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Small Firm - Owner wants me to buy in
6

Small Firm - Owner wants me to buy in

Small Firm - Owner wants me to buy in

(OP)
Hi there all,

Just wanted to get some views from other on a question I have. I work for a small civil/environmental firm with 4 full time professionals, 1 part time field tech and 1 office admin. I have been here about 1 year. When I was asked to come work here I as asked to help straighten out the engineering department and help get the company back on track. Over the course of the last 12 months, I have help the company get back into the black by bringing in clients, making key staffing decisions, and being very billable while managing the engineering staff.

Recently the current owner said he would like me to be one of the owners of the firm, I said we should talk about it since I am interested in owning a consulting firm. Well when he brought the paperwork he showed me how valuable the firm was (to him) by discounting the loss from last year and basing a value of the company on the first 5 months of 2013, and then projecting those profits over the remaining months of the year.

He has said that the company is worth approximately 7x to 10x times the EBITDA or the net income. He wants me to to buy in for 20% of the company and he said he will finance. However when looking at the numbers more closely it appears that I account for approximately 50% of the net income/EBITDA just from my ability to maintain billability. Then when you account for the projects I have bought in and profit from subs I have managed that comes up to about 65 to 70% of the net income. It seems that my contribution to the company is well above my percentage of employment and I am having a hard time justifying why I would pay someone 200k+.

Sorry for the long post any thoughts would be appreciated.

RE: Small Firm - Owner wants me to buy in

If you thought you could start a competing business and have the same billing percentage you would do it. While it may be true that 70% of the income comes from your efforts, what would your income be starting a new firm? The $200k may very well just be buying Goodwill and infrastructure that the company you are in has built up over time. Would you spend more money buying storage, printers, desks, computers, servers than you'll make in the first couple of years?

You might ask to either use the last 12 months or wait for the end of the year to get a full year to base the valuation on. Extrapolating from 5 months is a bit sketchy.

David Simpson, PE
MuleShoe Engineering

"Belief" is the acceptance of an hypotheses in the absence of data.
"Prejudice" is having an opinion not supported by the preponderance of the data.
"Knowledge" is only found through the accumulation and analysis of data.
The plural of anecdote is not "data"

RE: Small Firm - Owner wants me to buy in

(OP)
The valuation of the assets/infrastructure was shown to me to be minimal by the owner and the corporate accountant since all items have aged and been fully depreciated. I understand the start up cost would be high. My income would stay similar to my current income since I took a discount to come to this company with the signed agreement that I would be bonused on all new work that I brought in, and well as being offered ownership.

However before the books were opened up to me I was being told that we were in a net zero situation and was asked if I would use my bonus percentage as a help back to the company.

RE: Small Firm - Owner wants me to buy in

Get an external audit of the books, before any commitment.
B.E.

RE: Small Firm - Owner wants me to buy in

There's accounting and there's life. I have a perfectly serviceable printer that is fully depreciated. Someone starting out today would spend $5k on the functionality that I get from that "worthless" printer.

For an analysis of "should I stay" vs "should I buy in" vs "should I start up on my own" I'd start with what my start-up looks like (i.e., who are my clients, how much money do I need to open the doors, how much do I need in reserve, what stuff do I need, what people do I need and can I find them). Once I have a very realistic handle on that list then I know what I'm measuring against. Then I'd look at what my life looked like owning 20% of the existing business. If the difference is more than the buy in, then I'd buy in. If not I'd start my own business.

The traditional EBITDA, NPV, ROI measures don't really help much in this evaluation because they are all trying to predict what next year will look like relative to last year. If one individual is providing 70% of the revenue and they quit or die, then the company's values look really iffy for 2014 regardless of what the past looked like. For small businesses you need to look at things just a touch differently, since a single individual can be the difference between success and failure (which is not considered in the traditional measures, they treat people as commodities).

David Simpson, PE
MuleShoe Engineering

"Belief" is the acceptance of an hypotheses in the absence of data.
"Prejudice" is having an opinion not supported by the preponderance of the data.
"Knowledge" is only found through the accumulation and analysis of data.
The plural of anecdote is not "data"

RE: Small Firm - Owner wants me to buy in

Two sets of books?!
What your were led to believe before the offer and after seem to be different.
The owner wants as much from his business as he can get. You want as much for your effort as you can get. That's what negotiation is made of.

