Having watched shark tank, I’m curious how dividends work in small companies. I know the show is nothing like reality, it was just the basis for this question.
If I have a company I had two different early investors- one who has a 10% share and one who has a 15% share, who determines when dividends can be drawn?
If my company gets to a point where it’s earning enough revenue to net 100k profit after reinvesting for growth, what’s to stop me from issuing myself a 100k salary instead of receiving profit in terms of dividends?
In: Economics
Also, depending on your entity type (C-Corp, S-Corp, LLC, etc) you may be required by the IRS to pay yourself a reasonable salary to avoid the appearance of skirting self-employment tax by simply paying yourself distributions instead of pure payroll. Of course, consult your tax advisor-definitely not reddit 🙂
The investors will require clauses in the operating agreement. These often include limits on spending above a threshold without approval and specifics on compensation.
Experienced investors know how to structure the agreement so everyone makes money.
Edited to add:
Also, as the person running the company, you have a fiduciary responsibility to protect the interests of the shareholders.
In a small company, the early big investors are probably on the board of directors. Major decisions like CEO salary and whether to declare a dividend are typically a negotiation between the CEO and the board.
The CEO might argue that he needs more pay, but if the board votes to pay a dividend instead, the CEO is out of luck. Of course, the CEO could threaten to quit. Like I said, it’s a negotiation.
When you do declare a dividend, it’s a fixed amount per share. So the investor with 15% would get 50% more than the investor with 10%.
A lot of times, nothing. You need to be very careful being a minority investor in a small company. Read the shareholder agreement carefully. Small companies are very hard to valuate, and it’s hard or impossible to sell your shares.
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