Reply
 
Thread Tools Display Modes
  #1  
Old 12-18-2016, 04:51 PM
kwc27 kwc27 is offline
Guest
 
Join Date: Aug 2001
Location: South Dakota
Posts: 129
Can someone explain a profits interest to me?

I started work at a brand new company. We are building a $100 million manufacturing facility and once it is done being built in two months, I will be an operator. I came for the money and benefits but they also offered a profits interest as part of their incentive package.

I am used to working for a cash bonus that is a certain percentage of my salary. I am under the impression that this profits interest is much better/more lucrative than a cash bonus. I've looked around online and cannot find any layman's terms examples of how it works.

I was issued 6000 shares of four different tiers, 1000 of each but 3000 of tier two for some reason.. Each tier has one million shares. The agreement states that I'm non-voting, subject to vesting. I understand what that means, and I'll copy and paste an excerpt of the agreement:

Tier I Units - In general, holders of Tier I Units, together, are entitled to a 15% profits interest in
the Company entitling the holder to participate in cash distributions that occur following a return
of capital to the investors plus a cumulative 10% annual rate of return (“Tier I Payout”).

Tier II Units - In general, holders of Tier II Units, together, are entitled to a 5% interest in the profits
of the Company distributed to investors after the investors have received a cash return equal to two
times (2.0x) their investment in the Company (“Tier II Payout”).

I apologize if this post is a disaster but can someone give me an example of how much money I could based on say $20 million in profits in a given year? Or something to that effect?

Thank you.
Advertisements  
  #2  
Old 12-18-2016, 05:38 PM
bob++ bob++ is offline
Guest
 
Join Date: Jan 2013
Location: Worcestershire UK
Posts: 5,388
I don't recognise the expression, but it looks like a bonus that tied to the profitability (or not) of the company. Maybe tied to the share price as that can be linked to profitability.

As an aside, linking bonuses to share price is risky. I had a friend who drove a truck for a major brewery in the UK. They had such a scheme and it worked well until someone made a takeover bid the sent the share price through the roof. Paying the agreed bonuses would have bankrupted them.

Last edited by bob++; 12-18-2016 at 05:38 PM.
  #3  
Old 12-18-2016, 05:50 PM
kunilou kunilou is offline
Charter Member
 
Join Date: Apr 1999
Posts: 22,010
It's confusing, but I think basically it breaks down this way.

No shareholder gets anything back until the original investors get their capital investment back. Tier II shareholders don't get anything until the original investors get twice their capital investment back.

So the shareholders take a back seat to the original investors.

Once the investors get double their money back Tier II stockholders start getting dividends, based on 5% of the company's profit. That is, take 5% of the total profit, and divide it among the one million shares.

Tier I stockholders only have to wait until the investors get 1X their money back, but they won't get a dividend until the company is earning a 10% return. Once that happens, though, they'll divide 15% of the profit among their one million shares.

Where it gets confusing is if the investors get their capital back, but the company isn't earning 10%, then Tier I shareholders DON'T get dividends. If the company is earning any profit at all, Tier II stockholders will start earning dividends (but based on a smaller share of the profits) but ONLY if the original investors have made back their money twice.

If the company starts making money bigly and pays back the investors quickly, then Tier I shares make more money. If the company doesn't make as much money, but devotes its profit to making sure the investors get paid back double their investment, then Tier II shares start getting dividends first.

The question is, what's the board of directors' plan for paying out the company's profits (once it starts making a profit)? Do they pay the investors a fixed rate of return stretched out over multiple years, or do they concentrate on paying the investors first? Until you know that, there's no way of knowing what "$20 million in profit" actually IS.

Last edited by kunilou; 12-18-2016 at 05:54 PM.
  #4  
Old 12-18-2016, 07:37 PM
kwc27 kwc27 is offline
Guest
 
Join Date: Aug 2001
Location: South Dakota
Posts: 129
Quote:
Originally Posted by kunilou View Post
It's confusing, but I think basically it breaks down this way.

