Selling a company is not a quick process. Ray Gauthier, 48, knows that. If his strategy goes according to plan, he'll sell his $2.5 million company, Lynbrook of Annapolis, Annapolis, Md., in about 17 years to as many as six partner/employees.
His closely held S Corp. has two levels of stock. Gauthier holds control through V (voting) shares, while two employees, Bryan Beauchemin and Steve Podlich, hold N (non-voting) shares. A third employee, John Sasenick, will be given the chance to buy non-voting shares soon, based on his two-plus years at the company.
"I'm trying to grow the company, and you grow with quality people who are committed," Gauthier says. "The way to get them committed is with ownership interest."
He wants to grow the $2.5 million company by $500,000, or one job, each year, with $10 million his 17-year target.
Gauthier owns 65% of the company; 35% is owned by Beauchemin and Podlich. Sasenick will buy 5% of Gauthier's stock. Each owner shares a percentage of profits equal to their ownership. Some will always own more than others, based on seniority and what they purchase when Gauthier decides to issue new shares or make his available. His target of six potential partners is arbitrary, and his vice president, Beauchemin, will exert influence in hiring strong new employees so Gauthier has partners to buy his shares when he leaves. Money to buy the stock comes from the partner's savings or profit sharing.
Once a year, the business owners set an "agreed value." They look at assets, estimate the value of good will, and assign a value after subtracting liabilities.
"Everyone at the table doesn't know if they will be a buyer or seller of stock that year," Gauthier says. "We come up with a fair number that way." The percentage split is not redone annually, the partners simply determine the lump sum value of the shares. An operating agreement stipulates if someone dies or is unable to continue, the value of his shares is determined by the last agreed-to value.
Good will is the hardest value to measure. In the past they've used two times net profit, although as the business gets more profitable and has deeper roots, it's less risky, so Gauthier anticipates higher goodwill value.
Experts say, in general, good will can run three to five times net profit. The multiple is important because it also affects how much in profit sharing the partners receive. For instance, with a 2x multiple, Sasenick's 5% ownership will mean a 33% return on investment annually, if the company matches its past profit record. A higher multiple would mean a more realistic return of 20%, which Gauthier's advisers are suggesting.
"However, when you make the company very valuable, you create a higher buy-in value," Gauthier says. He doesn't think he wants to do that.
Gauthier's goal is to end up with a smaller percentage of a bigger pie, through revenue growth. He will maintain control until he divests all V shares. His partners will get options to buy his stock, with each one's percentage based on how much they already own of the company. Technically, he will have fewer shares over time but will still maintain voting control until the V shares are gone.
Gauthier has gone further in doling out ownership than his advisers suggest. But he feels doing so will make his partners eager to push the company and build value, so he can exit with cash in hand.
Selling to the Competition
Soon after the terrorist attacks of September 11, 2001, Jordan Lourie's electrician of a decade died. The combination of events was an epiphany of sorts for the 47-year-old contractor. "It made me look at what I'm doing with my life," Lourie says.
The year 2002 marked Silver Hammer Construction's best year, with $1.9 million in revenues. Profitability was increasing, along with Lourie's salary. But he had grown tired of managing. The owner of the Oakland, Calif., design/build firm realized, "I'm not enjoying this as much as I used to."
Like many remodelers, he didn't think there was value in his company and thought about just closing its doors. But at the prompting of his wife and colleagues, he realized the value of the company was its reputation, and its reputation was based on its employees. So he started looking for a compatible company to sell his name and his employees to.
After false starts with potential acquirers, he met with Michael McCutcheon of the $5.7-million-a-year McCutcheon Construction, Berkeley.
McCutcheon had missed a previous acquisition opportunity and regretted it. He saw value in bringing on skilled employees whose systems and market approach were similar. This presented him a chance, for minimal investment, to bump up revenues by Silver Hammer's $2 million in work and to add eight of Lourie's 10 employees to his 35-employee roster
They agreed on a price of $115,000, paid in installments through January 2004. Although a lawyer drafted a 16-page agreement, in the end, Lourie and McCutcheon created their own three-page pact, covering tools and equipment, systems, and client lists, but not the company -- a move designed to limit McCutcheon's liability for Silver Hammer projects. McCutcheon says experts recommended this move. "While this does not take the liability to zero, we are told it helps," he says.
Added later was something neither anticipated: Lourie became McCutcheon's VP of sales and marketing.
Lourie estimates he saved $50,000 by not simply closing down, based on liquidation costs other businesses spend. "I wasn't greedy," he says. "I might have undervalued it by $50,000 or $100,000. But I found a great home for my staff, and I may have found a great home for myself as well. And I wasn't looking for that. You can't put a dollar value on that."
One Way to a $1 Million Buyout
Dave Cooper, a Twin Falls, Idaho, accountant, believes employees must buy stock for it to be valuable, not have stock given to them. ESOPs, he says, make everyone an owner, but not everyone wants responsibility.
Cooper, of CooperNorman, began helping businesses develop succession plans based on minority interests financed by banks primarily because the plans create buyers (employees) and protect the bank against default on payments for the shares.
Under his employee participation trust plan, stock ownership is subject to a shareholder agreement that allows employees, through a "put option," to sell shares back to the company for any reason, at purchase price.
Those minority interests are typically worth nothing to banks, because their owners have no management control, but because of the put option, they now have value without that control.
Banks also like the fact that by creating new leaders motivated by profits, the majority interest also becomes valuable to employees. The owner's shares are valuable because when the owner leaves, his profit is left on the table.
A predictable profit stream determines fair market value and helps pay the loan taken by employees to buy shares, enabled through profit sharing. By empowering the next generation, the company owner captures this value, along with good will. Cooper says a general rule for transferable profit is about three to five times its value. So a $1.5 million business growing to $3 million and earning a $250,000-a-year net profit could be worth $1 million. The owner retires with $1 million, plus profits generated over time. "I haven't had any difficulty convincing a bank to do our plan," Cooper says.
It takes about seven years to implement the transition. Plan documents cost up to $15,000, plus ongoing consulting. Contact Cooper at email@example.com.