Offered 50% share in company. 27

[NorthCivil]

I work at a small specialty structural consulting firm. 2 owners, both early 60s. 3 employees. 2 smart young juniors, and myself, mid 30's. just been offered to take over from one of the owners who wants to retire.

We are in a HCOL area, in a niche business, right now the construction market is booming. Company is only 6 years old. for the past few years, books show annual profits of 700k before the bosses pay themselves. I'm being offered to buy the retiring partners half for 700k (initial offer).

My main concern is the nature of the existing partnership.

The partner looking to retire is the technical guru, day to day manager, who brings in all of our value clients and lucrative projects from his contacts and relationships.

The partner to remain owns a separate engineering company, much larger, that occupies all of his time. He is not technically skilled in our area of practice. He is not involved one bit in the operation of our business. Sometimes he will bring in work to our business - he will pitch combined engineering services to clients, in conjunction with his other business - but usually that work is not the kind of work that is good for our business. The two businesses operate at two different ends of the market.

That said, we do operate using the infrastructure of the larger company. Office, legal, admin, reception, IT, its all provided from the larger corp. Though it is tracked and we do pay for it - and not a discounted rate! quite expensive, actually. but taking care of those operational headaches though obviously has some value.

I do not know how this business partnership has propogated. it has become very one sided, in my opinion. I can visualize how it may have started as a partnership between the retiring partner who was a solo practitioner, and the remaining partner who already had a business - and then over time became lop-sided. The retiring partner is a very conflict averse guy, I'm imagining he just let things slide to where they are today. Prior to being offered shares and getting a peek at the books, I was under the impression the shareholding was an 80/20 deal or similar between the two partners.

I always visualized starting my own consulting company, with a partner of the same age, where we could together tough out the hardtimes and enjoy the victories. I am leery to get into a partnership where the other guy doesnt lift a finger. No load-sharing, so to speak. In my mind, I feel like the only way I could go forward would be if significant shares were stripped from the do-nothing partner. But I dont imagine such a conversation will go over well with dr do-little.

Am i passing up a good opportunity? any thoughts?

One additional fact: Maybe its just me being cocky, but i cannot see a reasonable alternative succession plan for this business, that could be carried out in the next few years, outside of locking me in. Specialists in our field are very few and far in between. The two juniors, though very bright, are just too young, inexperienced, and not licensed.

 

[azcats]

I'm leery of investing that much in a company where half would be owned by a non-contributing partner. Cutting him that check every year would sow massive discontent with me.

And why would the other guy ever retire or sell?

I'd probably need a succession plan that includes total ownership over some timeframe.

Does do nothing realize the company is not worth much without someone there running it?

 

[Retrograde]

Can you possibly come to some arrangement where you take on the "technical guru, day to day manager" role and the retiring partner stays around for a couple of more years (maybe part-time) until you are able to bring in clients. If you do not think you can eventually be that guy bringing in the business then the firm will not be viable long-term.

As for the other partner, maybe you can come to an agreement where you pay him down to 25% ownership over time (or whatever value you think reflects his contribution).

If the firm is making $700k profit/year then $700k for a 50% share is a good deal provided the business is viable long-term.

 

[NorthCivil]

Relevant info:

I am already involved on the business side, pricing jobs, renegotiating contracts, managing key relationships.
I do have relationships around town, though of course not as extensive as my boss who's been in town for the last 40 years.
I am mentoring the young staff.
I've been here a few years and am already technical guru-ish. Of course not 40 years experience level, but enough to run the outfit. The retiring engineer has expressed a desire to be involved a few hours a week for the interesting bits, helping with the tricky stuff.

The young staff might not be as keen to work under me as the very experienced boss though, and might be a flight risk. Im also worried about the future of the construction market. we've been in a boom for a long time. 2008 was quite a surprise to most people when it hit, those were difficult times. I dont want to be carrying a massive loan when the next slowdown hits.

 

[dik]

You may want to talk to the retiring owner and explain that you would like to pick up his share of the company, but would like him to defer his retirement for a year or so to act as a mentor and for him to introduce you to his list of clients.

Dik

 

[msquared48]

Of what value is the other "partner" to the company? Just an investor?

