Ask HN: Fair evaluation of equity for buyback?

[jweather]

I hold 3% sweat equity in a service-oriented startup, and the founder is offering to buy it back since I am no longer involved with them. Based on his forecast $600k in revenue and a market-sector average of 6% profit, he estimates $36k profit this year, and thus a valuation of $72k, making my 3% worth $2160. Is this a fair way to compute the value of my equity? What questions should I be asking?

[brudgers]

If you don't think $2160 is fair, then say "no". Unless you really want to sell, there's no reason to counter offer. If it isn't worth more than $2160 to the potential buyer then it's worth more to you than them.

If you want to sell, then decide what you think is a fair price and negotiate your way to it.

Next time, consider having a buy-sell agreement, vesting, options rather than shares, etc. irrespective of which side of the transaction you are on.

Good luck.

[7Figures2Commas → brudgers]

> Next time, consider having a buy-sell agreement, vesting, options rather than shares, etc. irrespective of which side of the transaction you are on.

Huh? Based on the situation described by the OP, it sounds like he or she owns shares outright, possibly free of any major restrictions. This is the very best scenario a (former) employee will ever be in because the company has far less leverage.

Buy-sell agreements, vesting and options almost always work against the interests of employees and former employees.

[brudgers → 7Figures2Commas]

Perhaps the OP will be on the other side, next time. Perhaps the OP overpaid for their shares this time. Perhaps a buy-sell agreement would have established a higher valuation or simplified the current transaction by injecting obligations and certainty. Energy that goes into buying the shares back is mostly a distraction and makes the company less likely to succeed and thus the shares may be worth less.

Suppose the OP holds out until the offer is quadruple. It's only the difference between a weekend in wine country and a week in Barcelona.

[jweather → brudgers]

sweat equity = no money invested. At the moment I think I'm planning to hold out unless he's willing to pay for a third party evaluation.

[brudgers → jweather]

Appraisals are made for a purpose. The person paying has more influence on that purpose. If the offer does not interest you "no" is best. If you want to move on, sell.

[greenyoda]

The value of an investment is usually calculated based on a recurring income stream over time. If you held on to your equity instead of selling it, you'd be entitled to a 3% share of the profits over the life of the company, not just for one year. And if the company was growing, the income stream would be increasing over time. So valuing the company based on one year's profits seems unfair. (Also, if the company were ever sold, you'd be entitled to 3% of the proceeds.)

Also, since the founder would know what the real profit of the company was, why would he be basing the valuation on market sector averages? It sounds like he's trying to take advantage of you.

[jweather → greenyoda]

Last year's profits were zero. He says he doesn't have a forecast for this year's profits. I don't think the company will get bought by Google, but I think they have the potential to make $100k-$200k a year on their current track. If the founder wasn't asking to buy me out I'd probably just sit on my shares.

[jseeff]

Good points already posted, especially about buy-out being a multiple of earnings not just based on one year. A few other things to think about: why is the founder trying to buy you out? No one just pays for equity buy-back without a reason. It might be as simple as "minimising shareholders" for administrative reasons, but it may also be something else. A $2160 check is a nice thing to have but it isn't a huge amount so it may be better to keep the equity. If you do agree to sell, I would recommend some "protections" for example, if the company gets sold in the next [X] months (or even years), you get paid the difference of value or even, if profits hit [Y] any time in the next [Z] years, you get an earn-out of some kind...

[7Figures2Commas]

Suggestion: find a business valuation professional, ideally one with demonstrable experience valuing businesses in your market, and ask the founder to agree to reimburse you for the cost of a valuation.

The cost of the valuation might exceed the amount the founder has offered you, but if he is sufficiently motivated to acquire your shares and believes he is not significantly underestimating his company's value, he should be comfortable agreeing to such an arrangement.

If he does not agree, it doesn't mean that your shares are worth significantly more than offered, but unless you need a couple grand, it's hard to see why you'd be motivated to sell.

[alain94040]

It sounds low. Here is a very simple test to find out if it's fair: ask the owner if he'd sell you an extra 3% for $2160. Does your gut tell you that the answer is "no way?" There's your answer.

[j2bax]

Not that it matters too much, equity is equity, but how much sweat equity are we talking here? How much of your time did you invest for that 3%? I would consider that when thinking about how much the equity is worth to me. Again, this is only a small factor, but a factor none the less. If you put 10 hours in $2160 might be more appealing than if you had 100+ hours of your time invested.

[jweather → j2bax]

From my perspective, the equity is a bonus. I already got paid what I expected for the work I did. I don't have a dollar figure in mind.

[saywahat → jweather]

No matter you perspective, it belongs to you. Value it just as much as other forms of compensation you labored for.

[joshu]

That seems absurdly low.

[csa]

Based on what you've said elsewhere in this thread, I am going to take a very different tack than the rest of the folks so far.

> Last year's profits were zero.

OK, so the the shares aren't likely worth very much.

> He says he doesn't have a forecast for this year's profits.

> Based on his forecast $600k in revenue and a market-sector average of 6% profit, he estimates $36k profit this year, and thus a valuation of $72k, making my 3% worth $2160.

Well, it kind of seems like he does. That said, his math is voodoo math. He can pretty much make it say whatever number he wants it to say.

> I don't think the company will get bought by Google,...

So your shares will not be like lottery winnings, and anything you make will most likely not be life-changing money.

> but I think they have the potential to make $100k-$200k a year on their current track

$100k-$200k is a salary, not profits that you will see any part of.

This is the bit of the story that I want to emphasize. You have a minority stake in a small business (not what most would call a "start up"). It is trivially easy for the majority owner(s) to make decisions such that you will never see any distribution of profits. They can bump up their salaries, they can give themselves bonuses, they can go on team-building retreats to Cancun -- the ways that they can legitimately spend any potential profits is mind-numbing. When you're talking about $100k-$200k of "profits", you have to expect that your share of that will round to $0.

> If the founder wasn't asking to buy me out I'd probably just sit on my shares.

After reading my comment, I would like to ask why (serious question). I think your trying to optimize something that very far out of your sphere of influence. To be honest, the value of the time that you have spent thinking about this is probably worth more than any reasonable market value.

If I were you, I would do something like counteroffer $10k while fluffing they guy's ego, expect to negotiate down to ~$5k (depending on your negotiation skills), but take whatever I can get. You should fully expect that something will happen that will benefit the new owners of your shares -- maybe an acquihire, maybe a big contract, maybe VC funding. Whatever it is, just let it go. You were never going to see any of that money anyway.

If you don't like the guy or you just don't like the situation, figure out what number below which you will gain more psychological value by not selling. Whatever number that is, set that as your base that you will not go below, and expect to get that number and be happy with it. Depending on your motivation, this might just be a dick move, or it might just be how much you're willing to pay in opportunity cost to prove to your peers that you won't be potentially manipulated.

For me personally, I would do what it takes to get this off of my plate. I would want to minimize the brain cycles I spend on it. Because I like negotiating, I would probably do the following:

- Counteroffer $10k while complimenting him and the company and watch how he reacts.

- Based on his reaction, I would let him negotiate down to somewhere in the $5k to $8k range (this really depends on the company and how well you know the CEO).

- I would then do the friendly walk away move as I tell him that my offer is good for a week.

- He will call back with a lowball offer. I will stick to my guns.

- He will acquiesce.

- He will also probably try to do some last minute bullshit when things are signed. I would have a lawyer look over the paperwork before I signed anything.

- I would celebrate with dinner at State Bird Provisions once the money is in the bank.

Best of luck!