't have to pay all of its profits to the shareholders. In fact, if there's nothing better to do with the money inside the company than to pay it out to the shareholders, that would at least make me start wondering about the long-term viability of the company. Paying some of the profits to shareholders is one thing; paying all of the profits to shareholders is something very different. – a CVn Nov 5 '15 at 19:45
  • @MichaelKjörling: It's not unheard of for companies to intentionally have no long-term viability. For instances, it's not uncommon for a ship to be owned by a dedicated company. Once the ship is lost or scrapped, the company is liquidated. Profits therefore can be channeled straight to the shareholders. – MSalters Nov 6 '15 at 12:41
  • @MSalters Hopefully, some of the profits up until that point would go toward maintaining the ship! This might be not just day-to-day operating costs but also setting money aside for future, larger expenses. (I don't know what exact expenses are involved in such a business as you use in your example, but I can imagine major engine overhauls costing quite a bit of money while still being cheaper than getting an all new vessel, for one.) – a CVn Nov 6 '15 at 13:42
  • @MichaelKjörling: Regular maintenance is an expense, so it's not paid out of profits. Large-scale maintenance is ordinarily done by reserving money. Reservations also are deducted from income, not profit. And when the actual big maintenance job is done, it's paid out of the reserves, which means it doesn't impact that year's profit. – MSalters Nov 6 '15 at 14:43

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