Experiences buying into a medium sized company? 13

[Nalzoe]

Hi All,

First time posting although I have been reading for a long time. I have read all the threads that I could find within this forum in regards to investing in, purchasing and selling shareholdings in engineering companies; many of those threads relate to small firms or sole practitioners however.

I currently work for a medium sized engineering firm with approximately 100 or so staff and have between 5 to 10 years engineering experience, most of which was obtained at this employer.

I have been invited to invest (buy shares) in the company and I am trying to weigh up the pros/cons; there are approximately 20 partners and my shareholding would be < 1% of the company. I would appreciate any and all advice, tips and other info that anyone is willing to contribute.

Thanks

 

[LittleInch]

Biggest issue I think is how shares are valued and sold. Without a liquid market with price determined by a stock exchange your shares are a gamble with no way to get the money back or cash in if you need to.

Also read the share and company info very closely. How does it treat people who leave? Are there different classes of shares? What is the difference between this classes?

For a company of this size the usual aim for the guys with the big shareholding will be to sell it (the company) at some point. That's probably the only time you could actually "make" money on the deal. How far is that away? Do you think the current valuation of the company by share price and number of shares is a realistic one?

Do they issue dividends? What's the past amounts per share?

Relatively recently I was offered much the same and basically took a chance. I got lucky and managed to get my money back as a "good leaver", i.e. they made me redundant, I didn't quit which was a 20% penalty on my "investment". Others after me I think basically lost the lot as the business gradually decreased in size and eventually basically folded.

SO decide if you can afford to loose the lot / not get access to it for years and make your decision accordingly.

For many partners it's not negotiable, to become a partner you need to put your money where your future income in and essentially buy yourself a job. Usually the investment is a fraction of their annual salary or profit share, so can afford it. YOU?

Whatever you do DON'T BORROW ANY MONEY to buy shares.

Remember - More details = better answers
Also: If you get a response it's polite to respond to it.

 

[MikeHalloran]

Once offered part of a company.
Trusted advisor, who actually has money, said don't buy less than 51 pct, or you own exactly nothing.



Mike Halloran
Corinth, NY, USA

 

[GregLocock]

Even with publicly traded shares that holds true to some extent. For instance, 'they' could decide to issue new shares at a discount. Even if these are pro rata, that means you have to put money in or get diluted.

Cheers

Greg Locock


New here? Try reading these, they might help FAQ731-376

http://eng-tips.com/market.cfm?

 

[EnergyProfessional]

typically you should get shares for free for years of service or so. like an ESOP. If you have to pay with cash, you may as well buy real shares from the stock exchange.

I assume those are not publicly traded shares. so if you need $, who do you sell them for? Who determines what one share is worth?

And if your employer goes bankrupt you lose your job and your savings at the same time.

 

[phamENG]

Nalzoe - that's probably about the smallest firm I'd consider buying shares in. At that level, the business is probably disbursed enough that the departure of any one person probably won't tank the business. That means it's developing into more of a company brand than a set of personal relationships. Everyone else has brought up some good points, though.

1) Liquidity is certainly a concern. Buying into a closed market as a (or perhaps THE) minority member puts you at a serious disadvantage for resale. Make sure you understand how your shares are and will be valued and how you can get out of ownership without losing everything.

2) ROI - how will you see a return? I are you simply buying with the hopes of selling it back when you retire in 40 years at a sufficiently appreciated price to make it worth it? If that's the case, it sounds more like a devious retention technique than a benefit. If you're going to get a share of the profits, what does that look like? How much would you have received over the past 10 years? What are the company's forecasts for the next year to five years? Five years may be pushing it depending on your market sector, but a company of that size should have a market outlook to predict revenue and profitability. How have those forecasts compared to actual outcomes in the past?

3) Is this a requirement to move up? If so, I'd start looking for another company to work for. That was one of the motivations for me leaving my last firm. The ownership offer was coming but it was often sold as "well the partners make this much, but when you consider the profit share it's THIS much." That was a red flag. It's important to understand the difference between wages and profit. They are NOT the same thing. Wages is what you earn for the work that you do. Profit is what you earn for the risk you take. It's a bit more clear cut for a merchant who has to buy the material to stock his shelf and needs a return on that up front investment to make it worthwhile. For an engineer - the risk is much less tangible until something goes wrong, but it's still there and if anything the consequences are worse. For more information on this line of thought, I recommend Adam Smith's "The Wealth of Nations" - Book 1 (skip the digression on silver - fascinating if you're interested in the historical aspects of a precious metal backed economy, but not too applicable for modern application). It's an old book, but the principles of economics haven't really changed much.

It could be a great opportunity for you, but it could also be a shackle around your ankle. It's likely to come with a non-compete clause, making it difficult to do much in your region if you decide you can't handle working for them. A big part of the value of a mid to senior level engineer is bringing new clients with them. If you have a non-compete, you can't really promise to do that unless you want to get sued. Go into it with your eyes wide open, and don't be afraid to review the inevitable paperwork with an attorney. This is NOT the same as buying stocks on the open market, so your approach should not be the same.

