Purchasing the company I work for - good idea?

[frugalnacho]

My boss approached me the other about buying part of the company from him.  A little background - The company was started by my 2 bosses 11 years ago.  I started working here 10 years ago.  Since then it has steadily grown to about 13 employees.  I know the bosses have made tons of money.  They both have paid off houses, multiple paid off rental houses, and their own vacation cottages complete with toys and boats and jet skis etc.  If I had to guess I would have thought they were both netting $300k+/yr each for the past several years. 

So he approached me and was talking about how he wants to retire, but doesn't want to just straight up sell the company for a variety of reasons.  Reason #1 is that it's hard to find someone interested in paying full price for the entire company.  The company isn't quite large enough to attract any of the really big multi-national players in our industry, but far too large to just be bought by some dude.  Reason #2 is that they are both a large part of the company.  You can justify on paper that the company is worth $5M, but if you sold it for $5M and my bosses stopped working and where to their cottages, I don't think the business would operate as well as it does now without their input.  Unless of course the person who bought it can bring the same skill set to the table...but then why are they buying an established business for $5M instead of building their own if they have required skill set to thrive in this industry?  I think of it like a turnip farm with a master turnip farmer.  Sure the turnip farm is an asset that generates lots of cash flow, but a large part of that is the master turnip farmer.  Once you pay the farmer off, what incentive does he have to keep growing turnips for you?

What he proposed was a way for them to scale back how much they contribute, and get some of the employees to put some skin in the game.  They want to semi-retire and start working like 20 hr/wk, and over the next 10 years maybe retire completely (they aren't sure.  They seem to like working and think they will get bored, but they don't want to do the shitty work, nor do they want to do a lot of work).  A hypothetical that was given was that they generated about $1M in profit last year,using a multiplier of 5 gives a value of $5M.  The employee would then be sold a 5% stake in the company for $250k.  The $250k would be given as a loan at something like 3% interest.  The end of the year bonuses would still be given, but for employees participating they would just go directly into paying the loan off (so I would probably be giving up $7-10k/yr of bonus).   I would be entitled to 5% of the company profits at the end of the year, which would go to pay off the debt.  If we did $1M in profit, that would be $50k towards the loan.  That should take about 5 years to pay off the loan if business continues at the level we are now, but will largely be dependent on how the company does. 

I would give up about $7-10k/yr in bonuses, but after about 5 years I should have $250,000 in equity in the company.  Or hopefully the company will actually expand and grow like it has been for the last 11 years, and be worth more in 5 years so that I might own $350,000 in equity.  Or the company could implode and I could be out tens of thousands of dollars. 

My main concerns:

How do  I get out? Assuming everything goes great and my $50k in forgone bonuses net me $350k in equity in 5 years, how do I cash out?  I think the entire premise of the plan is to have employees put skin in the game, so when the original bosses are semi retiring there are still several employees here still trying to grow the business, make things run efficiently, and have incentive to go beyond just earning their salary.  I can't imagine the other employees would take kindly to me just fucking off and not participating in the business but sitting back to collect my 5% at the end of the year - I certainly wouldn't like it they did that to me.  But then what are my options?  The market to sell equity in the company would probably be pretty limited, so unless the other employees want to buy me out I don't know what  I would do.  I know they are thinking this incentive will anchor the core group of valuable employees to the company, but for how long?  I'd like to bail ship in 10 years, and this could greatly increase my stach, but that I fear once I am in it I may be anchored for longer than 10 years with no easy exit strategy.

Do I really want to go all in here?  I have no plans to move or change jobs before retirement, but it's nice knowing I have the options.  I feel like I will not have any options once I do this.  I will be a company man and won't even be able to consider switching jobs.

What if shit goes horribly wrong and the company doesn't do nearly as well in the future?  Will I be on the hook for $250k in debt for a worthless or low worth company? 




This is a long way off, this was only a brain storming discussion to see if there was any interest from the employees.  The details and everything wouldn't be hammered out until probably fall or winter, so I won't have more accurate numbers until then.  I have a decent idea of what goes on with the finances, but I don't get to actually look at the books so I just gotta go on what they tell me for now.

This has apparently been implemented at a couple other firms in our industry successfully (they got the idea after discussing it with the owner's of other firms).

I know I shouldn't put all my eggs in one basket, but I won't be transferring any of my current eggs into this basket.  I will still hold my 401k and IRA ($160k), non retirement savings ($30k), and both my houses (owe $80k on mortgages, have about $145k in equity). 

Any thoughts?

[chesebert]

What are your veto, board and information rights? Can you take convertible bond or preferred stock?

[Fishindude]

Sounds like one heck of an opportunity for you if you have the drive, guts and confidence to see it through. 
We are in the final stages of doing something very similar selling the business to four key employees.  Myself and two partners owned the place and put the deal together for these four.  The total length of buy out / pay off to get all three of us out will be about 12 years, two are already out and I am the last to go.

Obviously, lots of details to work out and it would be best to get an unattached outside professional involved to establish value of the company, help work out the deal, etc.
Biggest thing is, everything has to be transparent regarding compensation, company books, etc., no secrets.   

Your ten more years to work time frame seems a bit tight for someone wanting to buy a business as it will take five years to pay off, then you would only reap the rewards for five.   The way you get out, is exactly the way your bosses are proposing.  Set up the next generation of younger managers similarly.

Your fears about the company going broke or falling on hard times are legit.  It's a guarantee that at some point you will have some difficulty or get stung financially if you run a business long enough, but as an owner you should have a hand in guiding the business profitably to prevent most of that.

Good luck !

