Sunday, September 25, 2005

It took a while to get my thinking where I wanted it to be, but I've finally finished creating my "business value" spreadsheets.

After really digging into the problem and trying to decide what makes sense, I finally decided to base everything on Marty's cash flow analysis approach, and look for a complete ROI for the business buyers in two years. I thought these terms were very reasonable, and they were essentially what we wanted before anyway.

Cash flow basis assumptions

While the decision to base my work on a cash flow basis sounds easy, I had to factor many things into the equations, including:

  • I was leaving the business.
  • My wife works full-time now, and she would also be leaving. Replacing her skills with another full-time employee would be a little more expensive.
  • I assumed David and George would split my duties, and the company would need to hire another good tech person at roughly $90K per year.
  • All the Class B business partners would probably be converted to Class A partners. There was no obvious financial impact here, but their salaries are currently all over the board, and one impression I got was that they all wanted to take more or less the same salary. Therefore, I assumed they would all take salaries of $75K/year. Truthfully I expected them to want more than that, but after all, this is my spreadsheet. (The less salary everyone takes, the higher the Net Income appears to be, which also leads to higher distributions to the partners.)

I expected Jack would also throw a wrench into this "equal partner salaries" concept, but I couldn't worry about that now, I just had to assume ideal conditions.

There were other factors to consider, but those were the most important.

Partner cash flows and earnings

It was weird contemplating my own business without me in it, but I worked through the spreadsheets until everything worked out, and determined the new cash flows back to the partners, assuming the business revenue stayed even. To me, there was no logical reason to assume that business revenue (and net income) would go down rather than up.

One thing the partners have made clear several times now is that they want me to be paid out through the earnings of the company, and while I can see their logic (my payout should partially based on whether the company fails or succeeds after I sell), the lawyers advice to get all the cash up front is still in my mind. I worked up a spreadsheet where I get 75% of the money up front, and 25% of the money in payouts during the first 12 months of the deal. My reasoning is that all sorts of things can happen after I sell my interest that are out of my control, and therefore I shouldn't be subjected to all of those possibilities, so a 50/50 split wasn't going to happen.

Partner tax consequences

I also realized a flaw in Marty's logic that was very depressing -- the tax consequences to the partners. For instance, let's say we worked through all the numbers, and we determined that my shares were worth $500K. By my calculations, this meant that the net income that would be distributed to the remaining partners would equal $500K on the 24th month of the deal. After that, they would be in the black.

The problem with this deal -- I suddenly realized -- was that all the money going to them was taxable. So even if $500K from their new shares flowed to them from the net income in the company, that $500K would be taxed at a rate of 33% or more. This was a huge blow to my calculations. If this was right, it would take them longer to really recoup their investment. Am I thinking about this right?

Ugh. After looking at this for some time I finally decided I need to talk to my tax attorney again.

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