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By Dr. Keith Roxo, Guest Writer

My medical consulting business, Wingman Med, had grown faster than initially expected, as previously discussed in our article about Starting a Medical Consulting Business. One of the reasons for that is that we paid attention to our client base and realized there was an unmet need that we could include in our product line.

Initially, Wingman Med focused solely on helping pilots navigate the FAA medical exam process and obtain their medical certificates as quickly as possible. Like preparing for any exam, knowing how to prepare for a medical certification exam for flight can improve the chances of success. Specifically, it can save months in the bureaucratic process.

In 2022, though, we noticed a trend—a trend that would eventually bring in a new owner to our business and force us to navigate the process of selling a minority stake.

Developing New Products

It turns out that some of our clients were military veterans, and many of them had started receiving letters from the FAA questioning their disclosure, or lack thereof, of their disability benefits on their FAA medical application form. As we helped pilots through these issues, we noticed an alarming trend: significant overdiagnosis associated with their VA disability with very little evidence to support those diagnoses. Some of this was just inherent in the way VA disability exams seem to be performed, and some were from the occasional embellishment on the part of the service member.

We decided that perhaps it was worth starting our own VA disability consultation service for pilots to help avoid the overdiagnosis issue and to ensure that everything is prepared properly to notify the FAA. The FAA doesn’t particularly care if you have a disability; it cares about the condition and how it is doing. Asking about disability is just like asking about medication use and past physician visits—it is a way to elicit a complete history.

Bringing on New Team Members

But we had an issue: we knew how these conditions could impact the FAA medical, but we didn’t know as much about the VA disability claim process. Fortunately, we did know of a doctor, Ray, who was both a qualified Aviation Medical Examiner and who knew the VA disability claim process. Ray had previously been in charge of a military hospital department that oversaw medical separations. As part of a medical separation from the military, there is a concomitant VA disability evaluation, and Ray had become intimately familiar with the VA disability claim process.

Ray joined us as an independent contractor being paid by the case. He understood the value of our efficient processes in that the faster he could work through cases the more cases he could complete and the more money he could earn. As this new product line began to grow, it became one of the major influencing factors in our faster-than-expected growth in 2022. Enjoying both the remote work capability combined with having very few demands from a rigid hospital system, Ray started inquiring about long-term prospects and eventually asked what it would take to buy into the business.

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Valuing of Your Small Business

My partner and I had known Ray for many years, and he had the qualities of someone that we knew would be a valuable asset. We were open to the idea of him buying into the business, but we didn’t quite know how to make it happen.

• What are the legal implications of selling a piece of the business?
• What are the tax implications of selling a piece of the business?
• How do you assign a value to a small business?
• How does one actually buy a piece of a business?

All businesses should have governing documents. To sell a portion of the company to Ray, we had to approve the sale of shares, or percentage stake. After talking to our business attorney and our accountant, it became clear that there would need to be a formal ownership transfer agreement, a new operating agreement would have to be made, and a monetary valuation for the company would have to be established to determine percentage or share cost.

When you start from scratch, the company has no value, and you can divide up ownership almost any way you like for virtually no cost. But once a company has value, Uncle Sam wants his cut. If we assigned no value to the shares being transferred, then Ray would not be buying in and we would receive no money. If we assign value, then he either has to pay the total amount upfront, pay over time via a promissory note, or pay via some combination of the two.

But how do you actually value a relatively new small business? Investopedia showed several ways to do this:

• Market capitalization
• Discounted cash flow
• Book value
• Liquidation value
• Multiple of revenue
• Earnings multiplier

Since we are not a publicly traded company, the market capitalization method was out. Discounted cash flow seemed overly complex. It is a formula that requires an estimate of future cash flow. Estimating the future cash flow of a rapidly growing business was going to be difficult, and it could easily be criticized. Book value and liquidation value were laughably low given that we didn’t have a significant amount of money invested and no assets other than intellectual property. Yes, we had some cash into the business but not much. The business was primarily built on sweat equity of intellectual property. Given our low overhead and that we weren’t taking a salary yet, there wasn’t much difference between the multiple of revenue and earnings multiplier.

We chose multiple of revenue with a bit of a twist. Instead of a multiple of the last 12 months of revenue, we used a multiple of twice the last six months of revenue to better account for the rapid growth we had. Ray concurred that it was not entirely fair to use the prior 12 months, given the rapid growth. However, using the most recent two or three months may significantly inflate the value if revenue suddenly fell off again. Valuation calculation was part of the negotiations, for sure.

Using this valuation method, we determined the total value of the company. As an LLC, we were divided up by percentage ownership vs. shares, making it easy to determine what a 1% stake in the company was worth. We presented this to Ray and offered him the option to buy up to 10% of the company, via promissory note, with a three-year amortization schedule and no prepayment penalty. Per our advisors, a legitimate interest rate on the note had to be chosen as well. We used the Federal Discount Rate, which was 4.41% in January 2023 when the offer was made.

