[cjvillares]

I am shareholder of a company that will generat $450K /- in net earnings this year. The shareholders have decided to distribute $100K in dividends. We will not declare the rest because we are bringing a new investor in late 2011 or early 2011. We want to show financial strength for future investors and for expansion purposes. Is this the right thing to do?

[ArcSine]

It's possibly a good decision, but no definitive answer can be given without a consideration of all the underlying details.

Very generally, an earnings-retention decision should be based on a set of specific objectives. In broad-brush terms, those objectives are usually either...

1. To improve a debt/equity ratio that's perceived as too large or risky under current or anticipated conditions;
2. To provide capital for new assets.

The first item includes actions to bring your ratios into debt-covenant compliance. That latter category is itself a broad one that would include expansions, new capital additions, and acquisitions.

More specific to your post, note that many potential investors, in making a risk assessment of a potential investment, will focus more on earnings and cash flow, rather than the payout vs. retention rate thereof. Strong cash flow can shore up a weak balance sheet pretty quickly, whereas weak cash flow can deplete a strong balance sheet just as rapidly.

But still, your proposition might indeed be a good move in anticipation of taking on fresh equity investments. Just make sure that (a) in your forecasts you've taken into account the effect of the new investor's money coming in and landing on the balance sheet; and (b) if you're going to retain significant cash, you either expect to be able to earn an attractive return on it while it's locked up in the entity, or you need it to prop up your bal sheet ratios.

Unfortunately, though, can't give more concrete answers absent all the details. Best of luck with the business!