The game trade is booming right now and it would seem wise to extend yourself in various ways to expand or grow. As I've mentioned before, the trade has reached levels of normal, as in what normal businesses would do. Usually the game trade is a backwater, where we rob Peter to pay Paul for todays invoices and nobody in their right mind would want to get involved.
The Income Problem
The average store, this mythical business, rakes in about $200,000 a year in gross sales. This varies dramatically, but work with me here. If you pay yourself a salary as manager, that means you personally earn that salary plus profit on that $200K. Lets call it a $30K salary, and $18K (9% net) in profit distributions. $48K a year is a respectable income in such a business, although it's still below the median household income of $54K. In many parts of the country (not mine), you would be king at $48K a year.
As you begin to dilute your equity with partners and investors, this just alright number begins to fall. What we usually see are equal partners. A 50% partner is dropping your income to $39K, assuming you keep your manager position. The difference between $48K a year and $39K a year might be the difference between making a comfortable living and scraping by. Often what I see are two people working the store, splitting that manager's salary or not taking a salary at all, both making $24K a year and both living in poverty. So my point is, there's not much money here for more than one person to make a living, so adding investors or partners, even with small stakes, is not a great long term solution.
Also consider tax deductions. A typical small business owner will have a variety of expenses that will reduce their taxable income. Cell phone, auto expenses, travel and entertainment. When you have investors, they want to see profit and don't want to see a reduction of taxable income. They want you to show them the money. This will have a significant impact on your personal income and it's one of the better reasons to avoid partners and investors.
We're working on a six figure expansion project at the moment. We funded this in various ways, one of which could have been a cash call, asking investors to pony up cash or erode their equity stake. I'm 75% owner and didn't have this cash, so instead I did what Kickstarter taught me to do, I begged for money.
Consider asking your friends, family, customers, anyone who will listen really, for a loan. Structure it with a promissory note with decent interest rates, amortization table, and penalties for late payments. Make it as above board as possible, in writing, witnessed, and signed in blood if you have to. If this makes you uncomfortable, congratulations on finding a new skill in need of development.
Our current lenders are on five year terms, with various interest rates based on what I offered them in return: security agreements, senior shares, games at cost, whatever it takes, but not an equity stake. In five years, they will go on their way, knowing they helped me out and made money doing it. I don't expect conversations on how I run my business, although I don't mind that so much. One of my investors is a long term customer. One is at the publisher level of the game trade and another is someone who reads my blog (hi!).
Loans are risky, since you're banking on your ability to generate income based on your new business or expansion and you don't know if you'll have the income to cover it. If you're loan agreement isn't posing significant risk to you, you didn't structure it properly. I found it safe to make sure my loan payments didn't exceed current profit levels. But if you're new? You're asking a lot from a personal lender and a bank won't help you without collateral (and not your store contents). It's only natural they want an equity stake with such a high risk loan.
If you're going to have investors, you need to decide on a legal structure for your business. A sole proprietorship is not going to cut it. You want an LLC or corporation. These structures not only dictate how equity is determined and profits are distributed but they protect investors from lawsuits, provided they're not working in the company. When a customer slips and falls and sues your company, a proper LLC or corporation protects your investors. Nobody should invest in a small business that doesn't offer this level of protection, and if you aren't sure the small business you've invested in has such a corporate structure, you should find out and insist they form one.
A typical Nolo Form Your Own Money Losing Corporation book is shockingly sparse when it comes to forming a corporation or LLC. It's just the bare bones legal requirements. I highly recommend creating a shareholder agreement with an attorney. Such an agreement handles the thorny issues that come up in the life of a corporation or LLC. How do I value my shares? What happens if an investor gets divorced or dies? How do we wind down a corporation in an equitable, moral and legal fashion? You want a lawyer to help you with this because a lot of these "how to" questions are governed by law. Often they're either legal requirements or best practices. It's also an excellent document to point to when trying to get a loan. Personal lenders want to know what happens in a worst case scenario. This document dictates that.
My Own Experience
I started an LLC twelve years ago with a friend who invested 25%. I used a Nolo book and it was a piece of cake. He needed cash to start his own business, so I divested him down to 10%, with lots of thorny discussions of what his shares were worth, because we had no such understanding in our LLC Agreement. I then added three more investors to cover his missing 15%, to bring up investor levels to 25% again. Then I saw California's LLC punitive taxes on gross sales and converted the business to a C corporation (difficult, with lots of thorny problems). Then because I prefer pass through taxation like with my LLC, I converted the C corporation to an S corporation (super easy). Only last year did I have an attorney help me draft a shareholder agreement on how the corporation operates, something I should have done on day one.
Got More Questions?
Ask them in the comments. This stuff all sounds very complicated, but it comes down to one shareholder meeting a year and following best practices.