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Old 21st August 2011, 05:46 PM   #1
rwenlee
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Default Small Business Profit Sharing Plan Question

I am thinking of starting a new business and I have invited 2 of my friends (Jack and Jill) consulting jobs in the new company. I have invested about $100k of my own money to start the business. Jack and Jill will both be working full time in the new company but only as consultants. I have said that they won't be paid by either consulting fees or regular wages but all of us will split the profits at the end of every year. There will be only 3 of us working in the company.

I have promised to split the profits with them. I will take 50% of the profits since I will be managing the business, taking care of sales, marketing, accounting, etc and since I have risked some of my own money to starting the company. Jack and Jill will get 30% and 20% of the profits respectively.

For example, if we make $500 K revenue at the end of the year (we hope to) and $300 K in expenses , at the end of the year we will be split $200 K in the ratio of 50, 30 and 20.

Jack has agreed but Jill is saying the fair thing to do is to split the expenses in the same ratio as well, that is 50% of the expenses should come out of my pocket (I will bear 150 K of expenses and they will each bear 30 and 20%).

I am not sure which is correct. Does Jill's argument make sense? I want to be fair.

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Old 22nd August 2011, 12:25 AM   #2
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Tell Jack and Jill to do one of two things.

A) Get their own $100k to start their OWN company
B) Get lost

Hopefully they go with B. Then you pay consultants on an hourly or 'by the project' basis.

Sorry to be so difficult. Your profit share is way, way too generous. Their beef is out of the question.

Show them the door... NOW!

Hope this helps! Good luck!

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Old 22nd August 2011, 06:57 AM   #3
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Rwenlee, with your proposed arrangement, you are bearing one-half of the expenses from your own pocket.

If, as Jill insists, the fair thing is to split expenses 50 / 30 / 20, then by the same logic everything should be so allocated.

If you get 50% of the revenue and 50% of the expenses, you're getting 50% of the net, as with your proposal. Ditto for the other two.

I think Jill just had a temporary touch of math amnesia when she went up the hill.

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Old 22nd August 2011, 10:00 PM   #4
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Not only would I not pay 50% of expenses, but I would also ask both Jack and Jill to put some money upfront. Without them having some beef in the game you are really at a disadvantage. Ask them to put some of their own money upfront.

One other advice I would give is hire a good lawyer to put legal partnership agreement in place. We have seen number of businesses fail because of disagreement between partners. Remember, only you have money to lose with the current arrangement if the business fails. Jack and Jill can walk away anytime and lose only their time investment.

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Old 22nd August 2011, 10:03 PM   #5
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As noted, Jill's proposal is exactly what you have offered. I was wondering why Jill would be earning so much less than Jack.

Whatever the reason, if I was Jack or Jill, I would not accept your proposal. I would not accept because if you do a lousy job of managing the enterprise, I could finish up with nothing for my year's work. But if I do a lousy job, you could fire me.

If you want me to accept a share of the profits as my sole source of compensation, I want a share in the decision-making that leads to that profit. And that, I'm sure, you would not give me.

This is a very one-sided arrangement which I would find unacceptable.

But I don't like to leave on a negative note so here's a profit-sharing plan that will be most fair and, in fact, give you a greater return.

1. Pay everyone a fair salary, including yourself.

2. Share the profits on the basis of $1 earned is the same as $1 invested.

3. Suppose you pay yourself $40,000, Jack $30,000 and Jill 20,000 (Still not sure why, but assuming you have a valid reason for it.)

4. If the gross profit is $200,000, less salaries, net = $110,000.

5. Add salaries and invested capital = $190,000. Divide one into the other and you get a profitshare of 58 cents for each $1 earned or invested.

6. You collect a bonus/dividend of $81,000 ($100,000 + 40,000 x 58c) in addition to your salary.
Jack collects $17,400 ($30,000 x 58c) in addition to his salary, and
Jill gets $11,600 ($20,000 x 58c) in addition to her salary.

You get fairly compensated for your investment and they get properly compensated for their contribution to profit.

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Old 23rd August 2011, 01:52 AM   #6
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I feel both of them should start something of their own..once they get their money back..

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Old 12th September 2011, 09:26 AM   #7
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I don't see why Jill should be getting 20% of the profits for not really doing much. Why don't you pay her for her services accordingly. Either by job or by the hour, although if she's not satisfied with what she is getting she probably won't be satisfied with that arrangement either, and might take her time and bill you accordingly for each hour.

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