I saw that someone ran a search for this term so I decided I should deal with this subject. Why do people want to buy into a company? First what exactly is “buying into a company”? Buying into a company means an individual invests a significant amount of money into a private company and comes away with a significant, although minority, interest. He will also get whatever payments and perks come with the deal. He may or may not be actively involved in the company.
Usually a person who wants to do this comes in the form of a professional who is in between careers, has some savings and wants to jump in and help run an operation in which he has no experience. To a lesser degree we are talking about an investor who wants to buy some shares of a private company and sit back and wait for the stock to appreciate. But we would usually just call this guy an investor. What is the difference between these two?
The difference is how much money you can make for your invested dollar. The professional has skills and is willing to work for wages as well as reap ownership rewards. The investor on the other hand will only reap ownership rewards but they will be nil unless he negotiates them up front. Now you can’t do this with a public company, the dividend is set and the appreciation is what it is on the open market. Private companies typically do not offer anything in the way of dividends and don’t have a market for their shares. So the incoming buyers need to actively negotiate both aspects of such a deal if they want to come out whole.
However, the “active” party will have more control and get a better deal for his buck, plus a career assuming he can’t readily be separated from the company or fired.
Pros of Buying Into A Company
- Can provide immediate employment and/or immediate income.
- Can provide perks and benefits along with ownership
- Buyer does not need to finance the deal or raise capital beyond what he has
- Seller can mentor and train the buyer for ultimate succession
- Buyer gets a minority stake which reduces the valuation
Cons of Buying Into A Company
- Requires an immediate negotiated cash investment which usually can’t be financed with the company assets
- Buyer usually gets minority stake affords limited control over the company.
- Buyer has an untested relationship in the new partnership with seller.
- Buyer can be ousted by majority owner(s)
- Non-operating investor will usually get minimal ROI.
It is clearly a better monetary choice for a buyer to jump in as an operating partner, but that role comes with additional risks which essentially boils down to whether he can get along with the seller. So how do you go about finding this type of a situation where the seller will allow an incoming investor/partner? Of course you can propose this type of arrangement to any seller you talk to. The conversation can start that way or it can be a last ditch effort to save the deal.Not all brokers will support this idea as it lessens the valuation of the company and likely reduces the broker fee.
It is critical to know what will be done with the buyer’s investment. Will it be used for working capital or just go into the seller’s pocket? As we know that most buyers will want to start the discussion with little or no investment it should be noted that the best of all worlds is a seller that doesn’t need the money but needs an exit plan. The buyer then is basically providing the exit plan and his ownership could be phased in over a multi-year period and paid out according to a schedule which deducts from his earnings.
So there are lots of ways of getting into this game and it does solve a lot of problems for many buyers who may have a bit of cash and want to bypass the more complicated financing and closing process even if it sacrifices control and leverage.