OT: Advice on becoming Equity Partner

[mdMoose]

Was hoping anyone with experience would be willing to provide some insight or advice regarding buying equity into the company I work for. We do retirement consulting/tpa/record keeping.

Currently, there are 3 owners (each own a third and are good people) and I have been offered to become an owner. I do not have the cash needed to buy a significant stake in the company right away. My intention is to buy a smaller equity position right now and reduce my base salary by a certain amount in exchange for an additional 2% per year.

Profits are mostly stable (within 5% per year).

What multiple should I be looking to get on the sale price (I.e. what should my break-even point be) ?

Anything else I should be concerned about or need to think about?

 

[kupuna133]

Was hoping anyone with experience would be willing to provide some insight or advice regarding buying equity into the company I work for. We do retirement consulting/tpa/record keeping.

Currently, there are 3 owners (each own a third and are good people) and I have been offered to become an owner. I do not have the cash needed to buy a significant stake in the company right away. My intention is to buy a smaller equity position right now and reduce my base salary by a certain amount in exchange for an additional 2% per year.

Profits are mostly stable (within 5% per year).

What multiple should I be looking to get on the sale price (I.e. what should my break-even point be) ?

Anything else I should be concerned about or need to think about?

How much equity are they offering?
When was the last time the equity was valued?
Will they allow you to do proper valuation ie outside valuation?
Are you the sucession plan?

 

[Crazed_RU]

Are there strong growth prospects that your extra capital can help leverage ?

Illiquid, non-controlling equity positions aren't the greatest. If they want to run the company into the ground there's nothing you can do.

 

[kupuna133]

Are there strong growth prospects that your extra capital can help leverage ?

Illiquid, non-controlling equity positions aren't the greatest. If they want to run the company into the ground there's nothing you can do.

That is why I asked if he was the succession plan. Was offered equity in a business early in my career. Partners were getting lazy and the other employees they approached to assume partial ownership I did not want to partner with. I did not invest and decided to accept a position at another firm. Within a year the existing partners and the new partners made some bad decisions and needed to close up shop.

Sounds like you respect the ownership but make sure you like the colleagues who they may be offering the same opportunity.

 

[RUinBoston]

How much equity are they offering?
When was the last time the equity was valued?
Will they allow you to do proper valuation ie outside valuation?
Are you the sucession plan?

If this is an established company and the profits are stable, then you can do a valuation on a napkin. Sounds like from the OP the equity price is negotiable? Personally, if there is no real growth in profit, I would think, like, don't buy in at much more than 8 times earnings....which is sort of equivalent to buying a high risk bond with a 12.5% yield. If on the other hand the profits are growing each year by some steady rate, you'll have to factor that in and pay more.

 

[kupuna133]

If this is an established company and the profits are stable, then you can do a valuation on a napkin. Sounds like from the OP the equity price is negotiable? Personally, if there is no real growth in profit, I would think, like, don't buy in at much more than 8 times earnings....which is sort of equivalent to buying a high risk bond with a 12.5% yield. If on the other hand the profits are growing each year by some steady rate, you'll have to factor that in and pay more.

Agreed. But how many companies do you know that show the entire balance sheet to the employees? How much debt? Actual ownership structure? etc.... More to operating a small business than stable profits.

I know of many businesses that had stable profits and stable revenue streams that were mismanaged with leveraged loans and ridiculous family (no show job) contracts. That is why an extra set of eyes is always welcome.

 

[NickRU714]

I have to say it.
The irony of people talking about "valuations" is flabbergasting considering the conversations about Rutgers buying an equity stake in the Big Ten Network where there was no actual valuation done.
This is how an equity stake is done - valuation on the equity share being purchased and then payment (combination up front payment and reduced annual payments)towards that share.

Can't offer any specifics other than don't follow the BTN-Rutgers equity transaction template.

 

[Good-Knight]

Usually 7x net or 3x gross rev as a total value for a on-going concern. It's not out of line to ask for a certain % for free especially if you just did something great recently to justify the opportunity or age/ability/effort of the other partners puts them on the wain and you will be an increasingly important cog.

Even if you have no intention to do it, consider what it would take for you to build this business on your own and run it. Could you do it? Who really generates revenue?

If you become a partner, keep in mind that if you were not a partner, you would expect you salary to increase over time with bumps for increasing revenue. Your K1 distribution should be in addition to your W2. Are you inline with their general philosophy/formula for distribution?

This is a bit of a cash out for the partners. What's their motivation? Do they know something you don't? Are they just being fair? Is the business sellable...ever? Are the main assets of the company personal relationship? Law firms always over estimate their valuation.

 

[mdMoose]

Great replies and thank you all. I will try to answer some questions below:

I am a few years younger than the other 3 owners. The original owner retired 5 years ago and sold it to 3 of his employees (who have been with the company for 20+ years). I was brought in at that time with the intention that I would eventually be offered partnership assuming it was a good fit, so far so good.

They all work hard and are committed to growing the company.

I think the intention would be to make me an even partner over time. I doubt they want to give up 25% of the company just yet, and I can’t afford it anyway.

Small profit distributions are paid out monthly with a larger profit distribution disbursed at the end of the year (once the year-end financials are complete, and assuming there are profits left over to distribute). I would be paid a W2 for my base salary and a K1 for the profits.

I will be having a meeting this week to go through the company financials.

I am under the impression they bought in at 2.5 times annual profit and I expect to be offered more or less the same.

