Q: My friend recently asked me to join him in his computer networking and Web design business. He and his partners started last August and are breaking even on about $15,000 a month in sales. None of them have any business management expertise, but they have the technological skills to perform their offered services. I have an MBA and feel I can help manage the growth of this business. I can evaluate the company and recommend strategic alternatives. I'd like to do this for six months. How do I determine the value of this service business and what's a fair amount of ownership to take in exchange for my services?
A: The business sounds exciting, and it could be a good idea to add your managerial skills to the mix. Let's look at what's in it for you.
What's the company worth? Most valuation formulas are based on earnings. The most common formula is some multiplier times EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). Or you can assess the worth of the tangible assets-land, building and inventory. I imagine the company you're considering is heavy on intangible assets, such as knowledge and passion, but light on the tangible stuff. Another valuation method is what a buyer is willing to pay for the company. Are you getting the idea that this valuation business is pretty subjective? Basically without earnings, real assets or an offer on the table, the worth of the company is just a wild guess.
Sure some companies, notably Amazon.com and other hotshot Internet companies, are worth millions-even billions-without turning a profit. But that's a rarity. And those companies will have to deliver a profit pronto or suffer from dropping stock prices.
Talk to a mergers and acquisitions (M&A) specialist. Start by asking for the M&A experts at a reputable accounting firm. M&A experts can be very creative when it comes to structuring deals, and they'll have unbiased opinions when it comes to valuating the business. Seek the advice of the pros. Then it's up to you and your associates to decide what the company is worth.
Now about the ownership issue. I wonder, can you "retire" in six months if you choose to have an ownership position? If you get involved as an owner, your responsibilities will continue. If you're only interested in a six-month stint, I suggest you skip the stock options.
Stock can certainly be appealing: You could get in on the ground level of the next AOL or Yahoo! But, those examples aside, the best way to make money in any company is through solid profits. And to create profits, you need competent management. Sure, you could catch the brass ring and score on your stock holdings. But your odds of winning the lottery are greater than that happening.
If you want to make money in your company, you need to watch the money and price your product or service properly. You can apply all that cool information you learned in your MBA program, but make no mistake about it, if you sign on as an owner, it'll be your responsibility to manage the company for profitability.
So think about the short term and the long term and decide how involved you want to get. Play the "what if" scenarios out on paper before you jump in. Have a meeting with all involved parties. Work out several pro forma budgets-good, better, best and worst-case scenarios for sales and expenses. Discuss how much money will make all the risk and headache worthwhile for each of you. What's your time worth? Plug the compensation numbers into the budgets. My favorite question is, "Can we get there from here?" What's it going to take in volume to support your salaries? Then consider stock and profit-sharing opportunities. Work it all out in the pretend world first.
And lastly, the best advice I can give you is this: Figure your way out before you go in. People die, fight, change their minds, get divorced, get sick, get well, experience religious transformations, go mid-life crazy-you name it. All kinds of things can happen that will change you and the people with whom you're negotiating. Structure a buyout arrangement in the initial contract. Address non-compete issues and confidentiality agreements. Consider key-man insurance for the main players.
Ultimately, business is a gamble, but you can improve your odds by pausing and assessing. Look before you leap. Then leap!
Author Ellen Rohr nearly starved in her family's small contracting business-until she learned how to manage money. "Do what you love, certainly," she says, "but the money won't just take care of itself." Ellen's pricey college education didn't prepare her for real-world business. "Financial business basics aren't that difficult...but where do you learn them? Unfortunately, business literacy isn't taught in school. I teach the basics and take the mystery out of making money." Ellen's mission as an author, columnist and seminar leader is to help people make a living doing what they love.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.