Good luck.

 

[Nalzoe]

Thanks all, some great discussion above and I will reply to everyone shortly.

 

[Nalzoe]

Thanks for all the comments LittleInch. I have replied to them the best I can, I apologise in advance if I am slightly vauge in a couple of the answers.

Biggest issue I think is how shares are valued and sold. Without a liquid market with price determined by a stock exchange your shares are a gamble with no way to get the money back or cash in if you need to.

The lack of liquidity is concerning for me also as there needs to be a lot of new partners to replace existing partners. The valuation is based on the profitability of the company at the time.

Also read the share and company info very closely. How does it treat people who leave? Are there different classes of shares? What is the difference between this classes?

One class of shares only and most partners who have left have done so on good terms.

For a company of this size the usual aim for the guys with the big shareholding will be to sell it (the company) at some point. That's probably the only time you could actually "make" money on the deal. How far is that away? Do you think the current valuation of the company by share price and number of shares is a realistic one?

That point in time is approaching and will be in the next 1 to 10 years realm.

The valuation is reasonable however I (and I suspect many other senior staff) could only afford to buy 1% or so at the moment or 2 to 3% ever eventually.

Do they issue dividends? What's the past amounts per share?

The dividends are poor and the recent historical dividend rate is less than 1% per share which is obviously less than the NYSE on average. Capital growth and increased company profitability and valuation is required to make a return; historically this (capital growth) has been better.

Relatively recently I was offered much the same and basically took a chance. I got lucky and managed to get my money back as a "good leaver", i.e. they made me redundant, I didn't quit which was a 20% penalty on my "investment". Others after me I think basically lost the lot as the business gradually decreased in size and eventually basically folded.

There is no penalty to resign (other than the time it takes to sell shares afterwards) and initially I was leaning down the 'take a chance' route also as it is a good company to work for however the more I have thought about it the more I am leaning away from taking a chance.

I am concerned for the potential for negative growth also for a few reasons specific to the company; the pandemic sweeping across America hasn't helped either.

For many partners it's not negotiable, to become a partner you need to put your money where your future income in and essentially buy yourself a job. Usually the investment is a fraction of their annual salary or profit share, so can afford it. YOU?

The investment required is not a fraction of annual salary; the starting investment/buy in exceeds my annual salary.

Gosh, typing all those answers out is making it sounds less and less of a good opportunity.

 

[Nalzoe]

Typically you should get shares for free for years of service or so. like an ESOP. If you have to pay with cash, you may as well buy real shares from the stock exchange.

No free shares or discount on the price; all have to be purchased and paid for. Is that not how most engineering firms that are not publicly listed corporations operate though?

I assume those are not publicly traded shares. so if you need $, who do you sell them for? Who determines what one share is worth?

The price is determined on a version of annual profitability and the market to sell back to would be other partners in the company or new partners invited to join the company.

And if your employer goes bankrupt you lose your job and your savings at the same time.

This is a concern I have also. It is unlikely although not impossible.

 

[Nalzoe]

2) ROI - how will you see a return? I are you simply buying with the hopes of selling it back when you retire in 40 years at a sufficiently appreciated price to make it worth it? If that's the case, it sounds more like a devious retention technique than a benefit. If you're going to get a share of the profits, what does that look like? How much would you have received over the past 10 years? What are the company's forecasts for the next year to five years? Five years may be pushing it depending on your market sector, but a company of that size should have a market outlook to predict revenue and profitability. How have those forecasts compared to actual outcomes in the past?

That would pretty much be it - invest now and with growth of the company see a return through an appreciated price. I was also concerned that this is about retention as it makes it very hard to then leave the company and seek employment elsewhere should I seek to do that down the track.

Historically performance has been very up and down and the 10 year return rate is not good.

Forecasts in the past have again been very hit and miss although there will likely be a period of growth in the next few years.

3) Is this a requirement to move up? If so, I'd start looking for another company to work for. That was one of the motivations for me leaving my last firm.

I don't think that it is necessarily a requirement to 'move up' and I also don't think I will be out of a job if I decline although no doubt it will hinder me somewhat.

For more information on this line of thought, I recommend Adam Smith's "The Wealth of Nations" - Book 1 (skip the digression on silver - fascinating if you're interested in the historical aspects of a precious metal backed economy, but not too applicable for modern application). It's an old book, but the principles of economics haven't really changed much.

Thanks, I will try to track it down.

It could be a great opportunity for you, but it could also be a shackle around your ankle. It's likely to come with a non-compete clause, making it difficult to do much in your region if you decide you can't handle working for them.

It does and the shackle is concerning. This is probably the aspect I am struggling with the most at the moment as while it has been a great company to work for historically there is no guarantee of that continuing.

