About to buy a $4MM company!

Hello,

I am studying for my General Insurance / Management exams, and plan to enter into the Insurance Brokerage field.

I currently have a connection to a firm that will be for sale shortly (Valued at $4MM, with annual sales of $1MM and profits of $600,000 CAD).

Being a student entering university in September, I do not have the capital to purchase this corporation up front. I have prepared a presentation to the current owner offering the following:

He will maintain an 80% stake in the company for 3 years.
After which, he will maintain a 60% stake in the company for 3 years.
After which, he will maintain a 40% stake in the company for 3 years.
After which, he will maintain a 20% stake in the company for 3 years.
Finally, he will maintain a 10% stake in the company for the remainder of it's existance, and will be entitled to 10% of the profits when I sell the company in 20+ years.

** As I have also been studying investments, I will be expanding the business to both insurance and investment brokerage (expecting 5% annual growth of profit).

My questions are,

Would you take this deal if you were the owner of the company?

Would I be better off finding a VC firm or angel investors group to fund this?

What (typically) to VC firms require in return for such an investment.

Comments (14)

 
Jan 24, 2011 - 5:16pm

As the owner, not sure what my goals would be. If I want out...well then your deal doesn't sound too great. I need money up front.

 
Jan 24, 2011 - 5:43pm

Who did the valuation?
Will he be taking a salary/staying on with the business?
What sort of company is it? (I assume some sort of retail insurance brokerage)

There have been many great comebacks throughout history. Jesus was dead but then came back as an all-powerful God-Zombie.
 
Jan 24, 2011 - 6:03pm

What are you paying him for the company? If you think he's just going to hand over 20% of his equity to you every 3 years for free and then take 10% of the profits when you sell the company, you're nuts. Yeah, he'd want more money up front, but on top of that it's a losing investment unless the company is worth more than 10 times its current value (adjusted for inflation, too) when you're done.

VC would only be interested if this were a young company with serious growth prospects. And being as you're a high school kid, you would have to have a VERY compelling vision for them to back you.

But the main thing is this: you want to buy this company and run it for 20 years. That's not a part-time gig; that's a full-time job. Nobody's going to support your purchase of a company that you're going to run from your dorm room, and I would have a hard time believing in the managerial ability of anybody who's so young.

Your situation sort of reminds me of a search fund, where investors back a young person (usually a recent HSW MBA grad) in conducting a leveraged buyout of an existing company; the young dude then runs the company, eventually sells it, and hopefully makes a bunch of money on the exit. The timeline for such a fund, however, is usually less than 20 years. And more importantly, what the investors in the deal are really doing is making a bet on the managerial ability of the young manager.

That's the key point: for someone to bet on you (and someone handing you equity for free is just that), you need to get them to believe in you. That means a compelling vision, impressive experience, or something comparable.

One of those lights, slightly brighter than the rest, will be my wingtip passing over.
 
Jan 24, 2011 - 6:28pm

Not to burst any bubbles, but that is not likely going to happen...though it's probably worth a shot.

Like some of the other members have said, you are young, lack experience and capital...which makes this such a long shot for a VC or investors. The problem with equity is it could end up being worth zero, so in your payout scenario, as well as the VC/investor idea...promising some a percentage of something is only worth their time and money if it is likely to be worth more than what it was when they bought in...and truthfully, they are going to look at you (young, inexperienced, etc.) and think it is too great of a risk (most likely).

Like I said before, it's worth asking, it's just a tough sell...especially if the owner is looking to sell the business...which probably implies he just wants to retire/slowdown and/or invest the cash someplace else.

Regards

"The trouble with our liberal friends is not that they're ignorant, it's just that they know so much that isn't so." - Ronald Reagan
 
Jan 24, 2011 - 6:44pm

I don't know if I conveyed my main point well. This guy currently has 100% equity in the business. So if he sells it today, he gets all of the money. Any deal you offer him has to improve his situation if he's not going to just sell the company to a larger firm for $4 million.

You offer lets him retain some of his equity, but he parts with the majority of his current stake and doesn't get anything in return for it aside from the chance to redeem 10% of the company's (hopefully greater) value down the road - an opportunity that he already has right now, only with 100% of the company. A VC or angel investor will take equity in lieu of cash, but all you're offering the current owner is the chance to lose equity that he already has. There needs to be more in it for him than that.

