This is the third in the series on how contractors can build themselves up real businesses that they can get either sell, or get recurring income from, after they have quit. Most contractors get no income when they are not working or after they have quit.
It is surprising that more contractors don’t set themselves up in partnerships as other professionals like accountants doctors, dentists and lawyers do. In those professions that’s the normal way to go about things. It also means that the partners have something of value to sell or derive income from after they have departed.
These are truly small businessmen rather than the ‘disguised employees’ as too many contractors see themselves.
Would Contractors Be Interested?
It appears that many contractors would be interested in a partnership. A scheme was advertised extensively on another contractor site a while back in the forums, which suggested something similar. Well it was similar in the way that it should work except for the fact that those who were setting it up were getting the lion’s share of the equity in the new company, whereas contractors would get a smaller share – even though they would be doing the lion’s share of the work.
However, many contractors did take it up as they were sold the vision of having an equity stake in a company that would be worth ‘millions’ in a few years time when it would be launched on the Stock market.
The principal was that the contractor would get equity in the company depending on how much they put in. Every time some new contractor was to join as an equity holder, the company would be valued to see what price the new person could ‘get in at’, i.e. how much equity they would get.
Those that were in first (including those who set up the company) would get most equity as they got in when the company was not valued highly.
This sort of model would seem to suit contractors, and it is the one used by small businessmen with professional skills in other professions.
Why Not US
So why not IT contractors?
No reason at all. In fact CMG was set up like this and was a partnership until relatively recently.
It would also have the advantage of taking contractors outside IR35, even if they were working for the same client for an extended period of time.
They would be more like the KPMG’s of this world. If you can’t beat them, join them.
So how would it work?
Well, first of all, several IT contractors (say 5) with similar skills (preferably) would get together and form a partnership. Their equity in the new company would depend on how much income they would put into the company in the first year. Some would put more of their income into the company than others and would therefore get more equity. It would be best if they started out the same though.
At the end of a set period of time, other top-class contractors could be invited to join as partners.
The company would then get an independent arbitrator, e.g. an accountant, to value the company. The value of the company is likely to be greater than the amount of funds put into it. It would then be decide on what basis the partners would get shares in the company based on how much of their income they put into it in the second year.
It could be that the 5 original directors put £20,000 each into the company in the first year getting 20,000 shares at £1 each.
In the second year, and this would depend on the valuation of the company, it could be that everyone (old partners and new) could put £20,000 each in on the basis of £2 a share and get 10,000 shares for this.
In the third year, they might get fewer shares again for the same amount of money. Those that get in during the second and third years have to pay more for their shares, but they would be gaining from the increased valuation of the company based on the previous income put in.
It doesn’t mean that, in the beginning, that contractors have to get their own work. The five originals may well be working for agencies.
They could, however, use some of the income put into the company to look for business for themselves, e.g. by employing someone to do it.
The more that they sound like a professional outfit and a real business (consultants rather than contractors), the more work and the better rates they’re likely to get down the line.
If there are 5 people putting in £20,000 a year into the company, that doesn’t mean that the company is worth £100,000 after the first year. If that is all profit, and if profits are likely to increase in the future (with more people coming on board), then the company would be worth much more than that.
Even if half of the money went on expenses, that would give a profit of £50,000.
A friend of mine buys small companies for his client. He basis their value on 8-10 times profits. That would mean that the company would be worth between £400,000 and £500,000 after the first year. That’s why it would be more expensive for those partners that joined later to join.
This is only a rough guide but suffice to say that the value of the company would be greater than the funds put into it.
What would probably happen is that the original five would get work for themselves and also take on other contractors or full time workers. They would offer the best of them an opportunity to be a partner.
Perhaps three years down the line, the company could be offered for sale or put on the stock market. It could even be kept and income derived by the original partners from their equity stake – long after they’ve packed it in.
This is another way for contractors to be able to create something of value for themselves, instead of having only their savings to show for it at the end of a long career. It would also help during the downturns as they could still derive income from it – or be able to sell their stake.