Becoming "associate" in a small company you are working for

Investing / Others
1

Throwaway account. Long time reader, but I never posted.

Hi everyone!

I was looking for similar experience in this forum but didn’t find anything comparable.
Feel free to oriente me or move this topic in another category if necessary.

I (35, M, swiss) am working for a small non quoted consulting company (about 20 employees). We sell consult hours and niche software solutions and earn money from subscriptions (we have a half-moat).

Salary today as an employee : 120k + 10k bonus per year.

Networth:

  • Cash 100k
  • ETF: 100k
  • Stocks: 100k
  • 3rd Pillar: 50k

After 5 years working in the company, I could invest about 400k and acquire 10% of the company (the 90% are shared equally between 4 other partners or “associates”) and becoming a partner/associate. I would benefit from the company’s earnings each year: on average an extra 30k bonus (as salary) and 25k as dividend, yearly, while keeping about the same caped base salary (same for all partners).

Almost all earnings would be split yearly between all partners, a part as salary bonuses, a part as dividends.

The company has a half but solid moat and is 100% owned by the founding partners who are also employed (they are about 45 years old). It’s mandatory to work in the company to stay as a partner. One partner is leaving and can only sell to the other partners or to a new one (that could be me).

The company is private. Owned by 5 partners (each 20%) who developed and are still developing the company. They also all work for the company. There is no external financing. One partner is retiring and selling 20%. The other 4 partners will buy 10% from this, and I could buy the rest 10%. I would be able to buy another 10% if I decided to.

The good:

  • Earnings are constantly, steadily growing. I would be able to sell to (and only to) other partners if I decide to leave. It’s a bit like a lawyer or consulting office, where the profit is split equally between the owners who also are employed in the company.
  • Incentives: all the partners are working to maximize the company earnings.
  • Clever people: all the partners are high skilled, experienced in this company and dedicated to the company. If one partner is missing, the company would survive.
  • There is no external control. No other external investor or financing (bank).
  • Dilution is not really a risk, as the other partners would also be concerned.
  • I believe in the company’s future, who as still potential in the branche.

The bad:

  • Low liquidity could be a risk.
  • If two or more partners (one would be ok) are leaving, it could be difficult to replace them (very high skilled). But I don’t know why they would leave.
  • I would put all my eggs in the same basket.
  • I will have to take a loan to finance 1/4 of my investment. I have today about 300k in cash and easily salable ETF/stocks. For the missing 100k, I would have probably have to take a loan. I’ve been saving money and building my nest starting from zero the last 10 years. Taking this opportunity would mean putting all my eggs in the same bag … I’m am still not very sure if it’s a clever idea.

  1. How would you estimate the risks and returns of this investment?

  2. How would you balance between maximum cash/minimum loan or minimum cash/maximum loan?

  3. My concern is also, how should I calculate the return on investment?
    The shares I would buy could also increase in value and I could profit from it if a decided to sell if/when I leave.

  4. Would you do it? I project to fire or minimum “barista Fire” in about 10 to 15 years. Taking this risk would highly increase my returns, but is more risky (high risk, high return).

I get it is a bit risky but the company is nationally well known and renown in this niche domaine.

  1. Any recommendations to finance the missing 100k?

  2. Any recommendations regarding taxation?

Thanks in advance for your feedbacks or ideas.

4 Likes
2

Just to be clear: for an investment of 400k, you would receive an extra 55k from this investment? i.e. an expected 13.75% yield?

Aside from the concentration risk, this depends entirely on the stability of the sector and the outlook for the company. In particular, how susceptible it would be in a downturn.

If the outlook is good and the risk limited, I personally would go for it. You’re young enough to survive a failure.

I’d look into options for financing it to avoid taking an external loan. For example, if the seller would accept receiving the last 100k over 2 years corresponding to the 2 years worth of ‘yield’?

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4

yes, exactly, on average about 13.75%, depending on the earnings.
I don’t take into account the possible/probable increase in share value when I will “exit”.

I will be able to look in the books from the 5 to 10 years back. The business is simple, I know of it works.

Legal risks are a bit more tricky for me to estimate. The company has a very good reputation in his field, and a good potential lever abroad. But competition could also intensify.

5

How are the shares of the company valuated ?
Is there any formula or an accountant evaluating the shares ?
How long did the leaving partners stay in the cmpany ?
Was the shares reevaluated since he joined ?
What is the seller profit on this 800k ?

1 Like
6

Due to liquidity, I would not assign the shares any capital value at all in my calculations and instead look only at the future income stream.

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8

I see several red flags here:

  1. break-even after 7.27 years (assumptions number stay the same, if the 400k are in VT its more like 10+ years) in a very fast developping field.

  2. very small company which is somehow dependant on 2-3 persons at the top.

  3. low base salary → 120k in IT is not much for a management position → if you change your job and get 20-40k more, the deal is IMO a joke (considering the risks I see)

  4. no clear valuation + even if you have a formula the other partners might agree to measures/tricks to lower it

  5. no clear buyer/exit szenario-> what if you exit and the others are not liquid or don‘t believe in the future of their company anymore, what would you do then?

