Partial ownership offer

Discussion in 'Growing and Managing a Business' started by Oraveci, Jan 27, 2012.

  1. Oraveci

    Oraveci
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    Hi, i have been offered to come back to the company i used to work for. As owners(two brothers) are reaching the point in their lives where they would like to start reaping benefits of their life long enterprenurial results, they want me to step in and take over responsibility for day to day operations as well lead company into the future. They are not looking to completely walk away but lets say alow themselves to be away more and more for longer periods of time.
    In order to make this work out for both parties (them and myself), they are offing partnership share to create long term commitment. We are talking about the minor percentage ownership. So for example, if company is worth $3,000,000 today and i am offered 10%, i would be paying them $300,000 over a set period. My compensation package would be set salary of $xx,000.00 , plus 10% of the profits which i would probably use to pay of $300,000.
    As a minor stakeholder, they make final decisions. Should they decide in future that they want to sell, they cant unless i agree. If we agree to sell, i would be entitled to 10% of deal ( value at that time ).

    I trust them, know the business and want this. I belive there is a potential for great financial return.

    What are the questions i should be asking to enusre i am deciding based on relevant facts and not based my emotions.
     
  2. ArcSine

    ArcSine
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    Welcome to the forum, Oraveci, and congrats on your opportunity. I hope it proves lucrative and rewarding.

    That you know the business and worked there in the past is certainly a plus in a situation like this.

    Your questions should be organized around three primary issues: Pricing, Due Diligence, and Protection. And as you'll see, they have a lot of overlap and inter-relationship with each other.

    As to pricing (or valuation), it's not necessarily the case (in fact, it's usually not the case) that a portion of an ownership is worth its corresponding percentage of the whole. In other words, if the business has been valued at 3M in totality, it's not necessarily true that 10% of the biz is worth 300K. The reason is that a meaningful portion of a company's value lies in the ability to manage the assets for maximum value. And that's where there's a significant difference between a controlling owner and a minority owner. A controlling owner can do things like expand or contract the business; veer off into new markets; take on new debt; make cash distributions; and so on. And this owner can execute the maneuvers when and if they best suit this controlling owner. Since part of the 3M total value includes this so-called "control premium", then it's easy to see that 10% ownership wouldn't necessarily be worth 10% of the whole, since you'd have to remove the value of the control premium. (Deducting that control premium from a minority ownership interest is referred to as the "minority discount".) It's a large topic, and I'd urge you to Google the phrases "control premium" and "minority discount" for more info.

    None of the foregoing suggests that your would-be partners are less than ethical, or that 300K is not a fair price for your buy-in. The minority discount is simply an objective economic reality which has nothing whatsoever to do with anyone's ethics. And it might be that 300K is not only fair, but perhaps even a favorable bargain for you; it depends on the details. I'm just saying that you shouldn't assume that the 300K is the correct pricing for your buy-in, just because it's 10% of someone's estimate of the value as a whole. Don't agree to the price until you've satisfied yourself that it does indeed represent a good estimate of the true value of this opportunity to you, based on economic value factors a bit more sophisticated than "3M x 0.1 = 300K".

    As to the due diligence questions, note that, in this situation, you are indeed a "private equity" investor, placing a 300K bet on a privately-held company, with your own money. Professional private equity investors have developed due-diligence checklists that give them a somewhat standardized method of vetting a company before they agree to get out their checkbook. You should have a similar mindset when it comes to your own investigation as to whether this looks to be a wise investment on your part. One such checklist is here. I've yet to find a checklist that covers everything, though, so look around on the 'net for others. I realize that your insider's knowledge of the company will make many of these items unnecessary, and certainly this example list is overkill for your purposes. Still, I guarantee there are plenty of questions you haven't thought of, and a professional investor's checklist will help ensure (but not guarantee) you don't miss the important ones.

    The protection issue has to do with the terms and provisions you put into the buy-in agreement. Many of the protective mechanisms you might insist upon will likely come from your investigation of the minority discount issue. Anti-dilution is a common one, and I'll use it as an example. Suppose that at some point your partners become aware that the business has an opportunity to become much more valuable, for some reason (landing a huge, very lucrative new contract, say). What would prevent them from investing a bunch of capital into the business themselves---knocking you down to, say, 3 or 4% ownership---so that these new profits are allocated 97 - 3 rather than 90 - 10? The customary mechanism used by minority owners is some form of an anti-dilution provision, whereby if any new capital is to be invested in the biz, you have the right to participate in the investment pro rata so as to preserve your 10% ownership level.

    That's just an example, but it gives you a general sense of the kind of protective clauses you'll want to include in the deal. I'd strongly urge you to have a professional advisor help you with the deal-structure and contract-agreement aspects. An attorney with expertise in small business buy-outs and buy-ins would be valuable here. Also, you might want to consider having an accountant or similar financial pro help you with the valuation and investigation aspects. Also, the tax planning issues associated with such a buy-in can be a bit complex, and the accountant / tax pro would be quite valuable here as well.

    Bottom line: don't let a great opportunity slip by, but you've got some homework to do first, to figure out if it's in fact a great opp'y. Again, congrats on the potential deal, and best of success with it!
     
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  3. Oraveci

    Oraveci
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    Thank you ArcSine for thorough feedback. I was hoping for an advice and I sure got one. I will look at your suggestions and let you know how it works out.
     

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