Silent partners invest in companies without being involved in daily operations. They invest their money in your business, but they don’t attend meetings or make decisions. They don’t oversee finances or review strategies. They leave the daily work to the active partners in the business, and they trust that they will manage the business well. In short, they share financial resources in exchange for partial ownership in the company. Sometimes referred to as limited partners, silent partners have a limited financial stake in the company and can only lose the amount of funding they’ve contributed.
And though it might sound like a can’t-lose situation, it’s important to fully understand the relationship before diving headlong into it.
In today’s article, we look at three ways to bring a silent partner into your business.
1. Bringing on a money partner as a true business partner.
Bringing on a money partner as a business partner has several pros and cons. First, you can avoid the SEC registration issue, and your partner can now share in the profits. It saves you extra legal work, and you may even get the help and advice of an excellent partner.
However, by bringing them on as a partner, you must involve them in voting and decision-making. The words “silent partner” should never escape your lips, and they should never be treated in that manner. The reasoning is this: By not treating them as a silent partner, they can’t complain later that they didn’t know what was going on or didn’t have any say in the operations if the business fails.
The potential drawback in this situation is that you legitimately have to address their concerns on a regular basis. In fact, the documentation from the beginning of the relationship needs to reflect that they’re a business partner. There isn’t a loan or interest rate, and they have actual ownership in the underlying entity.
2. Treating Your Money Partner as a Lender
A lender relationship could be a great fit for you and your money partner. The positives include a fixed rate of return for your lender, which leaves them with much less risk in the venture. Moreover, if they’re considered a lender, you don’t have to listen to their complaints on how you run the business or follow through with their recommendations or advice. If you’re looking for a silent partner and don’t want to deal with the SEC, the lender classification may be the perfect fit. But they must be willing to live with a fixed rate of return.
As lenders, they cannot share in the profits of the business through some sort of percentage of ownership or back-door payment. This will drag you back into a potential SEC claim from them if you lose their money. They could also be unwittingly transformed into a partner, and now they’re personally and vicariously liable for the operations of the business. They could even be targeted by your creditors if a creditor gets wind of your relationship.
Having a solid promissory note is great start. At a bare minimum, the promissory note and terms should include the following information:
- The party making the loan, and the party responsible to pay it back
- The amount loaned and interest rate
- How and when payments are to be made
- Whether there is a penalty for repaying the loan early
- The consequences of a default in the repayment of the loan
3. Documenting an Investor Deal with the SEC
While bringing on a lender can be a great option, some silent partners want more than just an interest rate return on their money. They want to share in the profits of the business without worrying about how to run the business; in other words, they want an equity position in the enterprise. This is our investor classification and needs to be documented as such.
Here’s a short checklist for bringing on a silent partner as an investor:
- Consult with an experienced securities attorney to make sure a Regulation D offering (the format most applicable to small businesses) makes sense, and to choose the specific option that’s best for you.
- Make sure your attorney files Form D with the SEC within the allotted time frame.
- Don’t forget to make the necessary filings in each state where you will offer securities for sale.
The path of any Regulation D offering must be followed carefully to make sure that all parts and subparts of the rules and regulations are being satisfied. This is a path that a small-business owner would be foolish to follow without the guidance of an experienced and knowledgeable securities attorney. For this reason, bringing on a silent partner as an investor isn’t cheap; expect to spend at least $15,000 in fees if you wish to raise capital in this manner.
If you’re interested to learn more of similar business strategies, tips and how to tackle common issues that many SMEs face, follow the H.E.R Entrepreneur Facebook page. We post weekly articles on a variety of business related topics, and it’s all completely free.
If there’s a particular topic that you’d like us to talk about, please feel free to leave a comment!