[frugalnacho]

What are your veto, board and information rights? Can you take convertible bond or preferred stock?

Not exactly familiar with all this terminology.  It sounded like the tentative plan would be that I would get 5% ownership in company with entitlement to 5% profit, but not have any voting power until the loan was completely paid off.  Not really sure what good a 5% vote is going to do for me anyway.

[2Birds1Stone]

Sounds like an awful lot of eggs in one proverbial basket.

[chesebert]

What are your veto, board and information rights? Can you take convertible bond or preferred stock?

Not exactly familiar with all this terminology.  It sounded like the tentative plan would be that I would get 5% ownership in company with entitlement to 5% profit, but not have any voting power until the loan was completely paid off.  Not really sure what good a 5% vote is going to do for me anyway.

You will need to protect yourself and your investment. Your stake is for all practical purposes not transferable and is illiquid. You need veto rights on key corporate and operational decisions. You need information to make those decision. You will also want the financials are audited and ensure company has good corporate governance. You will also need to have put/call rights with your co-investors to ensure that they are not free riding on your work.

You can look at startup/VC dox that are generally available publicly for some idea on what rights you may want.

You need a lawyer to advise you on your investment. You need to do this right from the get go or face potential disasters down the road.

[frugalnacho]

Sounds like one heck of an opportunity for you if you have the drive, guts and confidence to see it through. 
We are in the final stages of doing something very similar selling the business to four key employees.  Myself and two partners owned the place and put the deal together for these four.  The total length of buy out / pay off to get all three of us out will be about 12 years, two are already out and I am the last to go.

Obviously, lots of details to work out and it would be best to get an unattached outside professional involved to establish value of the company, help work out the deal, etc.
Biggest thing is, everything has to be transparent regarding compensation, company books, etc., no secrets.   

Your ten more years to work time frame seems a bit tight for someone wanting to buy a business as it will take five years to pay off, then you would only reap the rewards for five.   The way you get out, is exactly the way your bosses are proposing.  Set up the next generation of younger managers similarly.

Your fears about the company going broke or falling on hard times are legit.  It's a guarantee that at some point you will have some difficulty or get stung financially if you run a business long enough, but as an owner you should have a hand in guiding the business profitably to prevent most of that.

Good luck !

I've been here 10 years.  The 2 other people they are discussing with have been here 8 years, and 2 years.   The guy with only 2 years hasn't been here nearly as long, but he is highly competent and already one of the core employees.  It would probably just be us 3 to start with.  It sounds like he would like to attract more project managers and get them in on the deal too, with the eventual goal of multiple employees owning and operating the business. 

We would definitely have outside people to look at the deal.  My boss seems to think it will cost the company like $30k to get everything all set up*, and then we (the employees purchasing) would need our own lawyer to look everything over.  I assume the 3 of us could all just hire one lawyer; seems unnecessary for us each to have a lawyer read over the deal.

Yea, the books would be fully open to all owners at that point.

I'm not looking at this as a deal to purchase a cash generating asset so much as using it to expedite fire.  Getting 5% of the profits on top of my salary sounds like a fantastic deal.  I mean i've been working here for 10 years getting just my salary while I watched the owners get filthy rich.    It would be nice to be able to cash out after 5 years and walk away with $300k cash instead of the $35-50k I would receive in bonus money over the same period.  Of course I could always reevaluate once I got to that point and might like to stay with some type of reduced hours arraignment. If I could drop myself down to maybe 3 6-hour days per week, and not go out of town on the shitty jobs, I would seriously consider staying on after FI to continue making money.  Not that I would need the money at that point, but if I could reduce my work related stress significantly, still earn a large enough salary to pay my expenses, and be earning 5 or 10% of the business profits (maybe $50-100k/yr) I could do a lot of good in the world.  Even just sticking it out for 5 years after I reach FI and I could fund a massive charitable endowment fund that would be equal to my entire FI stach.  And I probably wouldn't be retiring much later than my current plans are now, except I would get to control a charity with half a million in funds.

*I have no idea how it would cost $30k to structure everything, that seems mighty expensive, but he is drawing experience from other companies that have already done something similar.

[MrMoogle]

What are your veto, board and information rights? Can you take convertible bond or preferred stock?

Not exactly familiar with all this terminology.  It sounded like the tentative plan would be that I would get 5% ownership in company with entitlement to 5% profit, but not have any voting power until the loan was completely paid off.  Not really sure what good a 5% vote is going to do for me anyway.

You will need to protect yourself and your investment. Your stake is for all practical purposes not transferable and is illiquid. You need veto rights on key corporate and operational decisions. You need information to make those decision. You will also want the financials are audited and ensure company has good corporate governance. You will also need to have put/call rights with your co-investors to ensure that they are not free riding on your work.

You can look at startup/VC dox that are generally available publicly for some idea on what rights you may want.

You need a lawyer to advise you on your investment. You need to do this right from the get go or face potential disasters down the road.

You need to have voting rights if you own the 5%, even if there's a loan to pay for it.  You're still on the line for the loan if you it goes bankrupt.  If you were putting 1% in per year, and gaining 1% of the company, then you would have more of a vote over time.

This would basically mean the day after you sign up, you have $250k invested in the company.  Most investing advice says not to have more than 10% in any one asset.  For business owners, this is definitely not the rule, so if you do this, you now have to think of yourself as an owner and not an investor.

[frugalnacho]

Sounds like an awful lot of eggs in one proverbial basket.

