We're Splitting Off! Advice on Negotiating Ownership 7

[Estimated Profit]

I am a 14 year PE in Power Systems for a major utility in the mid-west (shall not be named!). I manage a group of engineers and have very strong experience doing, training, and overseeing two major sectors in our industry. There is a need for engineering firms to take on the level work like I do. Ok, so here's the part I need help with:

My manager and leader for most all of my career is great at networking, leadership, building departments, and a strong engineering background. Also a PE. He and 2 other middle managers (also PE's) started looking into creating a business with the plans to split away from the major utility. They did. They have been setting up long term contracts and have been moonlighting to make some money on smaller contracts. They've even been paid upfront for some - probably $200k or more. The issue is that he has been putting the bug in my ear about coming over to help build the departments FOR those contacts and lead a sector. That would be for a salary and profit sharing of that sector. They haven't left their positions yet but it's all being done legally due to not competing or any conflicts of interest.

My hesitation is that, I believe my skills are critical for that business to take off. One of the sectors I believe to be the most lucrative would require me. They are all 33% owners. When I casually mentioned if I could invest and come a partner he said they weren't looking for investors but that I could bring him an idea and they'd consider. I don't want to be an employee of something that I want to build, and know I can. How do you negotiate something like this?

 

[Ron]

Tell them....confidently, that you can build the business but have no interest in building a business that doesn't benefit you except with a salary. You want a piece of the pie and are willing to take the risk with them.

 

[Estimated Profit]

Tell them....confidently, that you can build the business but have no interest in building a business that doesn't benefit you except with a salary. You want a piece of the pie and are willing to take the risk with them.

Those are definitely my thoughts. I just want to be prepared by fully knowing their side of things and what I might expect to hear. So far I don't feel like they have taken any risk since they still have full time jobs. They probably have no overhead expenses at this point. They have spent some money in lawyers to setup the LLC or LLP (not sure exactly) and make sure everything is kosher. They have been traveling a lot out of state to get contracts. They have been working lots of hours to perform some jobs. If they ask me to "buy in" what the heck would I be paying for unless they are going to cut me a check for the profits they already made? However, it seems like just asking for 25% with no buy in.... is quite the bold ask, no?

 

[LittleInch]

What the current key people have been doing by the sound of it is investing large amounts of time and probably some cash to get the enterprise set up, with, so far, not much to show for it. So what you would be doing is essentially part paying for that time in terms of wanting a part of the pie.

I don't think you're going to get 25%, but start at 15 is my best advice and see how much they want for it and how much you think it is "worth" at this stage.

So you're buying into a business with cash instead of time.

But Rons advice I think is quite right - If indeed you are seen as crucial to their plans and can come armed with cash, then if they feel the same way then then going to 30% or 27.5% and you getting the remainded isn't that big a deal. but 25% I thin is going to be too far unless yu can agree some sort of complicated long term increase in percent

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

 

[IRstuff]

Since you are coming in after the fact, they probably don't see you as being "qualified" to own an equal share of the business, so being a minority partner is probably as good as it's going to get, unless you can demonstrate a greater benefit than a minority share's worth.

Ultimately, dilution of ownership is kind of expected; when you look at publicly traded companies, the founders' shares all got diluted to some, or a large degree. I once was invited to join a startup, but did the math and realized that the founder didn't have much of a share to dilute, having already given up a huge portion to an "angel" investor. Two years later, those "angels" booted him out of his own company, with his house having been hocked to fund the original startup.

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[CWB1]

Starting an engineering firm isnt big on the scale of investments but isnt cheap either. Somebody has to pay for decent computers and software licenses in addition to insurance and other basic overhead before you get into the intangibles like creating company standards, process, and all the lil spreadsheet calculators you've relied on for years. It adds up to quite a lot and most startups' first few years are very lean, commonly losses which is another important consideration that comes with ownership - can you afford buy-in + supporting the business and yourself if necessary?

Before too much discussion on this, my first step would be to have your current legal dept issue a formal letter accepting the scope of your side-gig and granting ownership to you for any IP developed therein. Also obtain a copy of any post-employment legal terms, you may be surprised what they are. Ensure that your manager and others involved in the business are NOT involved in the process. As I remind junior engineers occasionally, do NOT assume you can get away with anything even if others do. I have seen quite a few careers ruined bc bright people did dumb things like competing against employers, using employer assets for side-businesses, assuming policy or non-competes wouldn't be prosecuted, or assuming the terms of their employment. CYA thoroughly and dont be surprised if you find your employer doesnt approve, mega-corps like to keep their options open and often consider related work as competitive even if they're not currently in a given niche.