You need to go for 51% - you need control - otherwise run.

Mike McCann, PE, SE (WA, HI)

 

[Lomarandil]

So many small engineering companies only real 'book value' is tied up in those client relationships. (Plus a few computer towers and software licenses). It varies a little by industry, but once that key player is gone, so is the business.

Would the retiring owner accept a "X% of profits for X years" deal (or at least in part)? That way he's invested in your continued success (and can work as much or as little as he wants to aid that), you can bring his potential compensation up to match expectations (after all, this is his 'baby' -- he'll see it as more valuable than any objective bystander), without exposing yourself as significantly to the risk of clients all leaving enmasse. If he takes it in full, you don't even need to finance.

Agreed that I would want to have additional influence on the management than 50-50% to buy in -- either on paper or relationally, paper of course is better.

Agreed that relational and organizational issues aside, $700k for 50% equity in a $700k/yr business is better than average.






----
just call me Lo.

 

[Agent666]

As a comparison point, the people who I used to work for did a valuation and came up with $6M NZD (40ish employees) for the entire business, seemed total overblown estimate given most of the value to me is in the employees and forward workload. Anyway they were facing similar situation of 1 of 2 founding directors retiring and zero succession planning. The one going to be left was fairly lacking in running the business side of things (not that the other guy was that great either), and fairly average technically.

They preceded to offer 2.5% for $200k NZD to a number of select employees, with zero management say. Profit sharing might have paid you back 30k a year as I understand it. So quite a few years to even recoup the initial investment and putting up with an almost farsicle management style for that long meant only 1 rather nieve person took it up, most just laughed at the cost as a bit of a joke and politely passed.

I was never offered it as I had one foot out the door at the time.

Given your potential payback period on the initial investment of 2 years it seems very attractive provided that is profit in addition to any salary you'll be taking out. Though I definitely feel if you don't see it working with the non existent partner then think very hard about it. It does lock you in for years potentially, so if it were me I'd be asking if you see yourself doing the same stuff in 5-10-15 years and still not want a change.

If you have to come up with the 700k up front then you've got to consider how you are going to do that if you don't have the money burning a hole in your pocket already. Cost of finance, etc.

You can always start your own thing in the same field instead if working with this person was a problem.

I really hate making people lots of money who I don't respect, it just doesn't sit right with me.
I had a funny feeling you were in NZ as well (maybe used to be?).

 

[rowingengineer]

I would want the partner whom is moving on to stick around for at least 3 years and have a pick up system to buy shares. buy 15 percent first year, and some more each year until you have 51 percent. I would also want to know bosses pay, I would expect 150 - 200 a year each so profit is 300-400 per year?? So 150-200 payback on a 700 loan per year, plus interest 7? 8? commerical rates, 7 year term on loan? Looks like it just works?

http://www.nceng.com.au/

"Programming today is a race between software engineers striving to build bigger and better idiot-proof programs, and the Universe trying to produce bigger and better idiots. So far, the Universe is winning."

 

[phamENG]

"700k a year before the bosses pay themselves." When you say pay themselves, do you mean salary or share of profits? It's an important distinction I've noticed most engineers miss. Wages are what you get paid for your time and effort. Profits are what your money makes (usually based at least in part on the exposure to risk of loss of the capital investment, though there are lots of factors).

If the 700k is net profit, all wages and overhead expenses paid to everyone (partners included), then that does sound like a pretty good deal. Even so, I don't think I'd want to just pay it over as a lump sum from a loan. As others have suggested, tie it to ongoing profits. My old firm recently went through a transition, and that's what they did. Founder received a check each year for the shares he still held, and that amount was deducted from his equity holding and split between the new partners. Each year his check got a little smaller until the transfer was complete. The new owners didn't need to encumber themselves with debt, and the founder was still committed to their ongoing success.

It went south, though. The founder wrote himself a sweetheart deal (whether or not he deserved it is a matter for debate, of course), and he had the leverage to enforce it - for a while. The new partners worked hard to reduce that leverage, and once they had they called him back to the table to renegotiate. He balked, and started competing with them. He's still more interested in retirement, so he's not going to break their bank, but he is competing against them. I'm not privy to the particulars, but it's fair to assume he's under a non-compete. Unfortunately, enforcing those costs money.

