Looking for opinions on buying out my MEP company 16

[MemoryME]

Hello all,
I’ve been looking through a bunch of old threads and I’m very impressed with the quality of the responses here. I’ve been quite a lurker and am now ready to throw a question in. I appreciate any input.

I’m considering buying my current MEP consultant company. I’ve been out of undergraduate school for six years. California based school, family, work. Mechanical licensed PE. I’ve been in my current company for five years. Over the last three years the sole owner has been looking for me to buy him out when I’m ready. We had an evaluation done. Value came back at $1.1m including accounts receivable and accounts payable. Value was $700k for everything minus the accounts receivable and payable.

Owner and I have agreed upon a $500,000 price that I will pay off over ten years. I pay ~$50,000 per year and each year I get larger salary (up to $150,000 by year five). For the first five years I just the get profit I’m allocated (i.e. in year three I’m 30% owner and will have paid around $150,000, thereby getting 30% profit). At year five I receive total 100% ownership and pay the remaining $250,000 off over five years with minimal interest to the owner. Owner will NOT be taking account receivable with him when he leaves. Although we will likely negotiate making a draw form the company that leaves me enough to run it and give us both profit at 50% level.

I have a great relationship with most of our clients. I’m not at all concerned about losing work when the owner leaves. The owner will stay employed with us for the first five years and retire after five. At year three or four (still need to nail in) he might move down to four days a week, but will take a salary cut to do so.
Lets get to my questions:

1. I’m concerned ownership isn’t for me. I have a small but growing family and I worry about how much extra work I will have to do as owner vs right now as just a project manager. I love my kid and my wife and stress about being away from them more to do owner things besides just work things.
2. I worry about our staff. We have slowly deteriorating in quality staff. We are about 12 people. Electrical is run by a guy who will retire in the next few years. He is our only PE and I will have to find a replacement along with the owner to keep that side of business open. WE have no potential Electrical PE in line at the moment. M&P: our good folk have retired over the years and our current staff is lacking in motivation (near retirement) and skills (newly hired – but have potential). What keeps me up at night is people leaving the company and I’m left holding the bag. The hardest part about being an owner it seems (as I daily imagine what its like and try to get in my bosses head) is dealing with employees and helping them do work. A good chunk I wouldn’t hire myself. But most will be retiring in the next five or six years anyways.
3. I have an alternate opportunity right now that I could go work for my county. Unfortunately, I think I’ll like the work less than my current job. It’s more like a pure project manager and scope/estimator. I’ve loved my current job just because I manage work but also play a good role in staying in design and continuing to learn. I do have a call with the person who retired from that job this afternoon. I’m going to probe him many questions to ask about what his actual day to day is like. I’m attracted to county stability, no overtime, not having to manage a large staff, and getting paid well there (details at end of post).
4. Lastly, and some of the other threads I’ve read allude to this: I wonder I’m even making the right call entertaining buying a company. I could start my own after the owner retires, however I’m under a two year non-compete. The assets of the company are likely around $100,000 currently for physical things but by the time I’m a 50% owner I think that will be deteriorated and items will somewhat need replacing. Because out accounts receivable right now is ~$600,000 and that would NOT be transferred to the owner when he sells, It’s all a bit murky.
I don’t have many folk in my life who have been in a situation like this that I can hear opinions on. I do love my current company. The folks are nice enough, whilst not motivated. I am comfortable here. With the owner needing to leave I’m in a bit of identity crisis. I see myself potentially moving into his role (along with his guidance and help) but I can’t help feeling I might be stepping into something that either a bad bargain or something I just don’t think I’ll want to do in five -ten years. I also see myself working for my county and hating my job because It’s all desk work and kicking myself for not going out and missing the opportunity that was right in front of me.
Lastly, and please be gentile with this: I’m a rockstar at my work. I’m extremely self motivated, I work very hard, and have no doubt that If I wanted to run a company (in any way that comes about) I could likely do it. However, Money isn’t everything to me. My wife has full time work (Makes about $80,000 and will make around $110,000 in next decade with regular pay increases, very stable job). I feel I’ve passed the threshold to where my time is having a lot of value and an extra $40,000 per year, is that life changing or just situation changing?

County benefits are $~135k per year after a few years in, 15 days sick leave per year that becomes years of service, 5 weeks PTO after a few years, basic pension, 11 holidays per year.
If I work for the county and my wife work, we’ll be pulling in $200,000 per year in the next five years. Why work harder and more just to make more money?

Thank you, I’ll try and monitor the thread to help answer questions and provide updates, but during the work day can be a challenge.

