Potential pitfalls...running business for owner for 2 yrs...purchase at the end

I have posted before about trying to buy the business that I work for(6 employees). After speaking to my CPA a couple years ago and looking at the asking price, we were light years apart (400k). Fortunately, we kept things civil and no hard feelings developed.

Fast forward a couple years and they sit me down and tell me they just want to be done with daily operations and want me to run the company for 2 years while paying them 3-4k per month. At the end of the 2 years a price will be determined and the money I have been paying them for the last two years will go towards the purchase. The tone seems to have definitely changed since we last spoke about this, but I am still concerned that we could be far apart.

What advice can you give about a scenario such as this? How much should I ask for compensation, since my responsibilities will be greatly increased? Could my request for extra compensation be an insult since they seem to by trying pretty hard to sell me the business?

As always I appreciate the input.

I would like to know the purchase price before I began. No way I would invest my time and money for 2 years without have any idea what the price will be.

They want you to pay them, while they still own the business? and we'll determine the price later on? What would you say to car dealer that suggested you send him a couple of grand and after two years he'll tell you the price? That is just mental.

There is a corporate finance expression, its not what you pay, its how you pay. What that means is when you buy a business, you don't mind paying more if there is lots of vendor financing involved or better still some v.financing and an earn out formula. This means part of purchase price includes cash today, part is fixed repayment loan and part is paid out of future profits so is contingent. but YOU OWN IT 100% now....and make sure their notes are unsecured so you can get financing if needed

The difficulty in buying a small business is people lie to themselves. One part of brains says we want out, we want out....but when it comes to putting pen to paper, another part of brain wrecks the deal....the subconscious part that realizes they're not selling an asset, they're selling their identity....they can't stand the idea of not being President the Monday morning after closing because they've been so for decades.

That paragraph is worth a fortune as it is very hard come by experience. Its hard appreciate that its all driven by psychology not numbers, despite the topic being corporate finance. Its really, really hard to buy these small businesses if the person is healthy.

Modern machine shop has recommended using shares of the company to transfer ownership from family members for tax purposes. Perhaps instead of paying them monthly you instead buy shares of the company (say 100 to keep it simple) and at the end of the 2 years you buy them out of their remaining shares at a predetermined rate.

IMO it would make it easier to see what everyone has at stake in the business since the shares cannot be disputed.

masome said:

...want me to run the company for 2 years while paying them 3-4k per month. At the end of the 2 years a price will be determined...

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I wouldn't pay 10 cents toward the company unless I had a signed contract on the terms of the sale, and full control of the business finances and decision making.

They're searching for a sucker. Don't be a sucker. After you pay them for 2 yrs they will still ask the 400k or more espcially if you improve the business and increase profits.

Seems like the harder you work to run and build that business over the two years ,the more you will have to pay at the end.

pmtool said:

I would like to know the purchase price before I began. No way I would invest my time and money for 2 years without have any idea what the price will be.

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This is my main concern. We had declining sales from an abnormal peak between 09-12 and this year has picked up. So things run well these next couple years and show climbing sales, that in turn drives up the purchase price.

One other way I was looking at it was that this money i am paying them every month is out if the company coffer, so as long as i was compensated fairly during these two years it may not be too bad of a deal, barring an outrageous asking price.

I will also have full responsibility over finances although she will still keep tabs from home. I would most likely need approval for machinery purchases as well.

Hazzert said:

Modern machine shop has recommended using shares of the company to transfer ownership from family members for tax purposes. Perhaps instead of paying them monthly you instead buy shares of the company (say 100 to keep it simple) and at the end of the 2 years you buy them out of their remaining shares at a predetermined rate.

IMO it would make it easier to see what everyone has at stake in the business since the shares cannot be disputed.

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Very interesting. That does seem simple.

I would have the price set and buy it up front with a bank loan or what ever else, god only knows what ideas might come into someone's head in a year or two and you have been paying away at something you don't even know the price off, thats a new one for me and totally insane.

Figure they are netting x amount perhaps with little debt. You may be trying to pay the mortgage with that same net.
The family doesn’t want it or they would be considered. Machines likely worth way less than they figure. Do they have a safe manufactured product or doing jobber work.
Are you $400K apart on the asking? Or is the asking $400K
Is it even in the ballpark of 4x net and 2x gross

Agree if you grow the business they will expect a share so an upfront price agreement would be good.
You can't run your job when out knocking on doors or answering the phone, can the business afford the loss of your work?
loose $100k paying someone to do your current job.

They may have to pay a ton of capital gains so losing much with that.

[The tone seems to have definitely changed since] likely they have put in some research and heve found not a very good market for selling a machine shop and machines are often going for scrap..

Get a lawyer, get a GOOD lawyer...

Just because its a friendly transaction doesn't mean that you don't need a lawyer, your
own lawyer... To look over the paperwork and deal with their lawyer. This type of thing
is EXACTLY what business lawyers do.