 

[ldeem]

I am a solo operator but around 10 years ago I spent a lot of time looking at buying a firm to expand my operations. I never found a business to buy that made financial sense but here is how I valued the firms I looked at.

1. Get as many years possible of financial reports, minimum of 5 years. Make your own P&L and add back in any unusual owner benefits. Often times the owner may be taking an unusually large car allowance or some other financial maneuver that would not be typical of an employee.

2. Figure out the cost to hire a person to run the business (salary, benefits, expenses, etc.) and subtract that out of what you have from item 1. What you have left is the return on your investment. I know you will be doing this work but you don't want to buy a job.

3. Take the annual return and make an assessment of how likely it is to continue. Consulting firms are typically high fixed costs with owner relationships bringing in a lot of the business. Since you are already in the business you will have to be the judge of how many clients may go somewhere else when the owner retires.

4. Take whatever annual profit you end up with and divided it by what is a reasonable rate of return for your investment (perpetuity equation). Keep in mind the risks are much higher in buying a small consulting firm then investing in the stock market. I typically used 20 to 25% - this will give you some idea of a fair price.

I only looked at one business where I was buying into a partnership. The remaining partner and I meet several times to develop a repour and discuss our ideas on how the business should run. In the end I laid out a frank plan of my ideas and my expectations for him and that was not in alignment with what he wanted so we parted ways. I would suggest you do the same but it may be more difficult since the remaining partner is still your boss and if the buy out doesn't go forward you still have to come to work.

Final thought - if you go out on your own $700,000 would cover a lot of operating losses while you built up the business.

 

[JLNJ]

As said by Ideen, consulting firms come with a lot of risk, especially small ones. $700,000 seems like a lot but your line of “before the bosses pay themselves” is worrisome. In a firm of very few people, the profits ought to look good before 1/2 the staff is paid.

Don’t let the flattery of being “allowed” to buy in cloud your vision. This is an uncertain, illiquid investment, one in which you need to carry the dead weight of the other partner. If you don’t have a controlling interest, how do disputes get resolved?

 

[glass99]

The price earnings ratio for engineering firms in a private transaction is usually around 5. You would be getting $350k but you have to manage the business which is like a salary of $150-180k, so you are converging on a P/E of 5, so its fair from that POV.

P/E of 5 is like getting 20% interest which is very good, though you are left with an illiquid asset when you want to exit.

Probably the biggest question though is whether you can do your old boss's job. Relationships don't just magically transfer bc you don't have the same history etc.

 

[KootK]

I did almost exactly what you're contemplating doing. It worked out badly for me and did so in exactly the way that my financial advisers said that it would. My brother is a business guy and I'm close with a high powered recruiting executive who knows a great deal about merging and acquisition in the space that is small to medium sized consulting firms. Here are some of the distressing things that they told me to watch our for that did, in fact, come to pass.

1) Properly evaluating the worth of a business that is mostly just the reputation of a few key people is so difficult that the exercise is almost meaningless. Buyers and sellers pretty much never agree on something equitable to both parties.

2) Retiring partners that promise continuing involvement as a deal sweetener rarely live up to that part of the bargain in manner that the purchaser deems acceptable.

3) If you have the contacts and skill to run that tiny firm successfully, then you all ready have all of the tools that you need to step out and do that yourself without incurring the big debt load. As such, there's little point in taking on the big debt load. A firm as small as the one you're working at probably doesn't have any infrastructure that you couldn't replace for yourself in short order.

4) When my former accountant brother looked at the business model and financial statements, he said something to the tune of "I'm confused as I don't actually consider this to be a genuine investment. In my world, an investment is something that is largely passive wherein I could do nothing at all and still earn a return. What you're contemplating doesn't have any legs unless your working your ass off to make it happen. Therefore, you're not buying an investment, you're buy a job. A decent job, to be sure, but still just a job. That's weird since most people don't have to buy their jobs".

So I'm skeptical on this. And that doesn't even get into the issues related to the odd partnership arrangement. I agree with your concerns on that front.