It is, but I will be paying for it with eggs generated from owning the business, not transferring my other eggs into this basket.  I will still presumably be making enough salary to live on and save a significant portion of my income.  It's like a huge raise, except the entire raise is in the form of equity in the company instead of actual cash.  Of course if the company imploded I don't know exactly what the financial ramifications would be...I guess that's why I am here discussing it.  It also seems unlikely to me that the company is going to implode, but of course I realize I may be biased and too close to objectively see it.   A lot of the work we do is work for plants that need to comply with regulations from the clean air act.  I don't see the clean air act getting repealed any time soon, in fact I suspect environmental regulations will get even more stringent in the future.  As more and more regulations get legislated the demand for this work is increasing.   The people and firms with a long history of experience in the field are in high demand.  I suspect that at some point as new people infiltrate the field the supply and demand will balance out, but I will always have 10 years more experience than the people getting into the field now. 

[frugalnacho]

What are your veto, board and information rights? Can you take convertible bond or preferred stock?

Not exactly familiar with all this terminology.  It sounded like the tentative plan would be that I would get 5% ownership in company with entitlement to 5% profit, but not have any voting power until the loan was completely paid off.  Not really sure what good a 5% vote is going to do for me anyway.

You will need to protect yourself and your investment. Your stake is for all practical purposes not transferable and is illiquid. You need veto rights on key corporate and operational decisions. You need information to make those decision. You will also want the financials are audited and ensure company has good corporate governance. You will also need to have put/call rights with your co-investors to ensure that they are not free riding on your work.

You can look at startup/VC dox that are generally available publicly for some idea on what rights you may want.

You need a lawyer to advise you on your investment. You need to do this right from the get go or face potential disasters down the road.

You need to have voting rights if you own the 5%, even if there's a loan to pay for it.  You're still on the line for the loan if you it goes bankrupt.  If you were putting 1% in per year, and gaining 1% of the company, then you would have more of a vote over time.

This would basically mean the day after you sign up, you have $250k invested in the company.  Most investing advice says not to have more than 10% in any one asset.  For business owners, this is definitely not the rule, so if you do this, you now have to think of yourself as an owner and not an investor.

What type of real power would 5% have with voting rights though?  What major decision could I veto or vote on with only 5%, unless something required a unanimous vote? Seems ridiculous that they could own 85% of the company and be outvoted by me and the other minority owners.   It's not like there are 100 owners and we could all pool our votes - The vast majority of the company would still be owned by only 2 people, and they would be above the threshold for whatever could constitute a majority decision (unless it needed to be unanimous).  Eventually we would own enough to start having actual influence on the company, but I don't know how much to realistically expect with only 5% when I know 80%+ will be in the hands of the current owners for a long time to come still. 

With $250k debt I would have nearly 50% of the net worth in the company - a lot more than I would like, but that's the risk associated with owning a business.   

[Fishindude]

It would be nice to be able to cash out after 5 years and walk away with $300k cash instead of the $35-50k I would receive in bonus money over the same period. 

A few more comments for consideration.
You didn't mention your age, which is pretty important.
I think you are thinking a bit too short term and a bit too small. 
Why don't the three of you try to buy the whole darned business over time instead of 5% shares?  There are ways to do it.   Who else do they have to sell too?

$300K sounds like a lot if you've never had it, but in reality it's not that much.  It won't get you the lifestyles like your bosses are living.
Why not get a bigger piece of the place, stay a bit longer an, set up the next generation buy out, and walk away with a couple mil?

[AlwaysLearningToSave]

We would definitely have outside people to look at the deal.  My boss seems to think it will cost the company like $30k to get everything all set up*, and then we (the employees purchasing) would need our own lawyer to look everything over.  I assume the 3 of us could all just hire one lawyer; seems unnecessary for us each to have a lawyer read over the deal.

*I have no idea how it would cost $30k to structure everything, that seems mighty expensive, but he is drawing experience from other companies that have already done something similar.

A few thoughts:

First, if the entire company can be valued for $5 million (controlling interest w/ some marketability), the value of a 5% interest in that same company is probably not $250,000.  It should be less because you have no control over the entity and there is no market for you to sell your interests.  The only way it would approach that value would be if you get significant additional rights (put/call rights, veto rights, rights of first refusal to acquire additional interests, etc.). 

Second, if you are seriously considering this YOU should hire a lawyer.  Not you and the other two employees, just you.  You have your own interests to protect which may not entirely align with the other employees.  Yes, it will be expensive to talk to the lawyer but you don't want to screw it up.  $30k to set up the entity for sale does not seem unreasonable to me. 

Third, beware if the entity is taxed as a pass-through (S corp or partnership).  Sometimes these minority interests ownership arrangements look good at first blush but are in effect elaborate schemes to have employees pay a portion of the business's income taxes without much to show for it.  You want mandatory tax distributions, pro-rata non-liquidating distributions (an issue in partnerships, not S corps), and an ability to ensure the owners don't just pay themselves more, reducing the profit from which you get 5%. 

Fourth, beware of having too many business partners.  If you can, keep it to the small core group.  Additionally, you want the right to buy out the other partners if they cease actively working in the company-- you probably don't want one of your coworkers to make the investment then jump ship and passively profit from your hard work. 

[AlwaysLearningToSave]

Why don't the three of you try to buy the whole darned business over time instead of 5% shares?  There are ways to do it.   Who else do they have to sell too?

Yes, explore this.  Seller financing contingent on the company's performance and the current owners' agreement to provide consulting services for a period of time could be a better arrangement for you. 

[Fishindude]

Don't dive in too quick and start spending money on lawyers.
Get the deal worked out first to everyone's satisfaction, read and understand everything yourself first, then get a lawyer involved before you sign up for anything to get a second trained set of eyes looking at things.

