Buying the Family Business

Discussion in 'Growing and Managing a Business' started by MrEazyRider, Apr 12, 2013.

  1. MrEazyRider

    MrEazyRider
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    I've been asked by my grandpa to take over his business and I have a couple of questions regarding the transaction. I will be buying the business instead of having it handed to me, and I need some information about how to make this less risky.

    I'm only a year out of college and I have a great job working for a company that is top ten in the state. My grandpa is 75 now and still working 50-60 hours a week, and wants to get the business to a point where he can work part time for a while (probably until the end of his life, I don't ever see him retiring).

    My grandpa has told me that I will be able to purchase the company through bonuses, goodwill through performance (probably not the best way to describe it), or outright purchase. Here is one of my main questions. If I have a salary of $50,000, for example, and the purchase price is $1,000,000, how am I to buy this company in a reasonable time frame? Even if I were to put my entire salary towards the purchase of the business, it would still take me 20 years to buy it (not entirely unreasonable, but I wouldn't be able to put all of my salary towards it).

    I get confused because I'll be buying his current stake, but what money will I use other than my own salary? How can I take profits from the company that my grandpa currently has majority stake in and give it to him in exchange for shares? That's like taking his money and giving it back to him. I'm missing something here, so if someone could explain how exactly I purchase the company, I would appreciate it.

    Another thing that has me concerned is the security I'll have as far as rights to the company goes. His plan is to put his shares into a trust and assign me as the beneficiary. If he happens to die, I'll have exclusive rights to purchase the shares of the company. My issue is this: What if he finds a different buyer before he dies and sells to him? How can I protect myself to ensure that he won't sell out from under me? If someone comes along with the cash to buy the company, and he's willing to sell, that could pose a big problem for me.

    If anyone has any suggestions, I would really appreciate any advice I can get.

    Thanks
     
  2. LordRoco

    LordRoco
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    How about asking your grandfather a power of attorney of the shares he hold? This way, you can bargain with him enough time for you to earn and buy the shares as well as you can alleviate any doubts of your grandfather trying to sell off the property right under your nose. I aint sure if the regular attorney rules apply to your country, but you could consider taking some legal help on the matter.
     
  3. scifi

    scifi
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    Hmmm...Welll the case would be much easy ..if you accept your granpa's decision of handing the company to you..you just takeover his business..why do you want to purchase it??

    Work hard and follow the route of goodwill through performance...

    For direct purchase before else its better you make careful observations on risk and roi involved in business vis-a-vis your current job...
     
  4. LordRoco

    LordRoco
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    I would like to add something more into my advice: Like Scifi mentioned, if you have the option of taking over the business, your best bet would be to do that. If you plan to buy a power of attorney, too often, it leads to family problems and further more tensions within relationship. Why go around when you can approach it straight?
     
  5. ArcSine

    ArcSine
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    Agreed that the concept of a so-called "bootstrap" acquisition (buying a biz using its own cash flow) seems counterintuitive at first glance, for exactly the reason you mention. The rationale(s) underlying bootstrap deals tend to run along the following lines, with one or both of these conditions being present in order for such an arrangement to make sense...

    Bird in the hand beats two in the bush. For most privately-held / small companies, the profits and cash flow are like the weather---ya just never know what they're gonna do from year to year, or even month to month. And, a certain amount X of cash in-the-hand today has greater economic value than an uncertain and unpredictable stream of future cash receipts totaling Y, even when Y is significantly larger than X.

    IF the $1M price tag was properly arrived at by capitalizing the projected cash flows by some risk-appropriate cap rate, it means that your grandfather (if deciding rationally) is willing to swap his interest in some stream of uncertain future cash flows (2 in the bush) for $1M cash today (bird in the hand). I won't bore you with the mathematics, but that in turn means that if you could run the company in such a way that the forecasted cash flows would definitely materialize going forward, then these annual future cash flows would be of sufficient size to pay off a $1M loan within a reasonable period of time, after which time all the company's cash flows would belong to you.

    And especially for somebody with retirement (or semi-retirement) in mind, the notion of trading some unpredictable set of future profits for a definite lump of cash today which can be immediately plopped into a diversified portfolio which will generate a stable, safe, and certain stream of retirement income, is pretty attractive.