The only thing that saved my butt was that I wrote the contract such that my buy-in occurred gradually and, at the two year mark, I had the option to sell all of my shares back and walk away if I wished. And that's what I did. If I'd not done that, I'd be in pretty rough financial shape right now.

 

[KootK]

You might consider moving this to the Business Practices and Issues forum. I, too, often want to talk business with only structural engineers. That said, what you're looking at is pretty generic in the engineering world and you'll likely get a lot more people commenting over there with direct experience in this kind of thing.

 

[bones206]

So many small engineering companies only real 'book value' is tied up in those client relationships. (Plus a few computer towers and software licenses). It varies a little by industry, but once that key player is gone, so is the business.

If you have the contacts and skill to run that tiny firm successfully, then you all ready have all of the tools that you need to step out and do that yourself without incurring the big debt load. As such, there's little point in taking on the big debt load. A firm as small as the one you're working at probably doesn't have any infrastructure that you couldn't replace for yourself in short order.

Combining the two thoughts above, which I agree with, it would make more sense to me to start your own firm. None of the retiring engineer's clients are going to mistake you for him. They all know he's gone and you are now running the show. So the name of the company is really not worth that much in the end. In fact, I think his clients would respect you more if your broke off and started your own fresh thing rather than riding his coattails, so to speak. If it was a bigger firm and the brand had intrinsic value beyond just the client relationships, that might be a different story.

The benefits of ditching the other partner and not incurring debt seem like a win-win. You could try to recruit another partner to start the new firm with and share some of the financial risk. Maybe incentivize the junior engineers to buy-in and stick around by offering future stakes in the company as they progress through their career development and reach certain milestones.

 

[Compositepro]

Do not partner with anyone you do not completely trust and like. Contracts are only useful if you have lots of cash for lawyers to enforce them, and your opponent has little cash. If your opponent has cash, the the lawyers will end up with your cash and his.

It does not sound like a great investment. The only way it might work is if the retiring partner provides at least 90% financing to you in buying the company. He also must stay involved in at least an unpaid advisory and marketing capacity for a few years. he is working to maintain the value of what he sold to you so that he can get back the loan to you (which, would be no cash out of his pocket anyway). But then you still have the other partner, who seems to be more liability than asset. He certainly is not worth 50%. What will happen when he wants out or retires?

In negotiation keep in mind their perspective. What are their alternatives? Who else would have any interest in buying the firm? If they cannot sell out, the value of the business is zero. It will close.







/

 

[WARose]

One small piece of advise: whatever buyout money goes to anyone leaving......make sure it comes out of the company's earned profits of future business. (And be sure all that is in writing.) Be daggone sure NONE of it is expected to come out of your salary or personal finances.

I say this because I've seen this scam a few times: you agree to a buyout and the business leaves with the retiring partner.....and then you are on the hook (personally) for X amount of dollars. Be sure that doesn't happen.

Whomever you are working with probably doesn't have that intent.....but verbal assurances mean nothing legally.

 

[youngblood30]

Go off on your own....I did it and although it was a scary leap of faith it was the best decision I made. I am around your age and the only thing I miss is having older more experienced engineers to talk shop with. There is plenty of work out there now and I know this will change but I would rather build something of my own on my terms so I have more control and be liquid when work slows....

 

[NorthCivil]

Interesting to read all of the input, and I think in the end this is why a small business is so difficult to put a price on.

My gut is leaning the way of bones206, Koot, JLNJ, azcats. The numbers stack well and I think there is even room to negotiate the price down a ways. I believe the business has inertia. but the situation and intangibles don't sit will with me.

The only value in this business is that it gives a running start to what I plan to do anyway. In return, I have to carry a dead weight partner. From a pure numbers perspective, the running start might work out better in the long run. From an intangibles perspective, I would love to risk it all building a business from scratch (do it my way), and I would absolutely hate to sit at a directors meeting in a years time and cut the other partner a fat check for doing sweet F all.

Thanks to the mods, if this needs to move to business section, excuse me for this one.

Thanks to all respondents for your input and time. Appreciate this forum & all the people here, its one of my most trusted resources. Will update you all as discussions unfold over the next little bit.