Either you are buying it, or you are not buying it.. Hoping and praying that you might be buying
it is just flat out Bull Shit, and I would put a 98% chance that you will get screwed...

If they are honest, they would WANT you to have a lawyer looking everything over...

I recently bought (now) MY building.. Friendly deal, very fair terms.. SIMPLE terms when you talk about
it and shake hands... The landlord said "talk to my lawyer", and his lawyer is a cool guy.. And I asked
if it was OK if I had my lawyer look it over. My EX-landlord, being an honest and fair guy said "I would
actually prefer you have your lawyer look it over".. Turns out our simple handshake deal, when all the
legalities are added is not quite so simple, so the lawyers dealt with it. What should have been a single
sheet of paper ended up being about an inch thick of paperwork.. And I didn't understand a bit of it.

And again, just because there are lawyers involved does not mean it isn't a friendly transaction.

How do you find a good lawyer? Get another professional to recommend them.. Another thing that works in
this state.. On the state SOS site look up companies that you respect and believe are well run.. Other
shops, local stores, etc.... You *should* be able to see who their "agent" is. You should also be able
to search by "agent"... See who and what they represent... And then go with one that is apparently well
regarded in the business world. Good lawyers may charge more per hour, but they do things quick and proper and
cost less overall..

Do you want to work for this company? Do you have a compensation amount in mind to work for them? I would put aside the purchase and just agree on working for them under compensation and terms you would benefit from and would be willing to leave your current situation. I would have a hiring bonus upfront in case things don't go well and you might be let go or might have to leave. Again I would not suggest any part of this being buying the business. Once you work for the company you can judge for yourself: A- If you like it , B- see if it makes a profit C- understand which assets work/fit the business and which don't.

Once you evaluate it you can make an offer at any time to the owners.

I wouldn't hide this, just let them know you feel it's the most comfortable way you would like to approach it. Your compensation can be a minimum agreed amount and a bonus based on performance you define, etc. or any other terms you both can agree to. Leave the purchase out of it since you have a history of both sides not seeing it at the same value.

You might lose it if they sell it to somebody else but ask yourself who? Or in your employment agreement put in that you would have first right to buy the business at same terms of sale they have with any other buyer, should the employer have find a buyer.

masome said:

Very interesting. That does seem simple.

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disagree. You would really need a shareholders agreement which is not simple, but more importantly, being a minority shareholder in a private corporation can be a special kind of purgatory only fit for fools wasters and drunkards

Do a deal (now or whenever ) for all the shares, with a VTB and/or earn out and pledge the shares against the VTB. Puts you in control and gives the Vendor some security if you stop paying the VTB. Don't try to be partially pregnant

Stupid on their part as well. If a sale price is not decided on for two years, what keeps you from devaluing the company for the next two years in order to achieve a more favorable price.

Is this for real? I think the OP is testing us to see if we're awake!
I have the same deal for you; With my brains and your money we'll go places, just hand it over.
If this deal is for real consider what a bank would say to those terms?
Dan

masome said:

I At the end of the 2 years a price will be determined

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SHYSTER ALERT!
I'd say they're thinking they're last try didn't work with you, so
this is another attempt with a little different spin on it.
Lots of opportunity for them to "change their minds", their
moods, and their intentions (BTW the road to hell is paved with
good intentions).

If nothing else, I'm gonna guess the price they "determine" comes out pretty high.

ALL details, rules, specifications, and legals should be ON the table and up front with signed legal papers going IN to
such an agreement. No exceptions.....unless you're hankerin for a screw'in...
Depending on your age and personality, they may think you're a sucker they can
hook (as mentioned previous). I think IF you are really interested, you need to do some homework on your own. And have THEM get the assets appraised for starters.

My attitude would be light hearted. When they came up with that latest BS proposal I would have been grinning and maybe shaking my head a little.
Tell them "when you get serious, let me know so we can get REAL about this idea". If you're interested, you don't want to piss them off, but you want to make sure they know you're too smart for their foolishness and idiot proposals.

I'm going to guess in this economy they are fully aware that an auction would net them very little. You could be their best bet if they don't get too greedy.
What's their plan B if you don't buy it? Ask them that question point blank.

All of the responses so far have basically confirmed my suspicion that this is not a normal practice. It is clear that if i am to proceed with this that the terms need to be set in the beginning.
I used an attorney last time we did this and I will use one again if I decide to go forward.

I am working on something like this now. I am the owner and want to sell to an employee.
First, the company needed to be valued by an independent accounting firm that specializes in business. This sets a target price for what the company is worth right now.
Most owners think their business is worth far more than it actually is. (I was happy with it )
Without that, there can't be any real talk of where the deal was going.

Once we had that number, accountant and lawyer. Change by-laws of the company, issue stock blah blah blah. 2 different lawyers .
Employee has access to books, knows costs, profit etc.
We have talked to the bankers as well, so there is a very rough draft on how it will go.
I wouldn't dream of asking the guy to put his money into it.If they are not willing to pay to get it valued, I wouldn't touch it.