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.

 

[hydro3]

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.

 

[moltenmetal]

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.

 

[Forensic74]

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?

 

[hydro3]

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.

 

[IRstuff]

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
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[hydro3]

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.

 

[SAITAETGrad]

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?

 

[ajack1]

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.

 

[beej67]

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

 

[hydro3]

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.

 

[77JQX]

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

 

[MacGyverS2000]

<chuckle> LPS for 77JQX...

Dan - Owner

http://www.Hi-TecDesigns.com