How can you acquire an ownership interest in someone else’s business when you are bringing non-cash assets like your knowledge or time to the deal?
How do you structure a deal to let someone else into your existing business as an equity owner when they don’t have cash but do have something else that’s valuable to your company that you want?
We have done several deals including a recent one like this, so I thought I would share one approach with you that comprises 7 key deal points to remember.
You can use this to get equity in someone else’s business when you are bringing cash or non-cash assets or skills to the business, or if you own an existing business and want to bring someone in for cash or no cash and other assets or skills you believe are valuable.
The main points to consider are...
1. What are the roles of each party complete with full job titles, descriptions and employment agreements.
2. Detailed compensation package deal points.
3. In our last deal it was a buy-in for immediate equity plus performance based increases of up to 10% additional vesting 2.5% per year for four years (time based component) plus performance milestones based on revenue (performance based component).
4. It is also important to provide for what happens if things do not work out, so you build a breakup clause I to the agreement as well. In our case if they leave the business or are terminated, then we have the right to buy them out on a pre-agreed valuation formula with pre-agreed terms.
5. You need to agree on valuation for the buy-in as well. Usually this is done on an EBITDA (earnings before interest, taxes, depreciation and amortization) basis where valuation equals EBITDA times some industry typical multiple.
So if the business is earning $1 million in profits and you agree on a multiple of 5, then the valuation equals $5 million and a 20% buy-in would be $1 million (20% of $5M).
6. If the buy-in is not for money, but for some additional value they are supposed to be bringing then you need to place a value on the non-cash components you bth expect that they are bringing.
Say they have a book of business like the folks did in our recent deal and that’s the value they bring.
Let’s say you operate at a margin of 30% profit and their book of business or the things they are to contribute are expected to be worth $1 million per year. That would mean the first year value would be 30% of $1 million equals $300k.
If average lifetime customer value (LTV) is 3 years, then the total value they are bringing would be expected to be worth 3 years at $300k equals $900k in LTV.
If your company valuation is $1.8 million, then that would mean the things they are bringing to the deal are worth an estimated increase in value of 33%. $1.8M + $900k = $2.7M divided by $900k = 33%.
So, if all goes as you expect, then they would get 33% of the equity of the agency for bringing these assets/accounts.
7. You also need to have language that adjusts their equity based on any variance between what you both thought the value of what they bring to the table is vs what it ACTUALLY is over the course of the realization of the expected value.
So, let’s say that after 3 years the book of business they contributed only turned out to be worth $720k, which is 20% less than the $900k you expected.
A good and fair agreement would then adjust their 33% equity downward by 20% leaving them with 25.5% of the business instead of 33%.
There are tons of ways to do these deals l, so if you have any specific questions feel free to ask.
There are also lots of tax issues and other deal points so always be sure to get a good attorney and business advisor to help document and negotiate the deal.
What questions or additional adds or pluses do you have about this?