 

[structSU10]

What is generally the yearly profit the company produces? When you discuss salary, you are saying 150k base paly plus the company profit for ownership percentage? That profit number should be significant. I would anticipate for a 12 man operation that yearly profits would be 600K-1M if you keep everyone busy, but maybe its quite a bit below that? If you lose a business segment that is not insignificant though.

So you would be purchasing 10% per year for 5 years then 50% in the final year all paid within the year of transfer? It could be done where you buy 100% of the company and pay it off over the same amount of time but that is a tougher pill for the seller to swallow as he has to pay tax on the purchase price which he won't see for a while. Have you had discussions with a CPA regarding all the tax implications of the ownership transfer and beyond?

For buyouts there is sometimes a holdback of some percentage of the value that is 'made up' at a later date to cover if not all of the billed money is received. It sounds like you are paying for the backlog of money so it may be something to consider.

 

[TheTick]

If you're asking us, you probably shouldn't do it. If you don't have anyone in your network whom you can trust more than a bunch of strangers on the internet, you're just not in a good place to buy a business.

 

[SWComposites]

Didn’t read in great detail, but it seems like a bad deal. But you should get advice from an accountant and lawyer. Do you have a detailed financial statement for the current company?

I don’t like that part where you are only a part owner until year 5. Seems like it could lead to all sorts of issues.

Can you get a loan separately and buy out the owner 100% now?

Work/life balance is important. Your kids will grow up fast, and you don’t get that time back. And you will need your spouse 110% on board with this.

 

[SWComposites]

Also, who did the “valuation” and what was it based on? What assumptions?

 

[phamENG]

The assets of the company are likely around $100,000 currently for physical things

Then I'd say that company is likely worth about $100,000 plus the value of the cash account + a steadily decreasing percentage of accounts receivable based on age based on risk of recovery. Good Will is not something you should pay a penny for. You're not buying out an existing company that will continue to work and operate as is...you're buying a job as the head hauncho. Not a great move. You should never buy a job. If there's $600k in receivables now and you'll get all of that, you probably have a decent deal.

Why work harder and more just to make more money?

Good question. The answer is never simple, and it's about finding the right balance. If I can make $600/day and see my kids for 1/3 of it, get weekends, and a few weeks of vacation, would it really be worth it to make $1M/day, not see my kids, miss them growing up, and only come back into their lives when they've moved out and gotten married? No, it wouldn't be. But somewhere in between there's probably a good balance of income vs. time to spend said income. If you're not passionate about it, though, don't do it. Running a small business can be grueling. A well run business doesn't have to be - if anything you should only see a shift in your responsibilities, not so much an increase in labor, because there should be people doing the jobs that so many small business leaders feel compelled to do themselves (at the expense of themselves and the business).

Another thing: make sure you don't conflate the profits with the salary. It doesn't sound like you are, but I always feel the need to say it in threads like this: the salary should be commensurate with your labor (valued based on knowledge, experience, and efficiency) and profit should be commensurate with your financial risk. If you're going to put $500,000 into this, you should be getting an annual return that is much higher than any other investment opportunities you may have for the same amount of money. Would you be getting $50,000/year from that in the stock market? Then your profits had better be much higher than that. You also have to consider liability exposure as a business owner and practicing PE (yes, corporate structures and other legal instruments help shield you, but they are not absolute guarantees...there's always some level of risk for which you should be compensated through profit).

If you go through with it, make sure you have an off ramp. You may take a small loss, but there should be a way for you to get out of the purchase if things go south without losing your shirt. What if the economy tanks completely, you can't find a replacement EE, and your revenues halve each year for the next three years? If there's no provision to revalue the company each year, you could be stuck paying BMW prices and take delivery of a used Geo Metro in a few years. The flip side of that is that the price could go up if the value of the company increases, unless you can get the seller to agree to a price ceiling that it won't go above.

 

[CWB1]

Agreed with above, you're valuing the company way too high. I'd be curious to know what the $100k in tangible assets entails and whether/not they're rapidly depreciating disposables like PCs and office furniture or something with real value.

Personally I'd highly recommend option C - relocating to "not California" for the same or better income, drastically cheaper cost of living, and overall better/healthier lifestyle.

 

[SWComposites]

I don't think non compete clauses are enforceable in CA. And once the owner retires, the non compete is probably no longer valid anyway.