If you, individually, have a known reputation and client base, then there is no reason you couldn't start up and compete from day one. If you don't then you could use his reputation and build on it...paying the ticket as you go.

Before you sign on the line, have an AUDITED financial statement done...not just his monthly accountant who makes the ledger entries. From the audited statement, you can determine the value of the business in a variety of ways ( X x EBITDA, X x revenue, X x net asset value, X x net asset value + discounted goodwill, etc.)

RE: Small Firm - Owner wants me to buy in

(OP)
Everyone,

Thank you for the solid advice and information. I will ask for an independent audit to be performed since it seems some of the numbers are not matching up. I understand wanting to maximize the price of an item I am selling and wanting to minimize the price of something I am buying. However, it is hard to understand paying a lot of money for an investment that is majority based on the work I am already doing.

Thank you again.

RE: Small Firm - Owner wants me to buy in

(OP)
Would the price be the same to someone else? It seems like a risky investment for an outside person to come in and put money into something that relies on one person to make up a large portion of the investment income.

Sort of like buying investment property, buy a single family house for $100,000 and rent to a family for $1,000 a month. If the family does not pay rent then you are out the total income of the property.

However if you buy a 4-plex for the same 100,000 and collect rents of $1,000 a month if one unit does not pay you are out $250.

So it seems like a lot more risk for an outside investor to buy the single family house than the 4-plex. which would alter the amount one would alter the anticipated return on the property and then the overall value.

RE: Small Firm - Owner wants me to buy in

I was just talking about strict valuation, not necessarily a risk. Betting solely on yourself is likewise a risk; you could get disabled or suffer some debilitating illness that could curtail your career.

The real question, then, boils down to how much return on investment is there or could be? If the ROI is too low for the risk, then the path is clear.

TTFN
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Need help writing a question or understanding a reply? forum1529: Translation Assistance for Engineers

RE: Small Firm - Owner wants me to buy in

(OP)
IRstuff,

Thanks that is what I was meaning to say there is a fair amount of risk in small business so the ROI needs to be commensurate with that risk along with the knowledge that it is not guaranteed.

I will be talking with the owner more tomorrow and will request that an independent evaluation be performed to value the business and if he does not want this then I will not work on the deal any further.

Thank you for the helpful advice.
Ryan

RE: Small Firm - Owner wants me to buy in

Banks in Australia are large, stable, hugely profitable and protected by the government. They sell for 7 times EBITDA.

Owners of small engineering companies often aim for valuations of the order of 2 times annual turnover, in Australia, half that seems more reasonable to me.

Your interests and the sellers' are not aligned on this issue, there is non symmetrical information flow, and so I'd say buyer beware, caveat emptor, get independent professional advice and use a sharp stick, vigorously.

Cheers

Greg Locock


New here? Try reading these, they might help FAQ731-376: Eng-Tips.com Forum Policies http://eng-tips.com/market.cfm?

RE: Small Firm - Owner wants me to buy in

(OP)
Good post greg, thanks for the advice.

Unless some things change we won't be going further on the deal.

RE: Small Firm - Owner wants me to buy in

The real flag to me is this "Well when he brought the paperwork he showed me how valuable the firm was (to him) by discounting the loss from last year and basing a value of the company on the first 5 months of 2013, and then projecting those profits over the remaining months of the year. "

I'd have got away with that in a game of Monopoly when I was 10 and my next brother was 8.

He got wise to me soon after.

Cheers

Greg Locock


New here? Try reading these, they might help FAQ731-376: Eng-Tips.com Forum Policies http://eng-tips.com/market.cfm?

RE: Small Firm - Owner wants me to buy in

(OP)
Yea, it is hard not to be personal about it, when someone owns something they often see it as more valuable as it often is. I tried discussing it with him more this evening but he still thinks that the company is worth over $1mil when in the past 5 years it has never earned more than $67k in net income and last year apparently only lost money because of "the shake up of the partners"



RE: Small Firm - Owner wants me to buy in

(OP)
That is where I am leaning towards, after talking with the other senior employee this morning. The other senior said he was offered to buy in for 2.5% for a price of 30k. The whole deal seems somewhat risky to try and strong arm the two engineers that are registered on the corporate licenses in the two states where we do work.

