How should I pay back the investors in my small business?
If you are interested in starting a small business, likely you will have investors involved. Your investors may be friends and family, but many times your investors will be third parties who believe they can make money with you. With all investors, you need to determine how they should be repaid.
There are several options for repaying investors. They can be repaid on a “straight schedule” (for investors who are providing loans instead of buying equity in your company), they can be paid back based upon their percentage of ownership, or they can be paid back at a “preferred rate” of return.
If investors are paid back on strict, scheduled payments, it is likely because they are loaning money to you as opposed to purchasing equity in your company. This can be good for you if the terms are favorable, but can also be more risky, as the payments would likely become due regardless of how successful (or unsuccessful) you might be.
More commonly investors will be paid back in relation to their equity in the company, or the amount of the business that they own based on their investment. This can be repaid strictly based on the amount that they own, or it can be done by what is referred to as preferred payments.
Preferred payments would be where the investors are paid back at a higher rate than the amount of the company they own. This would occur in the case where the business owner’s equity in the company is greater than the proportion of capital that he contributed. For example, even if a business gets 80% of its capital from investors, the owner might keep 50% of the equity. Investors may prefer to be paid back by preferred payments, so it might be set up so that they are paid back at a rate of 80/20 (or even 100/0) until their investment is repaid, as opposed to a rate of 50/50 as the equity breakdown would suggest. This shows your investors that you are motivated to pay them back as soon as possible before you start to receive money based on your equity. However, it is important to note that preferred payments are not allowed for all business types (i.e. S Corporations).
If you’d like to learn more about structuring your business and ways that Helbraun Levey can help navigate the process, please click here: https://helbraunlevey.com/legal-services/corporate/, or contact Andrew Fine to get information directly from the Chair of our Corporate Group.