Contractual arrangements for hiring at principal level
Contractual arrangements for hiring at principal level
(OP)
Our hydrologic engineering consulting firm has been in business for 12 years, with two principals and (currently) four staff-level and project-level scientists & engineers. We are beginning conversations with a principal-level engineer at another firm, and he may join our firm if we all "click". I realize we'll need to offer him a stake in the company. At the same time, we do not want to give away the value of a company that we worked 12 years to build. What are some typical ways of structuring a contract at the principal level?
Incidently, the engineering firm I worked for previously eventually made me a "principal", and all that meant was a raise and new business cards -- no ownership. I'd appreciate any thoughts, links, references.
Incidently, the engineering firm I worked for previously eventually made me a "principal", and all that meant was a raise and new business cards -- no ownership. I'd appreciate any thoughts, links, references.





RE: Contractual arrangements for hiring at principal level
RE: Contractual arrangements for hiring at principal level
It is better to give him the opportunity for ownership than to hand over a piece of the pie without any commitment on his part.
RE: Contractual arrangements for hiring at principal level
RE: Contractual arrangements for hiring at principal level
It is hard to determine if someone would "click" with your company, and even harder to determine if someone is worth the value. A grace period, or trying out period allows both sides to determine the fit, and should either want to back out, the provisions in the contract would provide for that.
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RE: Contractual arrangements for hiring at principal level
I learned that first we need to have a valuation for our company, which could be performed by an "expensive" expert business consulting firm. The valuation process can be fairly complex because is based on projected revenues and profitability, but also a thorough market analysis of similar firms that were recently sold, business development marketing backlog, and other "intangibles" such as name recognition, and corporate culture.
A simple rule of thumb is to multiply our latest annual net income off our P&L statement by 3 to 5.
The next step after the valuation (i.e., knowing what my company is worth), is to develop the plan/contract for a time-structured buy-in with a cap on ownership. I welcome any advice about that.
I realize these are attorney/accountant type of questions. However, our firm is fairly small with annual gross revenues around $600K. I don't want to hire an attorney yet, since we're still only getting to know our potenital new principal. Besides, I'm less interested in what an attorney would say than what a principal engineer would want. Have any of you particpated in a structured buy-in? What worked? What didn't work?
The trial period is excellent advice. Thank you.
RE: Contractual arrangements for hiring at principal level
Any company is only worth what someone is willing to pay for it (that's pretty obvious)...however, few companies are actually on the market when they are "valued".....so valuations are somewhat "pie in the sky".
Good luck...I've been through it an it isn't fun!
RE: Contractual arrangements for hiring at principal level
An elementary question: How does this actually work? Is the individual literally paying money out of pocket to gain an ownership stake in the company?
RE: Contractual arrangements for hiring at principal level
There are many ways to do it...just be sure it is equitable and repeatable for the future.
RE: Contractual arrangements for hiring at principal level
You probably ought to start off with a business valuation. It's a service that many business accountants and CPA's offer. As I recall, the valuation for a consulting firm is generally based on earnings times a multiplier, and not on fixed assets. The earnings is generally based on 'earnings before interest and taxes (EBIT)'. The multiplier in my case when I was bought out was about 3.
If you are a sub-chapter S corp, then you have stock. You simply divide the valuation by the number of shares and 'sell' shares to an incoming principal by any number of methods as Ron has suggested.
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RE: Contractual arrangements for hiring at principal level
ANY FOOL CAN DESIGN A STRUCTURE. IT TAKES AN ENGINEER TO DESIGN A CONNECTION."
RE: Contractual arrangements for hiring at principal level
Based on this scenario, it sounds to me like it would be a while before one would reap any financial benefits of ownership.
RE: Contractual arrangements for hiring at principal level
Yes, abusement park, it will take a while for a new principal to reap the benefits of ownership. Just as it took me 12 years to build the company to its present value (incl. cash on hand, accounts receivable, goodwill, and backlog of work). The first year I started the firm, my income dropped to 42% of what I'd earned the previous year as a principal level engineer (without ownership) in a similar small consulting firm.
I appreciate all of the advice everyone has provided. Excellent ideas! Thank you!
BTW, another former colleague suggested a phantom stock option for a potential key hire. The phantom stock is a much simpler way to share in the profitability of the company. It's basically bonus plan without the formality of the stock options, but grants the key hire a stake in the appreciation of the company. Check out the link, which gives a more detailed description of phantom stock http://www.nceo.org/main/article.php/id/43/
A lot to think about....
RE: Contractual arrangements for hiring at principal level
Right, but that's why you and your partner are still going to retain the lion's share of the ownership.
I'm realize I am not looking at the whole picture here, but I assume the reason you want to make this guy a principal is because you anticipate he will add at least some significant value to your firm through his human capital. Wouldn't a small amount of ownership be justified on that basis alone?
RE: Contractual arrangements for hiring at principal level
Alan
"The engineer's first problem in any design situation is to discover what the problem really is." Unk.
RE: Contractual arrangements for hiring at principal level
I believe this accounts for part of the acquisition logic of monsters like AECOM.
RE: Contractual arrangements for hiring at principal level
it would hardly make sense to hire a new principal if that person did not bring in any new business. So it also fair to offer ownership in the company. You should not feel that you are selling the company but rather the company should be growing and earnings for all stockholders should increase due to this new business. If this is not your expectation with this new hire, than don't make him a principal and don't give him ownership.
RE: Contractual arrangements for hiring at principal level
That is probably too simple for a 12-year old firm.
But no matter what, make sure you discuss your plans with your accountant before you ink the deal so no one is surprised by the tax consequences.
Pete Madson
www.npcg.net