What do I need to be aware of before bringing on a silent partner?
So I'm thinking of purchasing a pizzeria with my brother in law. He is a silent partner investing a 100k. The business is being sold for 200k. The agreement right now is that I pay him back 60k and in exchange for the remaining 40k, he will have 20% equity in my company.
Now he wants 25% equity for the 40k because he will be paying more for taxes now (he already has an established career in IT). I don't think that's fair because the additional 5% cost 10k and will continue to cost me 5-6k extra in profits per year. I also read online that silent partners don't pay self-employment tax, not sure if this applies to our situation. I'm also confused about what a silent partner is liable for. For example, say equipment needs to be replaced, does this come strictly out of my pocket?
Your brother-in-law is probably calculating it based on the upfront risk he's taking by investing in a business he won't help operate (and therefore the thought process is he can't help make it successful). This is my assumption. If it's yours as well, then please confirm it with him. Misunderstandings now amplify into bigger problems later. If this assumption is true, then yes, you will be out of pocket on pretty much everything; meaning, I wouldn't count on him covering for you if he considers himself "silent" (which doesn't mean anything in my opinion).
There are a few more very important things to keep in mind.
1) Your brother-in-law comes from the IT world, so it makes sense that he's asking for more equity. The tech world is all about building sustainable growth and exiting businesses. But I don't see that here. You're buying a restaurant for $200k, not a tech company with a 90% growth rate. To resolve this misconception, you need to think about an exit strategy for him (and yourself).
2) Getting money from family is tough but necessary. Please please please ensure that he 1) has experience investing, 2) understands the food *business* (not industry -- but how a restaurant grows and sells), and 3) is completely aware that other than the cash you promise to pay him from your new business' income, he's still taking a risk of losing all his money entirely.
3) Align objectives and personal interests. Even if he doesn't want to be kept involved, you have a duty to keep his best interest in mind as an investor. If s*** hits the fan, remember this is America and anyone can sue for anything.
I hope this helps and doesn't sound too pessimistic.
It depends on the agreement. Naturally, the silent partner is not liable for anything. He will invest as per agreement and at the end of the year, he will take his profit. Taxes go on his shoulder. But still, it depends on the agreement.