    Playing the rate difference game. In most small-business scenarios, the capitalization rate I mentioned above---one which would appropriately reflect the degree of uncertainty of year-to-year fluctuations in the bottom line, is significantly higher than the interest rate a lender would charge for a buyout loan, provided that the lender has a senior claim on the company's assets (and provided further that these assets have satisfactory liquidation value). This particular element, if present, adds to the effect of the previous point, which you'll see next.

    Wrapping these two points into a simple illustration might be helpful. Suppose I own a biz which, over the past years, has averaged $100 a year in net profit / cash flow. But it ain't exactly been a steady annuity; this amount is an average over a number of years which have included some big profits and some big losses. So while the $100 is a long-run average, the year-over-year swings would do a rollercoaster proud. So I choose (say) 16.75% as an appropriate risk-adjusted cap rate for pricing this cash flow stream (equivalently, if you prefer, the appropriate cash-flow multiple for pricing the company is 5.97). Hence, I arrive at $597 as my selling price for the whole shebang.

    You want to buy the biz, and after reviewing my 50-page analysis you agree that $597 is fair pricing. You find a bank willing to lend $597 if given a senior position against the company's assets (along with, likely, some extra collateral in the form of your personal guarantee, as well as a co-signer willing to put up his stock portfolio in exchange for a reasonable fee). Given the bank's senior position and the extra credit enhancements, they're willing to lend the $597 at 7%.

    So it plays out like this: You borrow the $597 and hand it to me. You own the biz and I'm off to retirement-ville. You then use the $100 per year of company cash flow to make the loan payments. Guess what? At 7%, the $100 per year will pay off the $597 loan in exactly 8 years. After the bank's gone from the picture, all the company's profits from Year 9 and on belong to you. And thus, you've been able to buy the business using just the company's own cash flows to finance the deal.

    If you read between the lines, you'll see both the bird-in-the-hand and the rate-difference concepts at work to make this deal possible.

    I realize that there are a boatload of differences between this overly simplified illustration, and the scenario you're actually reviewing. Still, in addressing your question of how, fundamentally, can a bootstrap work when it seems on the surface to fly in the face of logic, the answer is found in these basic concepts. If they're present in your particular situation, they might not be immediately obvious, as these concepts can arise in a wide variety of different flavors and hues. But at the core they work the same.

    Best of success with your investigation!
     
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  6. scifi

    scifi
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    Mr.eazy..one thing I am interested in knowing from you is that why have made this choice of buying out and not getting business handed over to you from grandpa....what are your reasons and thinking.....just want to know this...
     
  7. Forrester080

    Forrester080
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    I don't know what field your grandpa's company is in, I just think that he wants you to help taking care of the business since he thinks that he's aged now. If you want to buy that company by taking your salary each month, you should convert it into share so you will become a shareholder. In this case you will take the least risk even if your grandpa sells it to someone else before you take it over.

    The point is that company seems to be NOT interesting. If it is, someone would come to make an offer and buy it that your grandpa didn't have to give you such an offer.
     
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  8. MrEazyRider

    MrEazyRider
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    Thanks everyone for the great replies. I'll take a moment to address everyone's questions.

    Scifi: It is really up to my grandpa, and he has made the decision that I will buy the company instead of just receiving it. I think this is for two main reasons. One, it will give me a greater incentive to work the business and make it successful, and to earn what he's worked so hard to build. Second, he'd probably like to see some of the assets be passed onto his children instead of just passing them straight to me, which I understand. I really think it's in everyone's best interest that I buy the company instead of receiving it. Although it may seem strange that I say this, I'm a real true believer in incentives, and the chance to buy a company such as his is a huge incentive for me to work hard.

    Forrester: Regarding your point about the business not being interesting and not being able to find a buyer, I have an explanation. His business is in a very specialized industry that is not simple to walk into and understand. It's focused on engineering and machining. He's had several interested buyers, but none of them have been able to get financing, and he's not interested in financing the company himself to someone he doesn't know. He decided that if he were to finance it to someone, he would rather it be a family member that could carry the business into its next chapter (which is where I come in).

    You bring up one of my biggest concerns. How do I protect myself from him selling out from under me? I don't expect him to do such a thing, but I definitely don't want that weighing on my mind for 10+ years, especially since I'm leaving a really awesome job to do this.
     
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