Oh well looks like I will probably just keep my mouth shut on the deal until my vacation is over and then look at the options of moving on and maybe just opening up a small single shingle or something like that.

RE: Small Firm - Owner wants me to buy in

By starting your own business will you be able to still take on the same type of clients yourself? Is the owner trying to sell shares to lock you guys in as partners so you won't compete? Sounds like you should try setting up your own shop.

B+W Engineering and Design
Los Angeles Civil Engineer and Structural Engineer
http://bwengr.com | http://bwstructuralengineer.com | http://bwcivilengineer.com

RE: Small Firm - Owner wants me to buy in

(OP)
That is what we are talking about, we do not have a non-compete and the owner himself is a scientist and not an engineer, so in order for the projects at our company to be completed engineers are needed, and the engineering projects we have were based on the engineers getting the projects and not the company owner.

I think the owner is more likely trying to fund a retirement package for himself and figured he need over a million for that package so he just named a price that equaled hi retirement package.

RE: Small Firm - Owner wants me to buy in

(OP)
Tell me about it ... I have about $5 for retirement ... so there is no way I should be investing it all in a single company.

RE: Small Firm - Owner wants me to buy in

2
MainMan has it right. This guy is trying to lock you up and prevent you from competing with him or leaving. He has the balls to ask you for a substantial amount of money in return for 20% of the future profit, despite the fact that you're generating 70% of the revenue!

The sale value of an engineering business this small as a corporate entity is ZERO- if you buy in, who is going to buy you back out, and what are THEY going to pay for it? It is an office, some crummy furniture and computers, some employees that are not your slaves, and a reputation/brand in the marketplace. The latter part is based solely on the performance of the people doing the work, who are free to leave at any time.

After your holidays, politely tell the owner that you and he differ greatly in relation to the fair purchase value of part of the company, and leave it at that. Oh, and insist that whatever inducements/bonus you negotiated to join the place are honoured. If there's a profit or cut of sales on work you dragged in, take that bonus as a return on your sweat equity to date, which this guy is taking as worth nothing beyond the salary he's paid you.

If he GAVE you 20% of that business in return for signing a non-compete, I'd hesitate to accept!

In the meantime, do all the legwork to set up your own business, preferably with a partner or two so you have some people to share the risk and legwork with. If that sounds like too much work to do while you have a full time job, then you're probably not cut out to run your own business- but given what you've done for his business already, I'd wager that you'd do fine.

RE: Small Firm - Owner wants me to buy in

oh wow, there's not even a non-compete involved? I would sit the owner down, introduce myself as "Bob" and ask him point blank "What would you say..... ya do here?" Is there some element of this company where a scientist is needed? Some sort of value added by this guy who is about to retire?

RE: Small Firm - Owner wants me to buy in

(OP)
Everyone's advice is spot on. I am pretty reluctant to invest money with someone just because they think they are worth it. Hell if that was the case then someone should just give me $3.5 million because I think I am worth it.

I am starting to put together the information costs for me to set up a small shop, the other 2 engineers that I currently work with have expressed interest in splitting off because they also do not see the value in the firm beyond just our names so there is no reason not to share in the profits. Hell as I was looking into the numbers even more, just our lease is a huge liability, a new 3 year term was signed for about $19/sf/year. After talking with some brokers the going rate for a decent space in downtown including parking is between $12.50 - $14 per sf.

Oh well once I have all my numbers together I will be sitting down with the owner and talking with him to show him that there are not any hard feelings but the best ROI appears to be not owning a portion of this firm but owning a separate entity.

The imbalance in value has become even more apparent as I have notified client's over the past couple of days that I will be out of the country for a couple of weeks, and they all asked if they could email me and if I could at least followup daily to make sure their projects are moving forward.

RE: Small Firm - Owner wants me to buy in

I would not be so quick to drink your own bathwater. "and they all asked if they could email me and if I could at least followup daily to make sure their projects are moving forward"

All that means is that they found you very responsive and responsible, but that's not necessarily any indicator for whether they'll follow you to a new company.

TTFN
FAQ731-376: Eng-Tips.com Forum Policies

Need help writing a question or understanding a reply? forum1529: Translation Assistance for Engineers

RE: Small Firm - Owner wants me to buy in

(OP)
Not drinking my own bathwater on that one.