Ray accepted the offer at the full 10%. Now, as an owner, he was no longer paid as a 1099 contractor and was instead paid via W2 for his role and casework. His income has to be subject to income and employment taxes, and then what remains is applied to his note balance. He has earned more than enough each month to cover his note payment, and he typically puts the additional amount toward his principal.

Adding Ray as a partial owner was not exactly an easy process. I did not think it would be easy, but I also did not fully appreciate the complexity involved in all the steps. Even when everything was lined up and the offer was made, Ray was hesitant to commit. After all, the company was new, and he did not particularly like committing to a few years of labor, given some of our spending plans for marketing (buying an airplane and painting it with our logo). As a minority owner, he would not have a lot of sway in those decisions. Ray is contemplative, and he perseverated for a while. And we gave him time because we wanted him in the company. He wouldn’t likely start a competing service as we had better credentials and an already established name. But we did need his expertise to keep this product line developing.

Eventually, I informed Ray that he could take as much time as he liked to make his decision, but given that the revenue growth was continuing, the cost per share would be re-evaluated each month—as would the rate on the note to match the Federal Discount Rate, which was also increasing. His option to buy in would remain, but his cost to do so was going to rapidly increase. That is what prompted Ray to finally commit.

Ray’s expertise helps us continue to develop and evolve a lucrative product with some of our core clientele. By having Ray on the team as a business owner, his compensation is more than just what gets deposited in his bank (actually nothing gets deposited now since it all goes to his note!) because there is continued growth of the business. He has been with us in one form or another for more than a year. Once he became an owner, he began getting the full financial details, and he could see the growth. This insight into the business gives him greater confidence in his decision to buy in, and he sees the value of his buy-in continuing to grow. This strengthens his commitment to us, which is what our goal was in offering him an ownership position.

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Ownership Has Its Privileges

Buying into the Business 

As part of the buy-in agreement, Ray has the ability to leave and request a buyout. This adds some financial risk to us. We could be left without our product expert and a hefty bill. In order to allay some of these concerns, we added a few key stipulations:

• Standardize the product so any one of us can handle VA cases
• No buyout option until at least 12 months after his note is paid off
• Minimum of three years payment terms for paying the buyout

By guiding the product to a standardized flow similar to what we do with our other products, any member of the team could handle these cases. This protects the product line should Ray decide to leave and take his expertise with him. His note was set at three years with no prepayment penalty. While he is on pace to pay it off a few months early, it likely won’t be too early. This gives us at least three years to get this standardization developed before he could request a buyout. And by giving ourselves a minimum term to conduct a buyout, we can avoid the need to liquidate assets.

We have had others express interest in buying into the business. Given the primary intellectual property nature of consulting, we don’t really need a lot of cash for equipment or other things. This makes a generic business investor less interesting to us, as we would rather fund any growth opportunities ourselves from either revenue or loans and keep the ownership undiluted. What we have currently settled on is that someone would have to bring a product line related to the existing business and develop it, as Ray did, to warrant diluting our ownership share.

Overall, things have worked out as we had hoped, and we continue to refine our services and work well together. And everyone on the team is better for it. But it took some figuring out, decision-making, and negotiation to come up with a plan.

P.S. Ray currently lives in Hawaii. We elected to bring him to a pilot-hiring convention that was heavily populated with military and veterans. Rather than have him fly directly into the convention city, I strategically asked him to fly into San Diego where my partner and our airplane were based. The day before heading to the convention, they did a short flight together to get fuel at another airport. On the trip to the convention city, they stopped in Yuma, Arizona, to pick up one of our nurses; stopped in Las Cruces, New Mexico for fuel; and then finally stopped in Fort Worth, where the event was being held.

When we all met for breakfast the next morning, Ray admitted that he accepted my intention of the airplane to be a “flying billboard that would be placed directly in front of target clientele,” but he didn’t think it was going to be significant. But at every airport they landed en route to the convention, at least one person asked for company info or a business card, and nearly every airport put our info up in their pilot lounge. Having seen it in action, he is now fully on board with the idea of the logo-painted airplane.

Have you ever bought into a business or sold a stake in something you owned? How did you determine the best way to make the transaction? Did it all work out like you hoped it would? Comment below!

[Dr. Keith Roxo is a Top Gun-trained adversary pilot turned Aerospace Medicine physician. He has more than 2,000 hours in a variety of high-performance military aircraft—including the F/A-18, F-16, and F-5—and he holds multiple military flight instructor qualifications. Keith also holds airline transport pilot and CFII certificates. His medical qualifications include board certification in both Aerospace and Occupational Medicine, and he is a HIMS-qualified FAA-designated Senior Aviation Medical Examiner. Keith provides aviation medical consulting with Wingman Med. This article was submitted and approved according to our Guest Post Policy. We have no financial relationship.]

The post Buying into (or Selling Part of) a Business appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: Lauren O'Brien
Title: Buying into (or Selling Part of) a Business
Sourced From: www.whitecoatinvestor.com/buying-into-a-business/
Published Date: Mon, 05 Feb 2024 07:30:43 +0000

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