Answer: AVVO: Structuring a silent partnership without actual ownership

Question: Structuring a silent partnership without actual ownership

Have a high risk, high reward business venture that my business associate and I are struggling to find the right structure. For liability reasons, I don’t want to technically have ownership in the company-but I will be providing critical resources to the company such as all funding and all of the knowhow. Any suggestions for an alternative structure to actual ownership?

Answer From Brad Bickerton:

I am going to answer my MBA and investor perspective more so than my lawyer perspective. 

I push back on not wanting ownership. I’m not sure what your ‘liability reasons” are. If they are personal that is one thing, if they are liability with the product that is another. The purpose of an LLC or C-corp or such is to keep the investment away from liability and risk exposure beyond the money put in. If you set it up right, the ownership that you take and the risk of that ownership should be limited to the dollars invested. 

As I’m sure you know, a balance sheet is balanced by the Assets vs. Debt + Equity. Meaning there are only two real ways you can insert money into a company, giving them a debt note or buying ownership. 

If you are truly worried about the potential liability then go for a debt structure. This is the same as a bank loan, just from you to the entity instead of a bank. There is no liability (other than the money) in a structure like this. You get your interest rate and you are first in line. There are numerous ways to structure a deal like this. 

Also, do you know about ‘Convertible Debt’? The 101 basics here of CD is that you give money in the form of a note. Let’s say $100,000 with a set interest rate, say 10% per/annum, and a fixed amount of time say 2 years. At the end of two years you have the option (choice) to ‘call’ the debt for $120,000 or you can ‘convert’ the debt into equity. 

The conversion can happen in a bunch of ways. Typically it goes something like this. Value the company at year two – say $2,000,000, then take your investment amount - $120,000, and determine the value of money as equity – 6%. However there is usually a ‘discount’ meaning when you convert your debt the value becomes 1.5x, or 2x the debt value. At 2x then your $120,000 would be equal to $240,000 of the $2,000,000 of the company, or 12%. 

Now you have ownership but no liability for the term of the loan, here 2 years. 

FYI: I fudged these numbers, technically the math does not work, also there are tax issues with any structure so be careful. 

You could also start up your own LLC with your own money. The purpose of this LLC would be to fund companies. You would only have one company that you fund. There are other considerations here but it is a mechanism available for you. 

But hey, what do I know