On co-owning a business and making a long-term investment
Norm Brodsky is a veteran entrepreneur.
Dear Norm, The owner of my company, Robert Slater, wants to buy a new facility in Brooklyn and has asked if I'd like to join him. I've been a loyal soldier for 12 years, and he wants to offer me and two other employees a chance to make some money. We can get the property for $6.5 million. The bank is requiring a 25 percent down payment for a 15-year mortgage. Bob would contribute more than 50 percent of the down payment and get an equal percentage of the ownership. Whatever percentage I put toward the deposit will be the percentage I own -- but I'd have to sell my stake if I left the company. I'd earn 7 percent on my investment in the first year, and the rate would increase by 5 percent each year. (So in the second year, I'd get 7.35 percent; the third year, 7.72 percent; and so on.) I am 35 years old. I'll be 50 when the mortgage is paid off. Is this a good deal?
-- Lance Kaufman, Hub Truck Rental Farmingdale, New York
There are two ways to view this deal -- from Lance's perspective and from Bob's. For Lance, the real issue is the creditworthiness of the tenant, that is, Hub Truck Rental. (Full disclosure: Our company does business with Hub.) Under normal circumstances, 7 percent would be a lousy return for a creditor who is second in line. If the new company set up to own the property is ever liquidated, the bank gets paid first. The property's owners could lose their entire investment. Given the risk, most investors would expect to earn a much higher return -- 13 percent or 14 percent annually. But this case is different, of course, because Lance and his partners would also be getting an equity stake in the property.
So, let's suppose Lance puts up 15 percent of the down payment -- that is, 15 percent of 25 percent of $6.5 million, or $243,750. Assuming the tenant is creditworthy and pays its bills, he will earn a total of $368,184 in interest over 15 years. At the end of that period, he'll own 15 percent of the property. If the property has kept its value -- a good bet, given that Brooklyn real estate is generally undervalued at the moment -- his share will be worth 15 percent of $6.5 million, or $975,000. If you add that to the interest he has earned, you get a total return of $1,343,184, or an average of $89,546 per year. That comes out to an average annual return of 36.7 percent, which is great. It's a level of return he probably could not obtain with any other investment he would be in a position to make.
I spoke to Lance and gave him four pieces of advice. First, he should try to get Hub to enter into a 20- or a 25-year lease. That way, he and his partners can be assured of having a tenant after they become owners. Second, he should find out how the deal will affect him from a tax standpoint. There could be benefits or liabilities, depending on how the deal is structured. Either way, he should know. Third, he might want to ask that the property be refinanced, if possible, when the mortgage is paid off, allowing him to get his deposit back at that time.
Finally, and most important, Lance needs to take a clear-eyed look at his employer's creditworthiness. If Hub's balance sheet is overleveraged, or the company is not being managed properly, he needs to think twice before putting his money into the deal. He could lose it all.
That said, my guess is that the company is solid and that Bob Slater's offer is not only generous but shrewd. He's using the purchase of the new facility to reward three key employees and tie them closer to the business, without giving up company stock to do it. That strikes me as a good deal all around.