 

[phamENG]

Attorney General Bonta Reminds Employers and Workers That Noncompete Agreements Are Not Enforceable Under California Law

 

[FSS]

That purchase price seems very steep. Hopefully he has shared all of the financials with you so that you know what kind of living he was making and how profitable the company really is. High valuations are great when you are selling to an outside party, but not so great (or even applicable) when someone is retiring along with an internal restructuring. Who is going to replace your high output? Or the owner's output? You need to be realistic on your revenue going forward.

On the plus side, this is an opportunity that not everyone comes upon. It can be way more satisfying (and lucrative if successful) to have your own company than to work for someone else or the government.

 

[MemoryME]

For general profit, it seems the business owner has only been recently comfortable taking about $30,000 per year since the company transitioned from C corp to S corp. The evaluation that was done showed the book profit as upwards $100k-$200k per year on good years, but not always that. It is about a 12 man operation.

I think its just the life stage i'm in I don't have peers buying companies, which is why I'm looking for more opinions on the internet. There are a few folks (older) who I have run this by, but wanted to open up the pool more to get more varied opinions. Its already been quite helpful, so thank you all.

I cannot convince the owner to let me have 100% ownership and then pay off over 10 years, that would be ideal right?

I honestly don't have my own accountant, but have lined up talking to a family accountant. That is forthcoming.

I personally don't want to go into debt to buy this company, because I feel risk adverse. And honestly as I type all this it really is starting to make me try hard to justify the purchase. It's like I want to defend the offer because to be considered seems like an honor, but I should only do it if it makes financial sense.

My spouse is on board with supporting me (whatever I think is best). However, if it were up to her she would rather no be placed in a risky situation. My wife is my other half, which is why I of course have some inner turmoil as well.

From various posters here, it does look like the profit to purchase ratio is much lower than it "should be." I've done my own private calculations comparing conservative estimates of the company profits plus my owner salary vs just doing the county job and throwing that all in a 401k and it comes up as a wash. There is tons of risk in the unknowns of the company and I really need to ask myself I think if I just want to be in this position. However, working for myself, and not answering to people to have a day off feels like a perk I shouldn't refuse.

The 100,000 in assets is EXACTLY depreciating PCS and work station/plotters, etc.

My biggest concern about the functionality of this change is that there needs to be a total restructure of personal in the company. We need to hire basically 50% new staff. I don't have anyone currently to replace my high output when I step in fully and the owner departs fully. Ideally I find that person or grow him/her over the next few years. Electrically is the same. We need to get a signing PE and then help that person get a competent staff.

 

[phamENG]

So is that $70k-170k per year delta in profits the result of reinvestment? If not, where did that money go? To constantly pull in 6 figure profits and only draw a couple tens of thousands each year without a multi-million dollar cash account or other investment assets owned by the company doesn't sound right.

Based on your last three paragraphs, it sounds like not doing it is the answer.

not answering to people to have a day off feels like a perk I shouldn't refuse.

This is (these are?) the biggest myth of entrepreneurship. Be your own boss! Do what you want when you want! That may work in some industries, but I've found it to not hold true for engineering consultants. Sure, if I'm caught up on my work I can take my kid to the park for a few hours. But my old job was no different - I had a decent boss who was flexible with time off. If somebody needed/wanted something and they had no outstanding responsibilities, they could go. If it was an emergency, they took care of you. But instead of exchanging one boss for none, I've exchanged him for 20. And they all want their tasks done now and don't want to hear about the other guy. This Christmas was the first time in three years I've taken a vacation where I was able to turn off my email and phone AND not work on any project related stuff (though I still put in a few hours wrapping up some financial matters for the year). So while I have more 'flexibility' after a fashion, I have far less 'freedom'. Again, this can be mitigated with a well run project and client management structure...but it sounds like what little of that you may have had is collapsing and will have to be rebuilt from nearly the ground up.

 

[MemoryME]

PhamENG, thank you so much for these thoughts. You're summing this up in a way I was not able to totally describe. You're completely right about exchanging one boss for 20.

I've asked my boss the direct question about the discrepancy between his draws and book profit. The recent change to an S-corp has made him not draw last year (first year being an S-corp) which is a year the company actually did not make any profit. Previous years must have been different though.

I'm now really looking forward to this call with the county tomorrow. I'm thinking they are going to push me over the edge to just let this opportunity base me by on my current company. I wish I had a better idea into EXACTLY how every dollar is being moved around, because that would be more helpful. however I also am making this decision based on work life balance. My wife has a solid stable job. I'm now leaning towards not jumping into the unknown even though I hate to call myself risk adverse.

Frankly my boss took two vacations last year, that were each a week long. I probably couldn't do too much more than than in his place unless I had a kickbutt team nailing Everything while I'm going. We don't currently have that team. That team would need to be created essentially from nothing.

