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When you accept an investor injecting money or expertise into your business, you usually surrender some control of your business in return for the investment. Depending on how your business is structured and the terms of the investment, the investor becomes a co-owner of your now joint business.
Even the funds are in the form of a loan and the investor does not take any actual ownership, the investor may still feel they have certain rights or entitlements to the business.
My experience in this area has shown time and time again that this phase only fails when the owner and investor do not clearly establish from the outset what role the investor will play in the business, the expectations and the return on their investment. There are a number of different legal mechanisms you can utilise to carefully introduce an investor into your business.
Selling a share or a percentage of the business to the investor
This usually involves the sale or issuing of new shares in the company, or units in a unit trust. It is important to consider the amount of the investment from both sides of the transaction. Usually, if you operate your business through a company or a trust structure, the person having the majority of the ownership will have control over the business. For instance, most day-to-day decisions of a company or trust can be made by those that have 50% interest, plus one of the voting rights in the entity that owns the business.
Some bigger decisions may require a bigger percentage; say 75% plus one of the voting rights in the entity. Whilst it may seem trivial, when a business owner is bringing in an investor, you need to consider the implications of that investment, what the investor gains for their investment, and what the business owner loses
Directorship in the company
Bringing in an investor as a director will often give the investor a lot of control over the business. Ideally this option should only be considered where the investor makes a large investment and intends to work in the business; otherwise, the investor will have too much control without the business receiving a corresponding benefit.
Bringing a partner into an un-incorporated partnership or joint venture
In these cases, the new investor assumes an immediate and significant degree of control in the entity, which is a big disadvantage for these types of entities. One implication that can’t be overlooked is the need for the dissolution of the old partnership or joint venture, which can have significant tax consequences in certain circumstances.
Seeking third party loans to assist with expansion
This is a common strategy for businesses such as property development, where an investor may lend funds at a certain interest rate for a limited period of time to allow for the property to be completed.
Where you seek to bring in an investor, the unique structure of your business will require careful consideration of both the business owner and the investor’s point of view to ensure that all parties are satisfied with the outcome. A clear understanding at the beginning of this phase will enable you and the other owners to successfully navigate your way through the further phases of the Business Legal Lifecycle to ensure that you build a strong and profitable business.
Where a business operates through a discretionary or family trust, it is important to remember the discussion of the different roles in the trust. Where an investor looks to invest through this structure, careful consideration needs to be given to who controls the business.
This is an extract from The Business Legal Lifecycle by Jeremy Streten. This book is designed to guide and empower you with the knowledge you need to successfully navigate your business journey.