Are you ready to take your hard-earned retirement money and spend it on your favorite bucket list? That sounds fantastic! However, you can do that and make some money on the side.
Most companies have founders and partners who actively participate in running the business. They work to raise capital and ensure the business’s success.
However, raising enough money can sometimes be challenging for startups. One option to get funding is to bring in a silent partner.
Silent partners are investors whose primary purpose is to provide funds for a company. If they have industry experience and knowledge, they may also guide the founders, but that is not a requirement. Many retirees become silent partners in industries they worked in before retirement. However, silent partners are not involved in the company’s actual running.
If you plan to invest in a company as a silent partner, you should know the roles you must play and your rights and liability. Startups and businesses looking to expand can significantly benefit from silent partner contributions. However, you should understand these partnerships’ complexities before committing to one.
What is a silent partner?
The role of a silent partner involves providing capital to a business in exchange for a share in the company’s profits. As the term suggests, a silent partner does not actively participate in the industry’s management and does not have the authority to make decisions on behalf of the company.
The main advantages of being a silent partner are two-fold. One is the opportunity to earn money from their investment without involvement in daily operations. The other is limiting your liability for the financial responsibilities of the business.
In a business partnership, the partners contribute different capital and assets. The partnership agreement lays out the amount of capital each partner contributed. Silent partners are investors who can review the company’s financial statements and have a say in decisions that impact the partnership’s nature or existence.
Most silent partners aim to gain an interest in a company’s profits to generate passive income. They are similar to venture capitalists, who typically invest in several companies. However, silent partners have a much less active role than venture capitalists in the companies they fund.
How Silent Partners Work
Silent partners are often involved with limited partnerships or limited liability companies (LLC) rather than general partnerships. State laws vary regarding silent partners, business relationships, and potential liability. However, silent partners typically receive protection from personal liability for business debts and financial obligations.
As with other agreements, a silent partnership generally requires a formal written contract that spells out the responsibilities of the general and silent partners. Per state regulations, the business must be registered as a general or limited liability partnership (LLP) before forming a silent partnership.
All parties will meet the business’s financial obligations, including general expenses or applicable taxes. The exception is when the partnership forms a part of an LLC.
As a silent partner, you can lose up to your investment amount and are liable for any part of the business’s creation you assumed. Entering into a silent partnership agreement with a company with much potential is an excellent way for retirees to grow their nest eggs. You can put your money to good use without exposing yourself to too much risk.
Silent partnerships often help new businesses form through capital infusion. That allows entrepreneurs to execute their plans for a company without having to find capital assistance from banks or multiple investors. Silent partnerships thus enable company owners to be independent in their business decisions. In contrast, silent partners can focus their efforts elsewhere.
Benefits of Being a Silent Partner
Silent partnerships often benefit all parties. The business owner receives the funds to start and maintain the company, and the silent partner gets equity. Other benefits of being a silent partner are detailed below.
Passive income
The most attractive thing about being a silent partner is receiving passive income. Passive income refers to financial benefits professionals earn from work they don’t have to do actively. Since silent partners focus on something other than a company’s daily operations, they earn income from the business’s success without contributing labor.
Easy investment
Another thing that makes silent partnerships an attractive investment option is that you can participate in a business even if you have no industry knowledge. For example, suppose you’ve always wanted to own a restaurant but know nothing about it. Signing on as a silent partner of people with expertise in the food service industry is the next best thing.
Though silent partners conduct research on their partner and the company before entering a partnership, these professionals can use skills in the company’s industry. That means silent partners can invest in companies that interest them or offer the most opportunity for passive income.
Limited responsibility
Once they enter the agreement, silent partners have little responsibility to the company besides their investment funds. Because of this, silent partnerships are an excellent option for retirees and those who do not have the time to enter full partnerships. Limited involvement in the business’s daily operations allows you to focus on other things.
Limited liability
Silent partners have limited accounting and legal responsibility. That means their liability only extends to the capital they invest in the company. They can lose all the money they put in, but not more than that.
Additionally, they can keep their partnerships private from the public and are free from legal penalties. Since most silent partners are not involved in the day-to-day management of the business, they are not held responsible for any wrongful actions of the company. That means their credit will not be affected if the company neglects its legal responsibilities.
Investing in startup companies as a silent partner is less risky because you are not personally responsible if the company doesn’t do well or the business owner decides to do something else.
Drawbacks
The drawback of being a silent partner is that you have no say over what happens. You can lose your investment because of bad business decisions. You can do nothing when potential disagreements or incompatibilities bring down the business. It can be incredibly frustrating when an otherwise sound investment goes down the drain because you have no control or influence over the people who run it.
Partnership Agreement
The partnership agreement identifies which parties are general partners and silent partners. It outlines the financial and operational functions the general partner will perform. It also details the financial obligations of the silent partner. Moreover, the agreement sets the earnings percentage for each partner based on profitability profits.
Capital infusion
Typically, a silent partner contributes a specific amount of money to a startup in exchange for an equity interest in assets or cash. The details of the capital contribution, including the date and description of the purpose, should be in the partnership agreement.
The contract should also detail any provisions requiring the silent and general partners to contribute more money. For example, you may commit to a partnership agreement requiring you to contribute additional funds to acquire assets or for R&D.
Profit and loss sharing
All partners, general and silent, have a share in business profits and losses. The contract must specify the silent partner’s profit share based on the initial investment. It may be a predetermined interest rate or a portion of the venture’s annual profits and losses.
Business management and operations
A silent partner invests in a company for equity and profit share. Unlike active partners, silent partners are not involved in operations, don’t make decisions, or manage the business.
