Small Firm - Owner wants me to buy in 6

[hydro3]

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.

 

[zdas04]

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"

 

[hydro3]

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.

 

[berkshire]

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

 

[zdas04]

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"

 

[Ron]

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.)

 

[hydro3]

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.

 

[IRstuff]

But, that's all part of the intangibles that make valuation of a company tricky. If the same 20% share were sold to someone else, wouldn't the price be the same? The bottom line is the whatever your contributions are,

TTFN
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[hydro3]

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.

 

[IRstuff]

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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[hydro3]

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

 

[GregLocock]

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


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[hydro3]

Good post greg, thanks for the advice.

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

 

[GregLocock]

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

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[hydro3]

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"

 

[hydro3]

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.

 

[brandonbw]

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

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http://bwstructuralengineer.com

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http://bwcivilengineer.com

 

[MacGyverS2000]

If the other senior engineer is good, why not start up shop with him?

Dan - Owner

http://www.Hi-TecDesigns.com

 

[hydro3]

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.

 

[IRstuff]

A million is barely enough to do anything with in retirement. My goal, which is yet unachieved, was to accumulate something on the order of 5 million, but I'm not there, so off to work I go...

TTFN
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