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My firm is offering me 5% of the company. The structure they laid out for buyback of this equity seems odd to me. What are your thoughts?

"The purchase price of equity shall be equal to 5X net profit for the 12 calendar months preceding the firm's election to repurchase the 5% equity

(net profit is defined as gross profit minus all expenses including but not limited to rent, salaries, accounting, legal, marketing, advertising, technology, sales commissions, revenue share, licensing fees, consulting fees, interest, repayment of loans etc.)"

Thanks

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are you paying for that 5% equity or is it in lieu of salary or something else? It might be defined elsewhere, but can the firm 'elect' to repurchase at any time - e.g. when net profit for the previous 12m is next to zero - they'll be able to take that equity back for very little money and you'll be out of pocket. – edralph Jun 5 '11 at 10:10

2 Answers

up vote 1 down vote

Structurally, it would probably be better for you to have it as a multiple of gross revenue, because there are fewer accounting games possible. Beyond that, the main question is whether you like the multiple.

More pertinently, why is there a buyback structure at all? You would (probably) be better off with a put option + drag-along/tag-along.

Disclaimer: Do not rely on free advice from the internet. Please carry on with your life and business affairs as if you had never read this. I take no responsibility for the quality or consequences of this advice.

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+1 - for why there is a buy back requirement. I can see right of first refusal, but not a forced buy-back. If I were you I would walk away or otherwise decline. They are clearly not willing to work on equitable terms. – TimJ♦ Jun 7 '11 at 17:34
-1 moneychimp.com/glossary/gross_revenue.htm for using a metric that does not take costs into consideration for the value of the company. – John Bogrand Jun 7 '11 at 18:15
@John Bogrand: No-one subject to compulsory buyback should agree to a measure that takes into account costs, because booking of costs can be manipulated. – Marcin Jun 7 '11 at 18:20
And no owner will agree to raw revenue it says nothing of profitability. – John Bogrand Jun 7 '11 at 18:22
@John Bogrand: So, because you can't get a good deal, you should take a shitty deal? If so, I have an investment opportunity for you. – Marcin Jun 7 '11 at 18:25
up vote -1 down vote

Net income is easy to manipulate. (Book an expense this year versus next year or just increase loans and interest expense.) So I would suggest pushing the calculation against EBITDA (earnings before interest, taxes and depreciation/amortization). This way when they change the capital structure your not screwed by it.

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Ebitda is net income with certain costs added back. You are confusing it with gross revenue. – Marcin Jun 7 '11 at 17:55
No I'm not confusing it. en.wikipedia.org/wiki/… its exactly as described and used as a common number for doing calculations for company value. – John Bogrand Jun 7 '11 at 18:12
Yes, the link agrees with the definition I just gave. Just because it's a common metric, it doesn't mean it's a good metric. – Marcin Jun 7 '11 at 18:20

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