Beyond that, partnership or employment - live life on your terms, not others'.

 

[BrianPetersen]

Beware the pitfalls of private ownership of a small company whose value is primarily based on the future value of cash flow brought in by whoever works there now, because whoever works there now might not tomorrow.

Exorbitant value to buy in. Worth next to nothing when it's time to get out.

I work in a company like this. I'm just an employee. I am fine with that. We are fine with being worth nothing and just operating to bring in cash. We have no debts other than whatever is in current company credit card accounts. We have no assets other than a few laptops and printers. Being just an employee will make things easier come retirement.

 

[LittleInch]

The main /only benefit of being one of the 4 would be in profit share brought in by others, not the "value" of the company in the long term. and at least some say in the long term vision of the company.

There are a number of threads here on the issue of what happens when a 2/3/4/ man owner wants to sell up and retire. Usual answer is don't do it or if you do recognise value for engineering companies is low.

As someone said on a different thread, what you're doing could be buying yourself a job. If that's what you do then fine, but don't borrow any money to do it.

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

 

[alchemon]

If they want you, make them come after you. If they want you badly, then a 25% pay raise and minority ownership is feasible. You shouldn't have to invest anything up front, but don't expect a huge amount of ownership. As an alternative, you could seek a higher bonus - which is basically the same thing as profit sharing at a consulting company.

Also as an FYI - $200k in the consulting world gets burned quickly. To support yourself and a CAD person, you'll need net revenues somewhere north of $400-500k/year depending on local labor rates.

 

[Guest090822]

It sounds like you have a great opportunity to start your own company and control the market in the area these guys are lacking in. You can bill them accordingly and eventually they will wish they brought you in at the start as a founding partner.

 

[Estimated Profit]

Thanks for all of the remarks. I have read over each one several times and have gained knowledge and perception with each reply.

To update: I talked with my boss about a month ago. He's a minority owner but has been my only contact throughout the discussions. I laid out all of the reasons I wanted a stake. I described that being an employee or contractor makes it about comparing my current salary to theirs...stability, benefits, etc. Being an owner with skin in the game makes me excited to bust my tail to grow a business. I said the last job I want is one where I am an owner and retire knowing I built something. As close as I am to him, I wouldn't want to face the decision of splitting off to do my own thing. I'd rather stick it out here and do that when I'm ready. He threw out a possibly 20% type of ownership and would discuss with the managing owner.

A few weeks go by and I ask. He said that the response was that they saw my employment more under the employee-profit-sharing model instead of ownership. I didn't say a whole lot at the time because we were discussing doing some side work for the business. Basically to help them with a contract they need me on. I told him that if I was to get paid, it would need to be as a contractor instead of employee for this work. I could have said I wont help with anything until we get an agreement, but at the same time, I feel like showing my value and helping the company gives me SOMETHING to say I've done...

I'm uncertain on where I should go from here. I could request a meeting with all 3 and pitch something. Something like 20% and they wouldn't have to take on the risk of a high salary and that it would increase their value despite percentage decreasing. There's also the thought that if they leave, I should be promoted - this is no guarantee with diversity goals but SHOULD happen in any reasonable world. I believe they are waiting for me to commit to being full-time BEFORE they leave... that I won't do. They'd have to leave first and show me they are a company worth working for as an employee. If they agree to ownership, then we can leave together.

 

[alchemon]

Right now, you need to be convincing them that they need YOU.

Once that is successful:

I'd ask for 10% higher pay than you were planning to, and 25% of the profit for the projects that you manage. This is kind of like "dating".

Don't sign a non-solicit or non-disclosure. Once they are ready to get married (give you full skin in the game), you'll have to, so be prepared.

 

[Estimated Profit]

That makes me think. If I get 25% of the profit from my projects, where does the other 75% go? I suppose to pay my salary and then pay the company\owners.

If I am an owner, all of my profit is being split out where I get my ownership-proportioned amount back. The benefit would come in when other owners are also bringing in. If they aren't earning then I'll wish I had a salary. At the same time, if they aren't earning than how are they going to pay my salary?

Side question what is the typical profit percentage of engineering contracts - I'm not talking EPC's but contracts that are ONLY for engineering work. I guess it's essentially ALL labor and engineering less some overhead (computers and software), right?

