What you're asking is very complex and to me 2% to 4% seems like a terrible ROI. There is a lot of information that needs to be provided to determine how to structure the deal and if it's even a good deal. Are you getting equity (a part of the ownership of the company) for your investment? If yes, how much (%)? Is the company valuation realistic? Is the company established and having sales or is it just starting out?
Simple example: If you're investing 250k $ and the company has a realistic pre-money (before your money is invested in it) valuation of 1 Million $, you should be getting 25% in terms of equity. Of course things aren't that simple in reality but it's a good rule of thumb.
- If I was to go ahead, how should the business be structured?
This is hard to answer without more information. In general you should seek to have both equity and decision making power if you're investing into a business, if you want to be an equal partner you need both equal equity and power. Especially if it's in an early stage or if you're investing a significant amount of money. Which to me seems to be the case. How you'll specifically structure the business depends on the area in which the business operates in ex. software, manufacturing, sales, consulting etc.
- What are the steps I can take to protect my investment?
A lot of research and consulting into how these kinds of investments are usually done. You should obviously have a specific contract drafted by a lawyer as well which denotes the terms of investment.
- How should any potential net income be shared if the proposer does not invest a single penny?
Depends on what else is the proposer bringing to the table. Maybe other resources, machines for manufacturing, their network, blood sweat and tears, or whatever has a determinable value. Of course you need to figure out if what they're bringing to the table is of equal or more value to the money you're bringing in.
- What are the pitfalls of such an arrangement?
Also depends on the details. Some are:
-> Giving the partner all the decision making power, "Trust is a terrible criteria for investment"
-> There's always the risk of the company failing of course.
-> If you don't draft specific contracts on what you're getting for your investment chances are you'll be getting very little
I would suggest reading up/researching on investing into businesses (or start-ups), there are established procedures and contracts that are often used when investing.