  6. its 133% of your cash → you risk to lose all your savings + job at the same time

I would only consider it if you plan to stay there for a very, very long time + you are very sure that this company will grow above the market and outperform its competition.

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9

External audit every year, company value based on yearly volume of sales (averaged from the 5 past years).

Share are reevaluated every year. Leaving partner stayed almost 20 years, bought the shares probably from a fraction from actual price 20 years ago.

10

clearly a).

don’t really like the competitor’s strategy/organization.
starting a new one is tricky, the moat (contracts, clients base, reputation) is quite big.

1 Like
11

What you could try to negoriate is an earn out deal where you share the risk with the exiting partner:

Example:

100k now + dividends AND 30k of Bonus for the next 7 years.

= he can profit or lose from the upside but you only risk 100k

12

  1. we provide more “expertise” than pure IT services. 7 years could look long, but shorter break-even would even mean “more risk”, no?

  2. yes, more 4 to 6 “key peoples”, but yes it’s quite small.

  3. I couldn’t except a lot more in my field (again, not 100% IT). I don’t have a managing position (yet),

  4. I didn’t see the valuation yet. It will be the next step. Valuation is done externally.

  5. that’s the bigger risk.

  6. true. but with my skills I will find a job very easily. but yes, it could be a problem when I get kids or mortgage for exemple.

13

sounds a good idea, I don’t know if it’s possible, will definitively check!

15

the only ones I know for the moment:

  • If you have a smaller share (let’s say 12% and the other 4 have 22% each), you are allowed to buy till everyone has the same share (here would be 20%).
  • you can’t leave the company and keep the shares if another partner want to buy them
  • you can’t sell your share to a third company/person.
16

Something to mention here before it gets lost is you can’t compare entrepreneurship and its ups and downs to a purely financial investment in the stock market. It’s impossible. Because the partnership / associate-ship status changes pretty much everything about your position in the capital hierarhy as you go from employee to employer.
Which people who haven’t done it can’t comprehend even if they say they’ve read things - Not The Same.

If you tick that way you wouldn’t go around asking on forums, let’s put it like this.

8 Likes
17

lot of true points here, thanks!

I’m not a “born to be entrepreneur”, true. I value financial freedom and independence: if I invest here, I would increase my financial freedom (highest earnings middle/long term) but would decrease my freedom to move from the company or move my assets/investment.

I’m not really on forums to only ask “should I do it or not” (that was my question number 4) but to clear some uncertainties, regarding my questions (all other questions).

18

Defintely a very big bet, and 7 years to have back the investment it is really a lot if you want to put more or less all your money in this.

The big part of the evaluation is the actualization of the future earning, it is important to understand which kind of grow they are estimating

If they are estimating 20% grow every year for the next 7 you are for sure overpaying it.
As soon you have the evaluation I suggest to ask for a neutral opinion, also if they are doing the evaluation from an external company.

19

Important to keep in mind that that “valuation” only holds true as long as business is doing well and (new) partners happily line up to take your shares.

If growth stagnates, you want out for whatever reason and the opposite holds, it’s really only worth what the other partners are willing to pay for it. If anything.

Another thing: ensure there’s a drag along / tag along clause in the shareholder agreement. This avoids the situation where a majority wants to sell (e.g. to a PE firm) but one partner, or potentially his wife/kids if (s)he dies unexpectedly dies, refuses to sell for the agreed price.

5 Likes
20

But this would be your business. If you don’t really see it as such and don’t want the long term commitment that this will mean, I would avoid it. As you can get up to 20%, the quesiton is whether the 20% represents enough considering the potential of the company.

1 Like
21

In your situation, I wouldn’t accept this offer.
Especially, because it’s would represent all your net worth and that you will be a minority stakeholder.

BTW, maybe they did this offer to multiple employees

22

Yeah it’s one of those decisions where you have to see if you get along well enough with the existing partners to make it worthwile, as you’ll spend a lot more time with them for an undefined time

How old are the four other partners? How close to retirement are they? How are they planning to help you get up to speed to executive management level? What are their strategic plans for the firm? Which new insights can you bring, and how does that complement theirs?

etc

1 Like
23

Sounds like a no brainer to me. If you do the cost/benefit analysis, it is probably your one single chance to go chubby/fat fire in a decade or two. IT sector is growing steadily by 20/30% every year, and do you think it will slowdown? Nope, unless your are doing some obscure technologies.

Make sure to:

  • hire a lawyer that knows about this particular type of shareholder agreement (drag/tag along, preemptive rights, etc.) = ask the associates in your current job if they have a reco, if you’re still in good terms with them
  • optimise the debt, I would look to borrow the full 400k if I could and the terms are acceptable.
  • make sure to go along well with the other partners, what you are doing is truly like a wedding…

Good luck, sounds exciting!

3 Likes