 

[Good-Knight]

2.5x is a 40% return. This is how people get rich. I don't like using home equity in most cases (and never have myself), but I think you'd want to borrow as much as you can at 8% to acquire as much as you can as fast as you can. I've never had a father-in-law with money, but if I did this is the kind of thing I call him about. This is the kind of deal offered to super star attorneys and hot shot brokers with their own book of business. Be careful, of course. You must be pretty smart to get to this spot. Don't stop thinking now. Try not to assert yourself as an equal partner. They will never see you as such. State your points but don't stick them in any of the other partners. Vet as deeply as you can. Small specialty businesses can be hard to fathom. If they stop the water delivery service and fresh flowers in the reception area, you'll know there's trouble.

 

[kupuna133]

2.5x is a 40% return. This is how people get rich. I don't like using home equity in most cases (and never have myself), but I think you'd want to borrow as much as you can at 8% to acquire as much as you can as fast as you can. I've never had a father-in-law with money, but if I did this is the kind of thing I call him about. This is the kind of deal offered to super star attorneys and hot shot brokers with their own book of business. Be careful, of course. You must be pretty smart to get to this spot. Don't stop thinking now. Try not to assert yourself as an equal partner. They will never see you as such. State your points but don't stick them in any of the other partners. Vet as deeply as you can. Small specialty businesses can be hard to fathom. If they stop the water delivery service and fresh flowers in the reception area, you'll know there's trouble.

Agree with this statement.

Vet as much as possible. Leverage expertise. And if you are comfortable with the above, take on as much equity as they are offering. This is an investment in all of your previous hard work and your future growth.

 

[Knight Shift]

2.5x is a 40% return. This is how people get rich. I don't like using home equity in most cases (and never have myself), but I think you'd want to borrow as much as you can at 8% to acquire as much as you can as fast as you can. I've never had a father-in-law with money, but if I did this is the kind of thing I call him about. This is the kind of deal offered to super star attorneys and hot shot brokers with their own book of business. Be careful, of course. You must be pretty smart to get to this spot. Don't stop thinking now. Try not to assert yourself as an equal partner. They will never see you as such. State your points but don't stick them in any of the other partners. Vet as deeply as you can. Small specialty businesses can be hard to fathom. If they stop the water delivery service and fresh flowers in the reception area, you'll know there's trouble.

Water delivery and fresh flowers in reception ? We never had any of those things. And we have never been in trouble. I know you were making an example, and just joking. We run lean and cheap, and it works for us. We never have clients visiting the office. We visit clients. Every $ saved on cheap frills is money in our pockets, and we like it that way. We actually don't have a buy in either. Maybe we are doing it wrong, but we keep things simple. No buy in, and no buy out on the way out.

 

[Bigs Hanter]

Great replies and thank you all. I will try to answer some questions below:

I am a few years younger than the other 3 owners. The original owner retired 5 years ago and sold it to 3 of his employees (who have been with the company for 20+ years). I was brought in at that time with the intention that I would eventually be offered partnership assuming it was a good fit, so far so good.

They all work hard and are committed to growing the company.

I think the intention would be to make me an even partner over time. I doubt they want to give up 25% of the company just yet, and I can’t afford it anyway.

Small profit distributions are paid out monthly with a larger profit distribution disbursed at the end of the year (once the year-end financials are complete, and assuming there are profits left over to distribute). I would be paid a W2 for my base salary and a K1 for the profits.

I will be having a meeting this week to go through the company financials.

I am under the impression they bought in at 2.5 times annual profit and I expect to be offered more or less the same.

Just want to point out that the IRS technically doesn't allow you to receive a W-2 and K-1 from the same company. If you are a partner, your wages should be reported on the K-1 as a Guaranteed Payment. This rule isn't always followed and not sure how strictly it's enforced.

 

[mdk01]

Just want to point out that the IRS technically doesn't allow you to receive a W-2 and K-1 from the same company. If you are a partner, your wages should be reported on the K-1 as a Guaranteed Payment. This rule isn't always followed and not sure how strictly it's enforced.

I believe you can if it's an S Corp. Partnership or LLC, no.

 

[RUBigFrank]

I worked in this industry at all levels. There has been much consolidation, and needed capital investments to meet regulatory requirements and disclosures.

It is hard to compete with the bigger players here-
is your client base desirable for other firms?
How is the staffing turnover/retention?

 

[rurahrah000]

2.5x is a 40% return. This is how people get rich. I don't like using home equity in most cases (and never have myself), but I think you'd want to borrow as much as you can at 8% to acquire as much as you can as fast as you can. I've never had a father-in-law with money, but if I did this is the kind of thing I call him about. This is the kind of deal offered to super star attorneys and hot shot brokers with their own book of business. Be careful, of course. You must be pretty smart to get to this spot. Don't stop thinking now. Try not to assert yourself as an equal partner. They will never see you as such. State your points but don't stick them in any of the other partners. Vet as deeply as you can. Small specialty businesses can be hard to fathom. If they stop the water delivery service and fresh flowers in the reception area, you'll know there's trouble.

Agree with the return on investment. That is a good deal.

I worked in this industry at all levels. There has been much consolidation, and needed capital investments to meet regulatory requirements and disclosures.

It is hard to compete with the bigger players here-
is your client base desirable for other firms?
How is the staffing turnover/retention?

Excellent questions. The retirement advisory business will eventually get taken over by AI.

 

[RUBigFrank]

The business here is record keeping and benefits from scale. Smaller players are squeezed or bought for their clients.