One of those lights, slightly brighter than the rest, will be my wingtip passing over.
 
Jan 24, 2011 - 6:49pm

thanks for all the replies! The owner is a close family friend, I call him 'uncle'. His motives for selling are wanting to have more lengthy stays at his vacation properties without worrying about the business. What I bring to the table is a young bright-eyed spirit with interest and the ability to learn and adapt quickly.

My 'uncle' would be willing to wait a few years (or so he has said several times) before he finally sells the business, giving me enough time to finish my commerce degree (going to Queen's if it matters).

Also, he has sponsored me for the licensing through RIBO (registered insurance brokers of ontario) and said he would be willing to spend ample time helping his buyer and clients progress from one owner to the next.

So, I don't feel that there would be any issue here beyond the money, and (so far) this is the offer I have come up with

 
Jan 24, 2011 - 8:11pm

bankster:
thanks for all the replies! The owner is a close family friend, I call him 'uncle'. His motives for selling are wanting to have more lengthy stays at his vacation properties without worrying about the business. What I bring to the table is a young bright-eyed spirit with interest and the ability to learn and adapt quickly.

My 'uncle' would be willing to wait a few years (or so he has said several times) before he finally sells the business, giving me enough time to finish my commerce degree (going to Queen's if it matters).

Also, he has sponsored me for the licensing through RIBO (registered insurance brokers of ontario) and said he would be willing to spend ample time helping his buyer and clients progress from one owner to the next.

So, I don't feel that there would be any issue here beyond the money, and (so far) this is the offer I have come up with

Truthfully, you are in a good position then. If he is willing to wait and has enough cash in the bank, he might be willing to do a structured earn-out like you outlined (or something similar). You have the benefit of knowing him, it's a small business which likely means he's attached to it and doesn't jut want to ruin the relationships he has built over the years, etc.

You could potentially do a "seller note" in which he would essentially transfer the ownership to you (because you don't have cash to "buy" the equity now) at whatever percentage you and he decided to. He would collect interest on the note for a given period of time and then at some point in the future you would have to start paying down the principal at a rate that is supported by the current FCF of the business. I don't know if this is much better than the way you outlined but as a debt security, he would have legal recourse should you default on your payments and could potentially recover some of the money through liquidation of assets (PPE and AR)...or just take back over the business.

Anyhow, seems like there are some possibilities given his relationship to you and your family. Good luck.

Regards

"The trouble with our liberal friends is not that they're ignorant, it's just that they know so much that isn't so." - Ronald Reagan
 
Jan 24, 2011 - 6:55pm

The way I see it, the first 2 "transition years" will return him more than the 20% equity I will own, and after this point he will always be ahead with regards to equity vs. cash. I guess I would be willing to take 0% equity for the transition years, and then go from there = 0,0, 10, 20, 40, etc.

 
Jan 24, 2011 - 7:00pm

I have a better idea. Why not have him hire you as the CEO. You figure out what your time is worth (say $25/hour for most new financial professionals outside NYC), figure out how much work the job is (maybe 60 hours/week), and say you want $75K/year from him to work on his business. $35K/year to be paid in cash and $40K/year to be paid in equity. Or maybe $20K/year in cash, $40K/year in equity with a performance bonus.

Hate to say it, but if you're a recent college grad, that's really all you're worth. And if the business is worth $4 million and everything stays constant in terms of value, pay, and income, you'll probably own the business in 20-21 years.

 
Jan 24, 2011 - 7:36pm

Don't quite understand. How much are you paying him up front? 20% of $4MM? And then you'll buyout his position after say 3 year increment until his ownership goes down to 10%? First like the other posters said the timeline is way too long for someone who wants to sell his company. Also your valuation is not gonna hold for even 6 months not to say 10 years! So, if this is a staggering payment the valuation would need to be evaluated at each point.

Array
 
Jan 24, 2011 - 7:49pm
Men are so simple and so much inclined to obey immediate needs that a deceiver will never lack victims for his deceptions. -Niccolo Machiavelli
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