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Funding A Friend's Business Venture

    
Sandy thinks her friend Danny has a great business idea—an exciting, almost revolutionary new service. Now he wants her to make a significant investment in the corporation he’s starting in exchange for a 10% ownership stake.

Sandy is tempted. Why not help a friend see his vision to fruition, claim partial credit for launching the wave of the future, and potentially earn extremely handsome returns?

Though such opportunities may feel like the chance of a lifetime, there’s plenty that can go wrong. If there’s any rule of thumb for investing in a private venture as a minority owner, it’s that you should do it only with money you can live without.

Consider Danny’s corporation. With no market for its stock, Sandy’s capital is likely to be tied up for five to 10 years. That’s how long it may take to build a company that can go public or attract an acquirer. During the incubation period, Sandy must be prepared to rely solely on other assets to meet her financial commitments.

Then there’s the failure scenario. Unlike stock in a deteriorating public company that can usually be sold for something on the way down, private shares’ lack of marketability means the investor is strapped in for the full ride to zero.

There’s also the matter of taxes. Owners of S corporations as well as partnerships and most limited liability companies pay income tax on their share of the business’s earnings, even when those profits aren’t distributed. While she’s waiting to get her investment back, Sandy might have to spend more money on taxes.

Still another concern is share of ownership. Assume things go swimmingly and the company seeks to expand. Can Sandy remain a 10% owner? Depending on the laws of her state and the articles of incorporation, she and other shareholders may, or may not, be entitled to first crack at any new shares the corporation issues, in the same proportion as current ownership. (Partnership and LLC operating agreements, when properly drafted, indicate whether owners have the right to maintain their original percentage of ownership.) Without that promise, Sandy’s interest could be diluted and her take of the profits compromised.

Not just money but also relationships may be at risk. If the venture bombs, will Sandy blame Danny? Will their friendship suffer? If it does, will she mind? Even with a successful venture, resentment can arise if some of those involved feel others are prospering more than their contribution merits.

For all of these reasons, investing in a friend or relative’s business can present problems from the get-go. Sandy should obviously research the investment before diving in. But her friendship with Danny could hinder her ability to objectively analyze his business plan and his ability to execute it, and could make it awkward to quiz him about the plan’s marketing or financial assumptions.

Dream deals do sometimes come along. But what often separates successful capitalists from dreamers is finding the right reason to say “yes” or “no.” Before you make an investment in a friend or relative’s company, talk to us. We can help you analyze the numbers and evaluate the opportunity.

    

This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.



INDEX
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  • 10 Easy Steps To Take If Opening A New Business
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  • Ever Considered Helping Your Adult Child Open A Business?
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  • Dispel These 7 Popular Myths About Retirement
  • 4 Retirement Plan Options For Your Small Business
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  • 4 Steps To Creating A Dynamic Business Budget
  • Can An Underfunded Small Business Startup Be Successful?
  • What Happens If You Have Excess Capital Losses?
  • This Is Not Granddad's 'Defined Benefit Plan'
  • Despite Much Pessimism, Slow Growth Persists
  • How To Take Your Section 179 Deduction To The Max
  • Squeeze More Out Of Bonus Depreciation Deductions
  • A Common Error In Powers Of Attorney
  • For The Self-Employed: 4 Retirement Plan Choices
  • Which States Are The Most Friendly To Businesses?
  • How Economic Myths Distort Investment Outlook
  • Don't Forget About Roth 401(k)
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  • Shopping For A Bank Account That Pays The Highest Possible Rate Of Interest
  • The Twenty Top Tax Breaks In The New 2010 Tax Act
  • Investing Defensivley Does Not Mean Deserting Stocks
  • 401(k) Alternatives For Business Owners
  • Tax Court Okays Deducting Cost Of MBA
  • Employers Find Ways To Mitigate Liability On 401(k)s
  • Working Longer: What's A Post-Retirement Job Worth?
  • Slash Taxes By Swapping Like-Kind Assets
  • Transferring The Family Business To Your Heirs
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  • Move Fast To Corral Emergency SBA Loans
  • Risk Management
  • Estate Taxes And The Obama Administration
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  • A Little Bond Logic Yields Insights
  • Avoiding The IRA Rollover Crackdown
  • Ruling Cites Business Owner Responsibility to 401 (k) Plans
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  • How Much Is Your Business Worth?
  • Managing Cash Flow In Tight Times
  • When Times Are So Scary, Opportunities Emerge
  • Avoid Being Accused Of Insider Trading
  • Lifecycle Funds May Pose A Hidden Danger
  • Funding A Friend's Business Venture
  • Beware Of Social Security Identity Theft
  • Regulatory Guidelines Update
  • Small Business And Work Opportunity Tax Act
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  • Free Credit Reports Available Online
  • Understanding the Importance of a Fiduciary Standard
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  • Timber As A Liquid Investment
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  • A Primer On Managed Futures
  • Identity Theft: What Documents Should You Shred Or Store?
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  • Know The Score
  • REITS: A Very Good Portfolio Diversifier, But Should You Invest In Them?
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  • Another Way To View The Current Valuation Of REIT Sector
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  • To Reinvest Or Not To Reinvest
  • Why Not Alternative Fixed Income Investments?
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  • Beware of Brokerage Firms' Misconduct
  • Identity Theft : Correct Those Credit Reporting Errors
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  • Q & A With Robert Arnott
  • Identity Theft : Applying For Credit? Better Check Your Credit Report First
  • Identity Theft: Everyday Prevention
  • Identity Theft : Help Is On Its Way
  • Identity Theft: Tips To Protect Yourself
  • Identity Theft : Don't Fall For That E-Mail!
  • Identity Theft : One More Reason To Protect Your Credit
  • Identity Theft: A Note About Social Security Numbers
  • What Do Rising Interest Rates Mean For Money Market Yields?
  • Exit Gracefully: How Business Owners Should Plan For A Comfortable Retirement
  • Section 529 Plans Are Popular But Not The Only Way To Go
  • The Importance Of Commodities In A Portfolio
  • A Tale Of Two Hedges
  • IRS Refuses Change Of Section 179 Election To Expense Depreciable Property
  • Small Businesses Need To Be Aggressive On Costs
  • Your Medical File Report May Need A Check-Up
  • Do It Yourself Tax Preparers Watch Out: Tax Answers From IRS Centers Oftentimes Are Incorrect And/Or Insufficient
  • Home Office Deductions: Hoops To Jump Through
  • Property Tax Challenges Should Not Be Overlooked
  • The IRS Will Follow Your Wealth To The Ends Of The Earth
  • Year-End Tax Defferal Planning
  • How To Find A Great Financial Advisor
  • Is It Time To Find A New Financial Advisor?
  • What Is Risk?
  • 4 Steps To A More Secure Investment Portfolio For Your Retirement
  • Traditional Investing May Decrease Your Retirement Lifestyle
  • Year-End Tax Planning Can Help Generate High Return On Investment
  • Businesses Receive Temporary Depreciation Bonus
  • Understanding Deflation
  • Is Your 401(k) Plan A Failure?
  • Succession Planning: Developing A Plan For Your Business
  • The ERISA Retirement Plan Law Spells Out Fiduciary Issues
  • Evaluating The Quality Of A Company's Earnings
  • Investing In Times Of Uncertainty And Risk: The Importance Of Diversification
  • Tax Issues To Consider When Buying A Long-Term Care Policy
  • Yesterday's Great Companies
  • Businesses Should Be Aware Of States' Use Taxes
  • Expanded Retirement Plan Contribution Limits Create New Opportunities For Business Owners
  • Succession Planning: Developing A Plan For Your Business



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