My two key clients will follow since I had them at my last company, and brought them over here. The other clients who like me because I keep their projects rolling can stay over here, but since their current tasks are engineering based they will need to find someone to complete that, weather it is me or someone else that can step in that is fine by me and I will offer whatever support I can to make sure the transition is there and nothing gets dropped if I do move on.

RE: Small Firm - Owner wants me to buy in

I'm surprised that nobody has commented on the 7-10 times EBIDTA more directly.

Now, I'm no expert on investment...but to me this appears unlikely to be a good option.

My first guess would be that a three times valuation for a three year payback period on your initial investment should be a reasonable goal...something around or above 25% ROI. This would be consistent with typical small venture and venture capital style investments.

But, it excludes potential growth. This article suggests that for 7 times EBITDA, you would need a growth rate greater than 50% year over year to realize that sort of valuation. Does that seem in any way likely? I think for most traditional consulting engineering firms, static growth is not unreasonably conservative. If this is the case, 7x earnings valuation has a payback period greater than five years. Would you even see your initial investment realized before your partner retired?

Then you have to consider that your ROI is being generated within the company. To take profits, you would face double taxation. Are you willing to keep the money invested in the company and maybe buy your partner out over time? For most, putting that much of your personal savings into one investment which you have limited control over would be a problem. Presumably you can trust your partner but can you be certain of a constructive relationship in the future based on just the last year working together?

Start-up costs for consulting engineers don't have to be that high. You really don't have to start off from costs any higher than you are comfortable with. Some start with a home based business and grow as their income allows. Who really needs a $5000 printer or a downtown office when you can rent shared business space and use printing services? If you have some employees, that's quite a bit bigger start-up cost but you could have a pretty swanky set-up for far less than $200k.

What value does your would-be partner offer? Presumably, he also draws a large salary...is he worth it?

RE: Small Firm - Owner wants me to buy in

Hydro3 welcome to the world of owning a business or at least the opportunity to part own one.

As I see it you have been made an offer, you can of course say no thank you or yes please however all good business people I know would negotiate. Nothing says you have to pay the asking price and in fact your ability to negotiate will to a large extent determine how successful you become.

If you speak to business owners most will tell you it a series of gambles, some you get right some you get wrong and usually there is no correct answer at the time, but you need to come out on top most of the time or at least on the big ones.

The example you give of the price of office space is a good one, had prices risen sharply it would have been a good call, had some new regulation been brought in or lots of similar properties been destroyed or removed it would have been a great call as it is it was probably the wrong thing to do however it might still be better than the cost of moving office and all the disruption and cost that goes with it.

There will always be people telling you to do this or that because it is obvious, if they happen to be the same people that have brought and sold property at exactly the right time, always had at least a 60% return on any shares and have the best pension plan available they are well worth listening too as they can possibly see into the future. If not and bad luck has held them back they are no different to the rest of us.

RE: Small Firm - Owner wants me to buy in

Quote:

If he GAVE you 20% of that business in return for signing a non-compete, I'd hesitate to accept!

Yeah, this.

Everything moltenmetal says above is spot on, in my opinion. I have see other colleagues get tied into a company with promises of stock or pensions, when in fact they would have made twice the money out the gate starting their own shop, and have 100% ownership of whatever they did on their own. Don't be that guy.

Shoot me an email if you want to bounce experiences back and forth regarding setting up your own shop. It's actually a lot easier than you might think. In today's computing world, overhead is for suckers.

Hydrology, Drainage Analysis, Flood Studies, and Complex Stormwater Litigation for Atlanta and the South East - http://www.campbellcivil.com

RE: Small Firm - Owner wants me to buy in

(OP)
Everyone,

This has been great reading and given me a lot to think about. I am currently on vacation but before I left I asked the owner to go back and really think what his company is worth without me there and I told him this at the most would bee the starting point for our negotiations. I also gave him the numbers that I had put together for how much of or current practice its based on my contribution to billable time a well as marketing.

When I get back into town I will see where he is at but if it is not more realistic the negotiations will be over and I will set about starting a new shop. Which is looking very attractive at the moment.



RE: Small Firm - Owner wants me to buy in

When you set up your new shop, will you give your current employer the option of buying in? That could be a fun discussion!

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