 

[alchemon]

25% of the profit - means you, everyone else, and overhead has already been paid. You get your salary plus 25% of the profit. The other owners get to split the rest of the 75% of the profit.

This is essentially what they are suggesting now sounds like.

No different than your current job, except that the profit goes to the share holders.

 

[phamENG]

So this may feel like semantics, and it is, but semantics are how we communicate so it's important.

An understanding of fundamental economics is imperative to somebody thinking about going into business. I recommend reading up on some Adam Smith - at least a summary of the component parts of price.

The money you receive for services is split into 3 categories - wages, which are what you and any other employees are paid for your time; rent, which is payment for the land/office/equipment you use; and profit, which is the money received in return for the risk incurred (this could be capital invested, liability exposure, etc.).

Don't conflate profit and revenue. Revenue is the money coming in, and goes toward paying overhead first (wages and rent) and profit last.

A lot of small business owners do this and they end up significantly undervaluing themselves. They think "oh wow, I'm making so much profit!" but they fail to realize that, if they paid themselves a living wage, they would be losing money.

 

[dik]

No partnership, then you can hire me as a consultant!

Rather than think climate change and the corona virus as science, think of it as the wrath of God. Feel any better?

-Dik

 

[TLHS]

25% of the profit on your own projects in a small company doesn't really sound particularly lucrative. Margin in consulting isn't great, and in a small company there won't be much other staff that you'll be taking a cut from. So you're basically just getting a couple percent bump in your rate. If you'll have 5 or 10 person teams, then maybe that's notable money. If it's you, a junior and a drafter and you're making 25% on an 8% margin...?

Depends on the margins, of course. You also have to be real clear on what counts as 'your' project. Like, if you end up being most useful for your technical contributions, and it makes sense to offload being the face on projects to someone else, what does that mean for your share? If you start the work on a project, and then offload it to bring in new work, do you keep a profit share in the first project?

 

[ldeem]

I have been self-employed over twenty years and have seen more than one person go off and be wildly successful as well as wildly fail.

Even if you became an equal partner that would be 4 total or 25% if its evenly split. That would mean all major decisions need a 3 person majority. That is tough, even 50/50 partnerships can have a hard time coming to consensus.

As for becoming an employee with profit sharing, that sounds like a big risk to go from an established steady job to a startup. You need a lot more $$'s than you earn now to make that a reasonable risk. Business is booming now but at some point things will slow down. If payroll gets tight they are probably not going to keep you on overhead.

You don't mention how old you are but I am guessing early 40's. That is a good age as you have many more years of work and if things go totally south you are young enough to find another full time job. Once you get in your 50's age discrimination is going to make finding a job more difficult. I don't speak from personal experience but what I have observed. Others can please weight in on this point.

Lastly, if you want to do this why not offer to be a business within a business. You set the department up, take on all the financial risk but pay the owners some percentage (like a royalty) to operate under their umbrella. Key point would be the client relationships, royalty would be a higher fee% for projects they bring to your group but lower and profit % for clients you develop. Some kind of system to recognize the importance of bringing in projects and developing client relationships. It should be reciprocal that you are similarly compensated when your clients send projects to the other departments.

 

[LittleInch]

This is all sounding like it is getting very complicated and just leaves the door open to unending arguments about what is overhead cost and what is profit.

Where I used to work in a largish consulting company, the gross margin they aimed for was about 35%. So 65% of the fee (LS or reimbursable) went to paying payroll costs (Wages, taxes, benefits) budgeted for the project. The rest got hit by overhead costs (buildings/power/ utilities/cost of bidding/cost of the non productive people, i.e. Mgt). What was left after paying taxes etc was anywhere from 5 to 8%.

So 25% of that doesn't amount to a whole heap.
And what happens if that project for whatever reason makes a loss?
How much of the overhead cost is the owners salaries?

But this sounds like it's coming down to a choice for the new people - if they want you to commit before they set up shop and split full time, then it's part ownership. Now maybe you could cut some sort of deal on an increasing share over time if you meet certain targets? Either turnover or profit.

If they don't they you become a contractor and essentially hedge your bets, but if work takes off that will leave you with a decision to make.

Anything that involves vague profit share without knowing the level of overhead costs or how they intend to work ( small salary large dividends? or the opposite) is a leap into the unknown.

Hmmm, Not easy.



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

 

[8thStreet]

You need to talk to all 3 partners at once and sell them on your service. It wont work with only going through your boss.