You are getting some negative and fear mongering feedback.  All parties have to trust one another for this to work.   If you don't trust the others, turn it down now, but if you feel like these folks you've worked with for the last decade are good folks and really trying to put a deal together that is good for all, and it you're heart is in it, move the plan ahead and see where it goes.  It will take months and you will have plenty of time to get all questions answered.

[chesebert]

Why don't the three of you try to buy the whole darned business over time instead of 5% shares?  There are ways to do it.   Who else do they have to sell too?

Yes, explore this.  Seller financing contingent on the company's performance and the current owners' agreement to provide consulting services for a period of time could be a better arrangement for you.

You are assuming they are buying the whole business, which I understand is not even on the table. Also, negotiating earnout is tough and will cost you more than $30k. I would guess even minority investment with investor note would cost more than $30k once you put together the purchase and shareholder dox. I assume y'all want the financials audited and get a third-party to value the business so you can establish your cost basis going forward. 

[frugalnacho]

It would be nice to be able to cash out after 5 years and walk away with $300k cash instead of the $35-50k I would receive in bonus money over the same period. 

A few more comments for consideration.
You didn't mention your age, which is pretty important.
I think you are thinking a bit too short term and a bit too small. 
Why don't the three of you try to buy the whole darned business over time instead of 5% shares?  There are ways to do it.   Who else do they have to sell too?

$300K sounds like a lot if you've never had it, but in reality it's not that much.  It won't get you the lifestyles like your bosses are living.
Why not get a bigger piece of the place, stay a bit longer an, set up the next generation buy out, and walk away with a couple mil?

The $300k would be in addition to my 401k, IRAs, bank accounts, and houses. The sum total of those other assets would be $30-50k less than they would have been otherwise because of lost bonuses, but the $300k would in effect push me over my FIRE threshold.  That's my train of thought anyway.

I'm not gunning for the lifestyle of my bosses.  I live happily and lavishly on about $30-35k/yr.  I would up that slightly if I had gobs of money available to me, but not nearly to the extent my bosses live.  I have been questioning for years why they still bother to show up.  I think they don't want to let a $5M asset go to shit even though they already have more than enough money to live high on the hog for the rest of their lives. 

I am 33 years old.  Was hoping to FIRE by 40, but realistically it will probably be somewhere between 40-45.  That's a good idea to buy a larger piece of the company.  This is all very preliminary, it was just yesterday I got blind sided with this all, so I still haven't fully absorbed it.  I think the discussion was just to feel me and one other guy out to see if there was even enough interest for them to start fully considering this as a possibility.

[chesebert]

Don't dive in too quick and start spending money on lawyers.
Get the deal worked out first to everyone's satisfaction, read and understand everything yourself first, then get a lawyer involved before you sign up for anything to get a second trained set of eyes looking at things.

You are getting some negative and fear mongering feedback.  All parties have to trust one another for this to work.   If you don't trust the others, turn it down now, but if you feel like these folks you've worked with for the last decade are good folks and really trying to put a deal together that is good for all, and it you're heart is in it, move the plan ahead and see where it goes.  It will take months and you will have plenty of time to get all questions answered.

It is clear that OP has almost no background in private investment and is lacking the requisite knowledge to negotiate. He can't ask for what he doesn't know. Get your lawyer involved at the term sheet stage. 

[Prairie Stash]

When its time for you to get out you'll need to sell it to employees. Are you capable of grooming a replacement for yourself to take over in 10 years from you?  Your current bosses groomed you, you have to pay it forward. Keep in mind you'll be tied to the company for several years after you sell, if it tanks quickly you won't receive a pay day, new owners won't pay you if they don't have the cash.

[frugalnacho]

We would definitely have outside people to look at the deal.  My boss seems to think it will cost the company like $30k to get everything all set up*, and then we (the employees purchasing) would need our own lawyer to look everything over.  I assume the 3 of us could all just hire one lawyer; seems unnecessary for us each to have a lawyer read over the deal.

*I have no idea how it would cost $30k to structure everything, that seems mighty expensive, but he is drawing experience from other companies that have already done something similar.

A few thoughts:

First, if the entire company can be valued for $5 million (controlling interest w/ some marketability), the value of a 5% interest in that same company is probably not $250,000.  It should be less because you have no control over the entity and there is no market for you to sell your interests.  The only way it would approach that value would be if you get significant additional rights (put/call rights, veto rights, rights of first refusal to acquire additional interests, etc.). 

Second, if you are seriously considering this YOU should hire a lawyer.  Not you and the other two employees, just you.  You have your own interests to protect which may not entirely align with the other employees.  Yes, it will be expensive to talk to the lawyer but you don't want to screw it up.  $30k to set up the entity for sale does not seem unreasonable to me. 

Third, beware if the entity is taxed as a pass-through (S corp or partnership).  Sometimes these minority interests ownership arrangements look good at first blush but are in effect elaborate schemes to have employees pay a portion of the business's income taxes without much to show for it.  You want mandatory tax distributions, pro-rata non-liquidating distributions (an issue in partnerships, not S corps), and an ability to ensure the owners don't just pay themselves more, reducing the profit from which you get 5%. 

Fourth, beware of having too many business partners.  If you can, keep it to the small core group.  Additionally, you want the right to buy out the other partners if they cease actively working in the company-- you probably don't want one of your coworkers to make the investment then jump ship and passively profit from your hard work.

If it's structured in a certain way, and we all receive an identical deal, how could their interests not line up with mine?  What could my own personal lawyer offer that a 3-way split lawyer couldn't offer?

-You guys are responding too fast for me to keep up!

[frugalnacho]

Why don't the three of you try to buy the whole darned business over time instead of 5% shares?  There are ways to do it.   Who else do they have to sell too?