However, you are not entirely “silent” when you become a silent partner. When setting it up, the partnership agreement should clearly define your rights regarding voting, accessing financial information, and consultation for critical decisions. That sets everyone’s expectations and establishes what will happen if issues arise.
Buyout and dissolution
Contracts should also include buyout terms for the ownership stake of a silent partner or otherwise dissolving the partnership. A buyout clause outlines the steps regarding the silent partner’s ownership interest should business circumstances change.
Anyone starting a business might welcome the capital a silent partner provides when getting their business off the ground. However, if the company succeeds, buying out the silent partner may become preferable rather than sharing profits long-term. Conversely, the silent partner may decide to dissolve the partnership when they believe the business is going nowhere and unlikely to profit.
The agreement should detail the circumstances that may permit a buyout. For example, consider what happens when a partnership dissolution occurs or an investor wants to sell their investment. The contract stipulates whether the silent partner can claim back their initial capital investment, whether they are entitled to interest, and whether another investor or general partner can buy out the shares.
Debt liability
In general, a silent partner is only responsible for debts equal to their initial investment. In a limited partnership agreement, they are not personally liable for any losses and debts incurred by the business.
However, suppose the silent partner starts participating in the day-to-day management and operations of the company as an employee. In that case, they may lose their protection from being held liable for the business’s debts. The Internal Revenue Service mandates that self-employed individuals, including business partners, must pay income and self-employment taxes.
Advisory capacity
Though most silent partners do not contribute to managing daily operations, some agreements specify when the business owner consults with the silent partner. Commonly, silent partners only act as advisors. Depending on your relationship with the founders and business owners, you may offer advice for any aspect of the business.
Business owners also contact silent partners about any significant management changes, as this would directly involve the silent partner. For example, say the business owner wants to transfer their shares to a third party. The silent partner’s approval would be needed before they can do that.
Taxation
Silent partners must report any profit or compensation resulting from their contract with a company as taxable income. That applies to retirees investing in US companies even if they are in tax-free retirement countries. While they’re responsible for personal income taxes, silent partners rarely involve themselves with the company’s taxes. Because silent partners have limited involvement with daily operations, they can’t claim the same number of tax deductions as company owners.
Silent Partners vs. Silent Investors
Most people use the terms “silent partners” and “silent investors” interchangeably. However, there are some differences. For example, a silent partner often owes part of the business. On the other hand, a silent investor puts in money but has no ownership rights in the business.
Silent investors are much more like angel investors than silent partners. Like an angel investor, a silent investor provides money to the business but doesn’t have a management role or take responsibility for the company’s debts. Silent partners are full business partners, even if they don’t have any role in running the company. Sometimes, a silent partner may be as responsible for company debts as regular partners.
Getting a Silent Partner
When someone launches a startup, family, and friends are typically the first to be asked for money. However, the financing you can get from your circle will likely be limited. You will need to find other funding sources, such as bank loans. Consider getting a silent partner if you do not get a loan but still need capital for your business.
A silent partner can help support your business endeavor but won’t interfere with how you run it. Silent partners can connect you with valuable resources such as vendors and contractors.
Suppose you want to work with a silent partner or investor. In that case, you should complete the following steps to develop a successful relationship:
- Set expectations: Discuss expectations from the alliance with your silent partner or investor to prevent misunderstandings and disagreements.
- Write a contract: The best way to set boundaries for a partnership is to formalize it with a legal contract. It ensures that all parties have legal remedies if the relationship goes south.
- Discuss risk: Starting a business is risky, so your partner should know it can fail. Ensure they understand they will only see an ROI if the company succeeds.
Becoming a Silent Partner
The flip side of the coin is becoming a silent partner. That involves entering into a limited partnership agreement with another person. The other person is the general partner, who will manage the business on a day-to-day basis. As the silent (limited) partner, your only role is to provide funding to the company.
When forming a limited partnership, it is essential to have a written agreement and ensure all partners agree to its terms. Additionally, you must formally register your limited partnership with the county clerk and Secretary of State where the business is located. It’s important to note that all partners, including silent partners, can be liable for the business’s debts unless you establish an LLP. With an LLP, only general partners are responsible for the business debts.
After completing your partnership registration, you should apply for an Employer Identification Number (EIN). This unique number is necessary for paying your business taxes. It can also facilitate opening a business bank account for your partnership.
Should you become a silent partner?
Going into business as a silent partner is an excellent way to earn money without too much effort. After contributing your funds or assets to a company, you can relax while someone else runs the show.
Active partners must often devote extensive time and energy to ensure the businesses take off. However, since silent partners have a different degree of responsibility or obligation, you have the luxury of time to focus on other projects and ventures.
That said, a silent partner role might not be suitable if you’d rather be more hands-on after investing your money in a business. Taking a back seat and letting someone else drive might be incompatible with your goals or temperament.
As with any investment, you’ll take on some risk as a silent partner. You get no guarantees that your funded business will succeed or that you’ll get your money back. If the company collapses, you could lose everything. Since you are not involved in running the business, you might not have the chance or right to keep a situation from going from bad to worse.
Silent but Deadly Serious Investment
Retirees and those looking to diversify their investment portfolios may consider becoming silent partners in a startup. That allows them to leverage their capital in a potentially profitable venture while enjoying the freedom to pursue other interests.
Suppose you’re considering hiring a silent partner or exploring becoming one in retirement. Before proceeding, it is best to understand what that entails fully.
Given the right partner and business, becoming a silent partner can successfully contribute to a company’s growth and success. With the proper due diligence and a clear understanding of the silent partnership agreement, retirees can find this to be a rewarding investment path that aligns with their goals for financial security and passive income generation.
Featured Image Credit: Photo by Marcus Aurelius; Pexels
