Silent Partner: Payments and Options – Pt. 2

An employee can buy your business.

First, you must determine if you have at least one eligible employee who wants to buy your business!

This is a continuation of the article, Silent Partner Questions: Payments and Options, originally posted on Wednesday, August 20. Please refer to that for the original summary, question, and pre-response insights.

The Original Questions:

  1. Should we sell the business to an employee? or
  2. Should we scale back the business to a manageable size?
  3. What is a quick and easy valuation?
  4. What is fair for a silent partner?

My Responses:

Selling to an employee

Before you seriously consider whether you and your business partner should sell to an employee, you must first determine whether or not you have any suitable employees who are interested in purchasing the Remodeling Company. Once you determine one or more such employees exist, you must ascertain what the person or persons think the Remodeling Company is worth, or if they agree with your price, or are willing to use a valuation determined by a reputable third party. If the Remodeling Company’s employees are only interested in remaining employees, you and your business partner will save time and worry regarding the who, what, and how of selling to one or more employees. On the flip side, if multiple suitable employees express serious interest in purchasing the Remodeling Company, you and your business partner must decide whether you both will sell to only one employee or to the interested employees as a group. Obviously, selling to a group of employees creates a completely different set of action steps!

Engage a Business Valuation Firm

Before you take any definitive action regarding selling or transferring the Remodeling Company, I strongly recommend that you engage a certified business valuation specialist or  business valuation firm to value the Remodeling Company. A reputable individual or firm will provide you and your business partner with a valuation based on a single (the best method) or average of multiple valuation methods. These methods may include a valuation based on book value, an asset-based valuation, and/or a valuation based on the projected cash flows compared to industry averages. Regardless of the final valuation method selected, the actual value will help you and your business partner decide if you still want to “scale back” the Remodeling Company if no employee wants to buy it, or, alternatively, offer the Remodeling Company for sale – typically through a business broker (depending on the value) – to whomever may want to buy it, i.e., competitors, customers, or aspiring entrepreneurs.

A Quick Valuation

For a relatively straightforward, easy, and quick valuation, analyze your balance sheet. What is the value that shows as shareholder’s equity? This is the book value of your company. If the Remodeling Company has been losing money, your shareholder’s equity will likely be negative. In that case, move on to an asset-based valuation. For a quick and dirty asset valuation, check with suppliers, equipment providers, and similar firms to obtain reasonable estimates of the current value of the Remodeling Company’s assets, accounting for wear and tear. Next, subtract the value of all your outstanding liabilities from the value of the assets to arrive at the asset-based valuation.

In addition, you can also look at the industry-specific multiples for remodeling companies sold in in the past 12-18 months, if you can access that industry information. The multiples that are measured depends on the industry and sub-industry. For example, the multiple could be owner’s cash flow, net income, or EBITDA (earnings before interest, taxes, depreciation, and amortization). If you have access to these, compare the Remodeling Company’s multiples with those in its industry.

Do you and your business partner have the same goals? Clarify this...and what those goals are...before having your other discussions.

Do you and your business partner have the same goals? Clarify this…and what those goals are…before having your other discussions.

Fairness to Silent Partner

Regarding, what is fair for you as a silent partner: It depends on several factors. Essentially, when you move from being an active to becoming a silent partner,  you become an investor. Therefore, in many instances, you would receive only the proceeds or distributions due to an investor. In other words, you would not be “paid”. As a silent partner, you have provide money but no consulting or other services that the Remodeling Company would compensate you for. However, if you retain an advisory role and advise your former business partner or occasionally consult on specific issues, you are not truly “silent” and can be compensated as an advisor or as a consultant. If you want to be compensated, you could receive a monthly advisory / consulting fee from the Remodeling Company, or receive payment as agreed upon for specific projects. This is a discussion you must have with your business partner because it is really up to the two of you to decide what is fair. Question for you: How did you both receive compensation before? Use the process you utilized to determine you and your business partner’s compensation before to re-assess and re-determine your compensation in your new role.

Same Goals

With regards to having the same goals, first refer to my answers above. What works for both you and your business partner may depend on the previous discussions and arrangements you had regarding the Remodeling Company. For example, if you worked at/in the Remodeling Company for eight months before your business partner became an active owner-manager but you both netted the same amount in salary and distributions, then it may make more sense to do that now. However, is such was not the case, a decision to split everything — salary, distributions, perks — between the two of you 50/50 for the Remodeling Company may be more agreeable if your business partner will receive the same salary from the Construction for the year as you, even though your business partner does not yet work for the Construction Company. Because you and your business partner are 50/50 investors in the Remodeling Company, the 50/50 profit split is fair. This is because, unless otherwise documented in an agreement (shareholder’s agreement, partner agreement, LLC operating agreement, preferred stock agreement), profits get distributed to owners in proportion to their ownership percentage. However, salary is a different matter. Salary is compensation for work provided. Typically, if you do not work, you do not draw a salary!