Yes, explore this.  Seller financing contingent on the company's performance and the current owners' agreement to provide consulting services for a period of time could be a better arrangement for you.

You are assuming they are buying the whole business, which I understand is not even on the table. Also, negotiating earnout is tough and will cost you more than $30k. I would guess even minority investment with investor note would cost more than $30k once you put together the purchase and shareholder dox. I assume y'all want the financials audited and get a third-party to value the business so you can establish your cost basis going forward.

I assume that was part of the deal as well.  I am just taking the numbers he gave me at face value, but will obviously confirm it all before signing anything.  I think there will be a lot involved before this thing officially goes down.

[chesebert]

We would definitely have outside people to look at the deal.  My boss seems to think it will cost the company like $30k to get everything all set up*, and then we (the employees purchasing) would need our own lawyer to look everything over.  I assume the 3 of us could all just hire one lawyer; seems unnecessary for us each to have a lawyer read over the deal.

*I have no idea how it would cost $30k to structure everything, that seems mighty expensive, but he is drawing experience from other companies that have already done something similar.

A few thoughts:

First, if the entire company can be valued for $5 million (controlling interest w/ some marketability), the value of a 5% interest in that same company is probably not $250,000.  It should be less because you have no control over the entity and there is no market for you to sell your interests.  The only way it would approach that value would be if you get significant additional rights (put/call rights, veto rights, rights of first refusal to acquire additional interests, etc.). 

Second, if you are seriously considering this YOU should hire a lawyer.  Not you and the other two employees, just you.  You have your own interests to protect which may not entirely align with the other employees.  Yes, it will be expensive to talk to the lawyer but you don't want to screw it up.  $30k to set up the entity for sale does not seem unreasonable to me. 

Third, beware if the entity is taxed as a pass-through (S corp or partnership).  Sometimes these minority interests ownership arrangements look good at first blush but are in effect elaborate schemes to have employees pay a portion of the business's income taxes without much to show for it.  You want mandatory tax distributions, pro-rata non-liquidating distributions (an issue in partnerships, not S corps), and an ability to ensure the owners don't just pay themselves more, reducing the profit from which you get 5%. 

Fourth, beware of having too many business partners.  If you can, keep it to the small core group.  Additionally, you want the right to buy out the other partners if they cease actively working in the company-- you probably don't want one of your coworkers to make the investment then jump ship and passively profit from your hard work.

If it's structured in a certain way, and we all receive an identical deal, how could their interests not line up with mine?  What could my own personal lawyer offer that a 3-way split lawyer couldn't offer?

-You guys are responding too fast for me to keep up!

I think one law firm can deal with 3 co-investors.

[frugalnacho]

Don't dive in too quick and start spending money on lawyers.
Get the deal worked out first to everyone's satisfaction, read and understand everything yourself first, then get a lawyer involved before you sign up for anything to get a second trained set of eyes looking at things.

You are getting some negative and fear mongering feedback.  All parties have to trust one another for this to work.   If you don't trust the others, turn it down now, but if you feel like these folks you've worked with for the last decade are good folks and really trying to put a deal together that is good for all, and it you're heart is in it, move the plan ahead and see where it goes.  It will take months and you will have plenty of time to get all questions answered.

It is clear that OP has almost no background in private investment and is lacking the requisite knowledge to negotiate. He can't ask for what he doesn't know. Get your lawyer involved at the term sheet stage.

Yes, I have none.  Took an engineering job straight out of college, and here I am 10 years later.

[AlwaysLearningToSave]

If it's structured in a certain way, and we all receive an identical deal, how could their interests not line up with mine?  What could my own personal lawyer offer that a 3-way split lawyer couldn't offer?

-You guys are responding too fast for me to keep up!

I think one law firm can deal with 3 co-investors.

I was too absolute in my statement about NEEDING your own lawyer.  Sure, if you all get an equal deal, one law firm could certainly represent three co-investors.  But that is a big "if."  Who says it has to be that way?  There could be good reasons for it NOT to be that way.  The fact you are on this forum suggests your interests may be different than your co-investors in that you might want to leave the company significantly sooner than your business partners.  There might be other ways your interests differ, there might not be.  Here is the important takeaway: if you hire your own attorney, that attorney represents only your interests.  If you jointly hire an attorney, that attorney's professional loyalty is to the three of you collectively, not necessarily to you individually.  If you choose joint representation, that's fine (and it in fact might be the most prudent decision), just recognize that the lawyer's obligations go beyond representing just your interests.   

Edit to Add:  If you choose to go through with this AND want to hold on to your FIRE plans, your opportunity to set yourself up for your early exit from the company is now, when you purchase the company.  My concern with joint representation in this circumstance would be that your early retirement plans would get lost in the mix.  It would cost more money on the front end to hire your own attorney but doing so will allow the lawyer to review the deal with an eye toward your early exit and give you the best chance at a clean exit later on.   

It is clear that OP has almost no background in private investment and is lacking the requisite knowledge to negotiate. He can't ask for what he doesn't know. Get your lawyer involved at the term sheet stage.

Yes, I have none.  Took an engineering job straight out of college, and here I am 10 years later.

I agree.  If you show up to your own lawyer's office (or the joint lawyer's office) with a pile of finalized documents and ask him/her to review them, the lawyer will be hamstrung and not be able to do much for you other than make sure you understand what you are signing.  If you get one involved at the term sheet stage, the lawyer can help you shape the major outlines of the deal and provide good value to you.  I would suggest having your own lawyer (or at least a joint lawyer for the investors) involved at the term sheet stage until the term sheet is settled.  Then have the company's lawyer draft all the documents.  Finally, have your own lawyer (or the joint lawyer) review the finalized documents before you sign. 