 

[Craig_H]

The point already made by EnergyProfessional about diversifying your risk is important from an investment portfolio perspective. By purchasing shares in your employer, you are adding a double-whammy of idiosyncratic risk to your personal finances. Some types of risk pay a risk premium in terms of positive returns; to my knowledge, idiosyncratic risk does not. This means you are taking a risk without any mathematical benefit. If you were being partially compensated with shares in the company, your idiosyncratic risk would accumulate slowly and could be offset by additional investments specifically chosen to diversify your portfolio. It sounds like this buy-in would consume a significant amount of money, potentially taken from other types of long-term investments, which is kind of a worst-case scenario.

It's probably worthwhile to separate your decision making a bit. Get investment advice from a portfolio manager - someone with a fiduciary duty to give you sound advice. Get advice on the valuation and legalities around the share structure from someone who knows their way around those subjects. Stick to making good engineering judgements in your own work. That's generally my approach - I try not to dabble when it counts.

 

[LittleInch]

The investment required is not a fraction of annual salary; the starting investment/buy in exceeds my annual salary.

Oh man. You've either got more cash than you know what to do with or for me that's a huge risk of an illiquid asset.

I would pay off the mortgage first and buy a fast car.

I didn't get the bit about a lot of new partners to replace existing ones?

Does this mean there are a lot of current partners looking to sell up and hence need new blood?

Never lock up money if you really can't afford to get your hands on it, even at a discount, when you really need it. You just don't know when that will be.

Craig H's advice sounds good to me. A dispassionate view form someone taking your views as paramount will give you a good balance to understand the risks and benefits of this arrangement.

Remember - More details = better answers
Also: If you get a response it's polite to respond to it.

 

[phamENG]

Gosh, typing all those answers out is making it sounds less and less of a good opportunity.

Listen to that little voice in your head. By all means get a professional opinion from an investment manager - from the sound of it there are a lot of much better places to spread that money around to get a nice, diverse portfolio generating some nice returns.

 

[LittleInch]

Apart from my near miss I started with above, the only time it's made vague sense was a share option scheme from a large multi national where for two years you put in X and they matched X with shares. Because of tax rules you couldn't sell the extra shares before 2 years and a bit years had passed. But after Y3 you could "roll over" your shares to lock away for two more years and they basically gave you tax free shares for nothing.

If you needed to get your hands on the money you could always sell "your" shares anytime into the stock market, but might loose two years worth of extra shares. So basically unless the price went down 50% you were always on the up.

The other way is to get stock options where you get the right to bay at price X in 2+ years time, but don't have to spend anything then. Hopefully the price then is X+Y so you are up by Y. Then keep them or sell them it's up to you.

To be brutally honest, this just doesn't sound like a good plan to me unless you really think the company will be sold in a few years time at a significant premium of what it is valued at now. Big risk.

If there is no guaranteed buyback clause from the company itself - you are actually giving money to the company to increase its capital base if you're buying "new" shares - then you are at the mercy of someone else buying your shares as opposed to the company getting the money.

So the option for me is

Remember - More details = better answers
Also: If you get a response it's polite to respond to it.

 

[phamENG]

Well put, LittleInch.

The only way I'd go for this deal would be if there is a good record of performance resulting in an actual, liquid return of greater than 10% per year, and reasonable expectation of it continuing or increasing. You can reasonably make 7% - 10% long term on the open exchange, so given the elevated risk and the fact that you'd probably be pretty boxed in, I'd even push that up to 15 or 20% as my minimum to invest. Of course there's never a guarantee.

 

[EnergyProfessional]

phamENG: on the surface your advice sounds good, but: "Past performance is no guarantee of future results"

Unless you get it for (almost) free, I wouldn't buy such shares that are not publicly traded. If you need cash, who do you sell them to? Do you chase colleagues down the hallway till someone buys them? For regular stocks the market decides what they are worth (and that already is risky). But for such non-public companies there is no market. so they sell you $100 of shares, how do you know they are not worth $20 only?

I know (not well) some employee owned companies here. Gas station chains, groceries etc. The employees get stock over time with years of service or through some other earning scheme. they don't pay cash... if I have to buy with cash, i buy some index fonds.

 

[FACS]

There is a lot of good information in the replies here so I'm not going to repeat any of them.

My burning question is "Why are they needing to raise money?"

Do they offer this to other employees in the past, and can you talk to any of them about their decision to buy into the company?

What will happen if you do not invest? Will they see you as a flight risk? Someone that has no faith in the company? Not a team player?

Then again, I know a guy that took a chance in a coffee maker company, against all of the "Experts" advising against it; and is now a millionaire after selling the company.

 

[phamENG]

EP - good article. That's why I stated "and a reasonable expectation of it continuing or increasing." At the end of the day, these sorts of deals are essentially just the purchase of a job. It may be buying a job that you couldn't get without putting some cash down first, and it could be worth it in the long run, but it's still buying a job.

 

[glass99]

The usual gist is that if you buy into your firm's stock you get a dividend of approximately 20% of the value of the stock. It's quite a bit better than the stockmarket and way better than cash in a FDIC account.