Sorry for the rambling and am truly grateful for the thoughts.

 

[SWComposites]

MemoryME - why is the county job your only alternate option? have you considered starting your own company? have you looked into jobs at other consulting companies?

And what is your current owner's plan if you do not "buy" the current company? is he planning to just retire and shut down the company?

 

[phamENG]

No problem - I'm certainly not a certified expert, but I went through a similar process a few years ago. I was going to be brought into ownership (it's a partnership structure), but as I started looking around I realized that 1) I liked the ownership but I really didn't trust them with my family's well being and 2) the team had some stars but more dead weight than I wanted to keep...and a couple either had an ownership stake or were close enough to an owner that they would be off limits. So I left, and now I'm in a prolonged startup phase of my own company...deciding if I want to scale and take on more and bigger, or stay small and just seek a better balance.

Best of luck in whatever path you choose.

 

[MemoryME]

The County is not the only other job, but I am very attracted right now to the stability. My current salary is $100,000 and I think I could pretty easily jump and get $125,000 elsewhere. I don't really want to jump of course and I bet if I stayed as a non owner I could request up to $115,000-120 and possible get it. But I really won't know what my future hold to stay on at a company where the owner is leaving in a few years. I'd much rather jump ship in that case on my own terms and boost my salary that way.

I honestly don't have the drive to start my own company right now. Being the family man with a new kid, I don't really want that level off effort:finacial pay off. That's why the established buyout was so enticing. I could potentially jump to some other firm and eventually buy in there. But if I want to buy in and own, I'd hate to miss this current opportunity.

I asked the owner yesterday what his plan was if I turn him down. I suspect he will sell to outside or wind down. At that point I guess I could start something and pick up these clients somehow. Just a lot of What if's I think.

I'll be sure to follow up more tomorrow as my story expands. I've been considering this for the better part of a year and I'm at the cusp of making the call.

 

[CWB1]

I cannot convince the owner to let me have 100% ownership and then pay off over 10 years, that would be ideal right?

No, but purchase agreements wherein you gain 100% control now, payoff over X years, and gain ownership upon final payment are common.

Buying a small service business for its real estate or other significant, long-term tangible assets can be worthwhile. In this instance tho it sounds like you could pretty easily replicate your employer for less than you could buy it.

 

[MemoryME]

I should qualify a few points:
1. The owner is essentially giving me control from year one onwards. He and I are very much like minded. We rarely disagree when it comes to how things should be done. He is taking my input on who how we hire very seriously. If I’m saying I think we need to move away from x program to use Y program instead, I easily see it happening.

2. One of the main values my boss has continued to impress on me is that he will continue to train and help transition me to ownership. Of course I can go rouge and learn on my own and the hard way. He is providing a (albeit paid) pathway to move into that role.

3. We have a high accounts receivable now. I think before I was swayed by the idea that owner isn’t taking that with him in the sale. But if I am only getting the amount of profits that I currently own for the first five years, that large accounts receivable I guess won’t be coming to me in any major way. I might end up with 10 percent of it if it all came in next year and I was 10% owner If that makes sense.

4. Lastly, I’m wondering if I’m misunderstanding the valuation breakdown with how my boss colored the last year taking Minsk draws. The four year average SDE was $270,000. I believe that does include owner salary, which he currently pulls $150,000 per year. He’s told me in the ~20 years of running the company, he has only once taking a pay cut one year (2008). 2019 and 2017 seemed especially good on paper which helped to offset last years loss.

 

[phamENG]

offset last years loss

This is concerning to me. I'm not sure what the market was like in California last year, but it was hopping here on the East Coast. I was turning prospective clients away because we didn't have enough time to get it done. What realm of mechanical consulting are you in? Industrial process? Commercial building design? If you work in the non-residential construction world, pay close attention to upstream and downstream trends (architectural billings as reported by AIA and construction starts as reported by a number of industry reporting outfits). If you're already operating at a loss, you could be in trouble in the coming years. That sector is expected to shrink over the next two years, which would likely pinch you even more.

 

[MemoryME]

I completely agree pharm. It has been concerning. I think it’s more of an operations issue as you say. This last year we’ve basically been turning away clients as well to maintain our long standing clients just because of the pace of work.

This year would have been a great win for us, but we pretty much broke even with about $600k in receivables. I’m sure some of that is bad debt, and I really should have the owner open up the accounts receivable list so I can see the details.

And I’m sorry, I’ve haven’t yet figured out how to respond in quotes here like others, I’ll dig into it.