[jda1984]

I didn't read all of the posts, but it sounds like where our company was 5-6 years ago.

What we did, for better or worse, was set up an Employee Stock Ownership Plan (ESOP).  An ESOP is a retirement trust that owns some or all of the company.  In our case, it owns 51% since there are laws about what the ESOP can buy shares for and such.  It does require an annual appraisal by a third party (I think ours is on the order of $20k) and a trustee to manage the ESOP documentation and such (participant statements, interface with the board, etc.).  Our company uses a third party to do this.  Probably another $20-25k/yr.  The value of the company is around $10mil per the valuation.

Before the ESOP, we were employee owned with the founder owning about 30-35%.  The next biggest shareholder was around 11-12%.  The valuation pre-ESOP was a bit high, so there was some shared pain in transferring to this method.

In our case, when a participant reaches at 55 they can diversify 25% of their ESOP holdings to non-company shares.  Another 25% can be diversified at 60.  At retirement the ESOP buys the shares from them at the going rate with contributions and redistributes them to the other participants.

The upsides are everyone is in it together.  Everyone is a part shareholder through the ESOP.  In good years, the distributions to the shareholders increase everyone's account balances.  It's a decent recruiting tool.  You're not spending your own money on this (we do it instead of a 401k match and it has worked well for the last 5 years or so).  It also creates a bit of a market for shares in the future if the owners don't want to sell everything to the ESOP or others at once.

The bad sides are you can't get out except through leaving the company or retirement.  Your job and part of your retirement are tied up in one small business.  It seems there comes a point where it makes sense to go to 100% ESOP owned, that may not be what you or the company wants.  It seems like a one way street.  Most of the ESOPs our trustee oversees don't sell shares back to others (whether employees, other shareholders, etc).  Our Buy-Sell agreement had to be altered to allow the ESOP to own shares.  The only pass-through vote (where ESOP participants vote the shares in their ESOP account) is on sale of the company.  So, I suppose someone could try to take it over again without the ESOP, but 75% of the shares (ESOP and traditional) would need to vote for it.

Anyway, there is a ton of details and intricacies to ESOPs, so if this sounds intriguing, seek out some advice from ESOP attorneys and/or trustees in your area.  I'd also recommend getting some outside sense of the value of your company whether you buy in directly or through an ESOP.  My guess is the current owners overvalue it.  Our valuation in A&E market is about 1X revenue and ~5X income/profit.

[frugalnacho]

If it's structured in a certain way, and we all receive an identical deal, how could their interests not line up with mine?  What could my own personal lawyer offer that a 3-way split lawyer couldn't offer?

-You guys are responding too fast for me to keep up!

I think one law firm can deal with 3 co-investors.

I was too absolute in my statement about NEEDING your own lawyer.  Sure, if you all get an equal deal, one law firm could certainly represent three co-investors.  But that is a big "if."  Who says it has to be that way?  There could be good reasons for it NOT to be that way.  The fact you are on this forum suggests your interests may be different than your co-investors in that you might want to leave the company significantly sooner than your business partners.  There might be other ways your interests differ, there might not be.  Here is the important takeaway: if you hire your own attorney, that attorney represents only your interests.  If you jointly hire an attorney, that attorney's professional loyalty is to the three of you collectively, not necessarily to you individually.  If you choose joint representation, that's fine (and it in fact might be the most prudent decision), just recognize that the lawyer's obligations go beyond representing just your interests.   

It is clear that OP has almost no background in private investment and is lacking the requisite knowledge to negotiate. He can't ask for what he doesn't know. Get your lawyer involved at the term sheet stage.

Yes, I have none.  Took an engineering job straight out of college, and here I am 10 years later.

I agree.  If you show up to your own lawyer's office (or the joint lawyer's office) with a pile of finalized documents and ask him/her to review them, the lawyer will be hamstrung and not be able to do much for you other than make sure you understand what you are signing.  If you get one involved at the term sheet stage, the lawyer can help you shape the major outlines of the deal and provide good value to you.  I would suggest having your own lawyer (or at least a joint lawyer for the investors) involved at the term sheet stage until the term sheet is settled.  Then have the company's lawyer draft all the documents.  Finally, have your own lawyer (or the joint lawyer) review the finalized documents before you sign.

I get you.  I was thinking it would be more of just a document review to make sure I understood everything, but having someone there from the start to shape it would be beneficial. 

[jda1984]

I should have added these links to my last post.  There is a group called the National Center for Employee Ownership that has a lot of helpful information on ESOPs and such.  The main website is here:
http://www.nceo.org/

A brief explanation of how ESOPs work in general is here:
https://www.nceo.org/articles/esop-employee-stock-ownership-plan

Certainly they are somewhat customizable, though they have to comply with certain federal regulations.

[Jim2001]

+1 for lawyer at the terms sheet stage.
+1 for a lawyer to represent YOU.  Having an expert who is invested in what's important to you and only you is valuable, especially since you want to FIRE so soon.

[AlwaysLearningToSave]

Edit to Add:  If you choose to go through with this AND you want to hold on to your FIRE plans, your opportunity to set yourself up for your early exit from the company is now, when you purchase the company.  My concern with joint representation in this circumstance would be that your early retirement plans would get lost in the mix.  It would cost more money on the front end to hire your own attorney but doing so will allow the lawyer to review the deal with an eye toward your early exit and give you the best chance at a clean exit later on.

I edited my post to add this, but OP replied to my post while I edited it.  I'm quoting it in a new post just so OP notices the change.

