I was recently approached by a friend (who I consider highly competent) who is looking for financing to open up a franchise. Lets assume the opportunity generally makes sense. My question is: is there a model/literature/best practice for determining how ownership of the franchise should be determined between me (providing 90%+ of financing) and the operating partner (providing basically management and expertise).
There is no one solution to every project finance problem. Two models might make sense in this situation, however.
In this case, you would count all the money that you give to your friend as a loan which he will pay back with interest. The interest rate and loan amounts will have to be agreed on by both of you. One one hand, the interest should be high enough to reward you in a successful outcome for the amount of risk that you take on if things don't work out. On the other, the interest rate needs to be low enough where his earnings after loan repayment justify your friend's effort, in addition to being competitive to ant rate your friend could secure from a bank. The downside to this plan is you don't directly benefit from the franchise's profits.
Shared Business Model
In this model, you will record the cash that each of you invests. Since your friend is also adding "sweat equity" by setting up and operating the franchise, you will need to quantify the work that your friend and you invest into the franchise. Then you can determine how much each of you has invested in terms of dollars and split any franchise profits based on those proportions. The downside of this plan is that it is difficult to estimate how much time each of you invests and how much that time is worth.
There is no right and wrong answer to this question. What you and your business partner perceive as Fair is the best way to split the ownership of the new venture.
First, regarding the two issues you have raised:
Capital Contributions: The fact that you are contributing 90% of initial capital does not necessarily translate to 90% of equity. In my opinion, what is fair is that you transform your contributions into a loan for the company. The securitization of your contribution into a loan will make it easier to calculate your fair contribution and also compensate you for your risk by choosing whatever combination of interest income and equity you see suitable. For example, you might decide to split the company in half and consider your contributions a loan with 20%, 50% or 200% annual interest.
Salary: It is common that co-founders of start-ups forgo their wages at the start of the company. I do not recommend that this forgone salary be compensated through equity because it is impossible to determine the suitable amount of equity to be paid. I suggest the translation of forgone wages into loans or preferred stocks in similar fashion to capital contribution
Also, consider the following in deciding the best way to allocate equity between both of you and your partner
Whose idea was it? Talk with you business partner how both of you value the inventor of the concept. In general, execution is more important but talking about how you both feel about it is good.
Full-time vs. part-time: A person who works full time at the new venture should have more equity than the partner who is only a part-time helper.
Control: It is important to talk about control and decision making of the company. You can separate the control and decision making of important decisions from ownership.
You can also check the following article about this topic at http://www.forbes.com/sites/dailymuse/2012/04/05/what-every-founder-needs-to-know-about-equity/#726842f3668a