No shareholder gets anything back until the original investors get their capital investment back. Tier II shareholders don't get anything until the original investors get twice their capital investment back.

So the shareholders take a back seat to the original investors.

Once the investors get double their money back Tier II stockholders start getting dividends, based on 5% of the company's profit. That is, take 5% of the total profit, and divide it among the one million shares.

Tier I stockholders only have to wait until the investors get 1X their money back, but they won't get a dividend until the company is earning a 10% return. Once that happens, though, they'll divide 15% of the profit among their one million shares.

Where it gets confusing is if the investors get their capital back, but the company isn't earning 10%, then Tier I shareholders DON'T get dividends. If the company is earning any profit at all, Tier II stockholders will start earning dividends (but based on a smaller share of the profits) but ONLY if the original investors have made back their money twice.

If the company starts making money bigly and pays back the investors quickly, then Tier I shares make more money. If the company doesn't make as much money, but devotes its profit to making sure the investors get paid back double their investment, then Tier II shares start getting dividends first.

The question is, what's the board of directors' plan for paying out the company's profits (once it starts making a profit)? Do they pay the investors a fixed rate of return stretched out over multiple years, or do they concentrate on paying the investors first? Until you know that, there's no way of knowing what "$20 million in profit" actually IS.
I understand it now. The description of tiers III and IV are the same as the first two only the stipulations are 7.5% after 3x and 7.5% after 4x, respectively.

Does it make sense that when the higher tiers start getting paid out, that the lower tiers are paid out as well, since those stipulations are also being met?

Thanks for your help. It sounds pretty lucrative.
  #5  
Old 12-18-2016, 10:02 PM
kunilou kunilou is offline
Charter Member
 
Join Date: Apr 1999
Posts: 22,010
Quote:
Originally Posted by kwc27 View Post
Does it make sense that when the higher tiers start getting paid out, that the lower tiers are paid out as well, since those stipulations are also being met?
But we don't know whether the stipulations are being met. What's the plan to pay back the investors? Are they being paid back from "profits" or are they being paid back from a pool of money that goes into accounting as an expense before profits? Are they being paid back on a fixed schedule that's built-in like a mortgage payment, or do they only get paid when there's money left over after all the other bills are paid. Remember, no Tier gets any money until the investors get paid in full, or 2X, 3X or 4X full AND the company is earning some level of profit.
  #6  
Old 12-19-2016, 05:27 AM
Isilder Isilder is offline
Guest
 
Join Date: Mar 2013
Posts: 4,194
Simplistically, a profits interest is a partnership interest or an LLC membership interest that gives
the holder the right to share in the profits of the business that arise after the holder acquires the
interest. The primary goal of issuing profits interests is typically to give recipients the ability to
participate in the growth of the partnership without incurring tax on the receipt of the interest, and to
enjoy at least some long-term capital gain treatment (instead of ordinary income treatment) on proceeds
they receive on a sale of the partnership or similar liquidity event.

See linerlaw.com ...

http://www.linerlaw.com/NewsMedia/.....nterests_1.pdf

Last edited by Isilder; 12-19-2016 at 05:28 AM.
Reply

Bookmarks

Thread Tools
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is Off
HTML code is Off

Forum Jump


All times are GMT -5. The time now is 08:13 AM.

Powered by vBulletin® Version 3.8.7
Copyright ©2000 - 2017, vBulletin Solutions, Inc.

Send questions for Cecil Adams to: cecil@chicagoreader.com

Send comments about this website to: webmaster@straightdope.com

Terms of Use / Privacy Policy

Advertise on the Straight Dope!
(Your direct line to thousands of the smartest, hippest people on the planet, plus a few total dipsticks.)

Publishers - interested in subscribing to the Straight Dope?
Write to: sdsubscriptions@chicagoreader.com.

Copyright © 2017 Sun-Times Media, LLC.

 
Copyright © 2017