[Axecleaver]

Posting to follow. You may want to consider bringing in a business broker to value the business. You simply accepted his valuation of 5x profit, but this is at the very top end of valuation for small business operations. You'll also need to forecast what happens once the founders reduce their commitments - presumably this will affect sales and profits.

This blog has some informative posts from a business broker perspective - a lot depends on the type of business, but nailing the valuation gives you the best chance to figure out how to model what you're describing. https://williambruce.org/2010/08/13/what-is-a-business-really-worth/

This link describes a term called "discretionary cash flow" - basically, how much money is being generated that isn't going toward paying your employees, rent, etc. This is different from profit because many owners artificially reduce profit to reduce their taxable earnings, then spend the corporate dollars on things like vacations ("sales travel expenses"), personal dining ("business meetings") and hookers and blow ("professional services"). You'll need to get a handle on this, as well.

[Fishindude]

The $300k would be in addition to my 401k, IRAs, bank accounts, and houses. The sum total of those other assets would be $30-50k less than they would have been otherwise because of lost bonuses, but the $300k would in effect push me over my FIRE threshold.  That's my train of thought anyway.

I'm not gunning for the lifestyle of my bosses.  I live happily and lavishly on about $30-35k/yr. 

This says a lot.
I really don't think business ownership is for you.   You could get to those numbers quite easily working for the other guy, with very little risk and some pretty conservative investing.
Your sights should be set much higher as a business owner.     

[frugalnacho]

Posting to follow. You may want to consider bringing in a business broker to value the business. You simply accepted his valuation of 5x profit, but this is at the very top end of valuation for small business operations. You'll also need to forecast what happens once the founders reduce their commitments - presumably this will affect sales and profits.

This blog has some informative posts from a business broker perspective - a lot depends on the type of business, but nailing the valuation gives you the best chance to figure out how to model what you're describing. https://williambruce.org/2010/08/13/what-is-a-business-really-worth/

This link describes a term called "discretionary cash flow" - basically, how much money is being generated that isn't going toward paying your employees, rent, etc. This is different from profit because many owners artificially reduce profit to reduce their taxable earnings, then spend the corporate dollars on things like vacations ("sales travel expenses"), personal dining ("business meetings") and hookers and blow ("professional services"). You'll need to get a handle on this, as well.

That was an arbitrary and hypothetical value given as an example.  We'll definitely deal with actual numbers if/when we actually go through with it.

[ShoulderThingThatGoesUp]

It sounds like it just isn't worth $5 million. You'll need to somehow sell of your portion eventually if you want it to be at all liquid, and is there any reason to believe you won't have the same problem then?

[frugalnacho]

The $300k would be in addition to my 401k, IRAs, bank accounts, and houses. The sum total of those other assets would be $30-50k less than they would have been otherwise because of lost bonuses, but the $300k would in effect push me over my FIRE threshold.  That's my train of thought anyway.

I'm not gunning for the lifestyle of my bosses.  I live happily and lavishly on about $30-35k/yr. 

This says a lot.
I really don't think business ownership is for you.   You could get to those numbers quite easily working for the other guy, with very little risk and some pretty conservative investing.
Your sights should be set much higher as a business owner.   

What does it matter if I want to live a lavish lifestyle, or beef up my vanguard portfolio?  Potentially earning an additional quarter million dollars over the next decade seems like the better choice than not earning it.  And if I have to work for the next decade before FIRE anyway, why not be a business owner and make more money and put myself in a better position? 

[frugalnacho]

It sounds like it just isn't worth $5 million. You'll need to somehow sell of your portion eventually if you want it to be at all liquid, and is there any reason to believe you won't have the same problem then?

What problem? Being unable to sell?  I don't know.  I see liquidity as a problem.  It has value and can generate income, but someone needs to know what they are doing and run it properly.  And they are going to have to anchor themselves to this company for awhile

[With This Herring]

I don't know whether you should go in on this, but if you do:

You will probably want the company to take out life insurance on each owner in the amount necessary to buy out his stake at fair value from his estate should he be hit by a bus AND have that insurance and buyout be part of the ownership agreement.  I doubt you want Joe Schmoe to get hit and then Joe Schmoe's nephew Roger, his only heir, to suddenly be a stakeholder.  You would also want provisions regarding what happens to his repurchased stake.

A 5% stake could be enough for you to do something if you have voting rights, even without special provisions.  If there are three of you small shareholders at 5% each, each of the big shareholders has 42.5% (assuming an even split).  So, if one big holder and two little holders want to sell off the company to BigCo, that is 52.5% of the vote, which is a majority.  With their history, it seems unlikely now that the two big holders would vote in opposite directions, but things can change.

Your purchase price should be less than 5% of the company's value.  Previous posters are correct: You stake MUST be discounted for lack of marketability and lack of control.  These discounts tend to be larger than you would think.

It seems like you are discounting the idea that you could be out $250K (or whatever amount) if the company folds with you still owing.  Could your ownership run through a corp to protect you?  (So, you own X Corp 100%, and X Corp owns 5% of your employing company and owes $250K to employing company.  So maaaybe if employing company goes bankrupt, the corporate veil won't be pierced and X Company can just die without you personally paying the debt.)  This might not provide the protection you would need, but it's worth asking your lawyer.

I am agreeing with everyone else who says it would probably make the most sense to retain your own lawyer from the beginning.

[Cyaphas]

It sounds like your bosses are trying to walk away but still be able to swing in and play monday morning quarter back when they want to. Also known as, having your cake and eating it too. I agree with some of the above posters. the $250k is way to high. If anything, given your experience and that they're offering this to you; I'd offer to take over the business for 10% of the company per year for the next 5 years and .01% on the last year. After the 6th year you'll control 50.1% of the company and they can split the remaining half's profits.

I would make it abundantly clear that you'd be in charge and not them while all of this is going on. You don't want 3 captains on the ship.

Don't play the multi-partner game, it sucks and it only takes one partner to make life miserable for everyone. If you can't come up with something simple and obviously lucrative to you, don't do it. They're the ones trying to get out. Offer them an out. It sounds like they already made their fortune. The amount of hoopps they'd have to jump through to sell the company to someone who isn't you are pretty extensive and the price they'd get probably isn't what they want.

Offer them something simple that gives you control of the business and controlling interest in the business but still gives them a check every time the profits roll in. Don't let them or more importantly, their inheritors control you and your business.

[chesebert]

The more OP talks about this "opportunity" the more I get the feeling the bosses are trying to screw with the employees. Instead of taking 10% from their holding and put toward a regular ESOP program, they want the employees to "invest" in the company. The bosses would get a $250k (or whatever amount) payout and the employees get 5% of the company, which really means nothing.

OP, you will not automatically get 50K just because that is 5% of the company's net income. You only get what the bosses want to distribute/dividend to you, which could be 0. The bosses can get their money in many ways without distribution/dividend. For example, they can get the company to loan them a pot of money at market interest and increase their salaries by some amount to cover the loan repayment. Alternatively, they can provide some dubious "service" to the company in return for a big pay day. Stuff like this may not be legal, but good luck trying to get evidence and sue in court. Stuff like this is why minority ownership without extensive veto rights sucks big time.

Also, stuff like this is why I am more than ever convinced that non-accredited investors really have no business investing in private companies. What's more, based on your answers, you have no business buying from your bosses and your bosses probably shouldn't even have offered their stocks to you in the first place. I would get your bosses to contact their lawyer....

https://www.sec.gov/oiea/investor-alerts-bulletins/ib_privateplacements.html

[AlwaysLearningToSave]

The more OP talks about this "opportunity" the more I get the feeling the bosses are trying to screw with the employees. Instead of taking 10% from their holding and put toward a regular ESOP program, they want the employees to "invest" in the company. The bosses would get a $250k (or whatever amount) payout and the employees get 5% of the company, which really means nothing.

OP, you will not automatically get 50K just because that is 5% of the company's net income. You only get what the bosses want to distribute/dividend to you, which could be 0. The bosses can get their money in many ways without distribution/dividend. For example, they can get the company to loan them a pot of money at market interest and increase their salaries by some amount to cover the loan repayment. Alternatively, they can provide some dubious "service" to the company in return for a big pay day. Stuff like this may not be legal, but good luck trying to get evidence and sue in court. Stuff like this is why minority ownership without extensive veto rights sucks big time.

I don't know that I'd go so far as to say they are TRYING to screw with employees.  Small business owners often have inflated views of the value of their companies and think they are being benevolent when they propose things like this.  Regardless of intent, I agree with the overall sentiment that it would certainly be unwise to buy 5% without significant additional rights to protect your interests. 

If you were to broach the subject of purchasing the entire business or a controlling interest in the business (either immediately or over time), their response would be telling.  If they are actually interested in getting out of the business, the negotiation will continue.  If they don't like that idea, then you know that they are not in fact prepared to hand over the reigns and walk away from the income stream, in which case I would be reluctant to buy in for fear the current owners would hang around too long and create problems in the future.   

[frugalnacho]

The more OP talks about this "opportunity" the more I get the feeling the bosses are trying to screw with the employees. Instead of taking 10% from their holding and put toward a regular ESOP program, they want the employees to "invest" in the company. The bosses would get a $250k (or whatever amount) payout and the employees get 5% of the company, which really means nothing.

OP, you will not automatically get 50K just because that is 5% of the company's net income. You only get what the bosses want to distribute/dividend to you, which could be 0. The bosses can get their money in many ways without distribution/dividend. For example, they can get the company to loan them a pot of money at market interest and increase their salaries by some amount to cover the loan repayment. Alternatively, they can provide some dubious "service" to the company in return for a big pay day. Stuff like this may not be legal, but good luck trying to get evidence and sue in court. Stuff like this is why minority ownership without extensive veto rights sucks big time.

Also, stuff like this is why I am more than ever convinced that non-accredited investors really have no business investing in private companies. What's more, based on your answers, you have no business buying from your bosses and your bosses probably shouldn't even have offered their stocks to you in the first place. I would get your bosses to contact their lawyer....

https://www.sec.gov/oiea/investor-alerts-bulletins/ib_privateplacements.html

I think you may be over reacting a bit.  He admittedly doesn't know the process or details, this was a very preliminary meeting just to gauge potential interest.  I think he spoke with some people during a conference and they did something similar, so he is gauging interest before he invests much into going forward.

My goal with this thread wasn't to bring accurate numbers or details, more of just an open discussion so I'm more educated on the matter.

Edit: I think everything is going to be on the up and up.  With lawyers on both sides. 

[Cyaphas]

I think you may be over reacting a bit.  He admittedly doesn't know the process or details, this was a very preliminary meeting just to gauge potential interest.  I think he spoke with some people during a conference and they did something similar, so he is gauging interest before he invests much into going forward.

I don't think he is. We don't know you, the business or the owners. But, given your wages, the amount of money they're asking from you is pretty ridiculous. That and you're going to be taking a hell of a lot more onto your plate with little to no benefit. 7-8 years of wages for 5% with no voice, a TON of risk and a lot of extra responsibility isn't worth your time.