Change of Control – Revisited

Cardinal Ximinez: “Nobody expects the Spanish Inquisition! Our chief weapon is surprise, surprise and fear, fear and surprise. Our *two* weapons are fear and surprise, and ruthless efficiency. Our *three* weapons are fear and surprise and ruthless efficiency and an almost fanatical dedication to the pope.” – Monty Python “The Spanish Inquisition”

I have seen my fair share of situations where change in control provisions in agreements resulted in unintended consequences. Until recently, I thought their sole purpose was as the name implies and as Curly said in “City Slickers,” “One thing; just one thing.” But maybe as the Cardinal suggests, there is more than one thing. Let’s look a bit more closely.

Every smart business owner knows his most valuable assets walk out the door at the end of each day. Most owners like to retain key employees and enter into employment agreements that among other things, provide for incentives (many of which vest over a period of time) that are protected, should the owner or owners no longer be around. This standard solution is known in plain English as a “change in control” provision. What this normally provides for is the acceleration of any vesting or even liquidity provisions of any incentive provisions for the key employee in the event the current owner no longer has more than 50% (usually) of voting control in the company. Everything seems fair so far; what is the problem?

In case one, I was asked to consult with a company that had a key employee that was promised an incentive payment in the event of a change in control. That provision was triggered when the Company was sold to a “strategic” but the Company took the position that they had accepted a lower sales price in return for the key employee being offered a position with the acquirer, thus they did not owe the incentive. While both sides believed their case had merit, the ambiguity created years of turmoil until we helped to resolve it.

In the second situation, an acquirer had issued an LOI for the purchase of one of my clients. During due diligence, they realized that the resulting change of control provisions would substantially “enrich the lives” of all the key management members, and they were sufficiently concerned with their motivation after the deal that they almost walked away. Fortunately, a solution was crafted which all found acceptable.

So just when I thought the key provision in an employment agreement with an incentive was a change in control, I have come to realize that it should be accompanied by a well-defined “continued employment” provision so both the team member and the company do not suffer unintended consequences when there is a change in control. Negotiating them at the start when both sides are not under the pressure of an impending transaction is also very helpful. I am starting to see these provisions in some recent transactions and strongly encourage their use. As the Cardinal said, the two key provisions are…

Kids in the business- Can it work?

“Kids suck” quote from James Beaudette – my very close friend

Jim and I have been friends for over 30 years. We first got to know each other when we began coaching our sons in soccer and our relationship has grown since then. We each had three children and many conversations would inevitably turn to something one of our children had done, which we would both find hard to fathom. The conversation would usually end with Jim stating his conclusion which we both share.

After 40+ years of consulting with family businesses, I could tell you stories about children in my clients’ businesses that would make your head spin. Some had unbelievable success; some abject failure; some were responsible young adults and others entitled brats, I have seen it all. I would almost be embarrassed to tell you how many times I had to lean in to a parent or parents and confide what Jim had taught me long ago.

But out of these experiences came some valuable advice on how to handle kids in the business. Now some of this will sound like motherhood and apple pie, but I have found that it does work. So here are three pointers.

The first is, family is family and business is business. I watched a young son take a $20 million business to over $1 billion in 20 years. Two young brothers who had worked part time in a business stepped up when their father passed away and turned it into one of the leaders in their industry. I also watched two brothers who were in dispute over leadership resolve their differences by craftily splitting the business resulting in two household name consumer products companies. The common theme here is while they shared that important bond of family, they never let family issues blur what they had to do for the business. It was appropriately striking this balance that resulted in each of their successes.

The next is when kids are in the business, be honest with yourself and your children. This is most important when you face major milestones and one that comes to mind is succession planning. I have done more than one succession plan where the end result of my work was that the oldest sibling did not become the heir apparent. They all ended with both successful transitions and with all talking to one another at Thanksgiving. I would love to take credit but it was the direct result of honest dialogue about the objectivity of the process and the importance of keeping the business sustainable. I have also walked away from assignments where the parents wanted me to “anoint” a family member as the next leader. To quote “In Living Color“, “Homey don’t play that.”

Finally, know the difference between being a mentor and being a parent. This is perhaps the toughest task of all. Too many parents make decisions as a supervisor (in one case to support the project a daughter was proposing that had little merit) with their parent hat on versus their mentor cap. This can enable bad behavior, lead to the ill-fated “bosses kid” syndrome and doom your child to failure. So while I am sure that on occasion you will reach Jim’s conclusion about your kids, try to be disciplined and follow some simple rules and you will find kids in the business can work and your family business will beat the odds of next generation success.

Your Business Plan; Are You Making a Living or a Killing?

“Go ahead. Make my day.” Harry Callahan (Dirty Harry) – from the movie Sudden Impact

I get the opportunity to see a good number of business plans / pitch decks each week and I focus on the section of the plan I believe is most critical. While some may believe it is the management team or barriers to entry; to me it is the financial projections. So at this point, you have to be saying, “Of course; he is a CPA. What is so surprising about that?” The truth is, there is no other place in a pitch where one can get a better picture of the “directional indicators” of a plan. Please allow me to explain.

Years ago, a colleague of mind was tired of working the long hours at our firm and wanted to become his own boss. He bought a Basking Robbins franchise. He accomplished his objective; he still worked long hours but now he was working for himself. However, at the end of the day, all he did was replace salary with small business income; from a financial perspective he was still just making a living.

If you are doing a pitch before investors, remember they are focused on high rates of return; getting their money back in multiples of what they invest. They are looking at what we euphemistically call “making a killing” and they are looking for you to “make their day” by showing them how. So where does the projection fit in to all of this?

First, what is the size of the opportunity in your eyes? If your projections show that in five years, your revenues will be $5 – 10 million, you cannot make enough money to attract most investors. Please do not get me wrong; growing a business to this size is a real accomplishment and can be financially rewarding. It is just not a killing.

Next, does the financial model follow the plan? If the plan is a SaaS model with monthly subscription payments, revenue is simple; multiply the expected users by the planned fee and that should be revenue. So now I can see how many users you expect to have (market share) as well as the monthly payment (market price). I can also look at how you plan to get to that level of users.

Finally, are the projections logical? If your margin or operating costs are substantially different from competitors, do you explain why or are you just plugging numbers to provide a financial result some online advice indicated was what investors want to see? It is a simple logic test that many fail on a daily basis.

Shakespeare said, “The eyes are the window to your soul,” and I think your financial projections serve the same purpose as it relates to your plan. So after you get done “crunching the numbers” please step back to see what they really say. There is nothing wrong with creating a nice profitable business model that might allow you to make a very good living for a long period of time. I have had hundreds of successful clients who have followed that path. Just keep in mind how this approach has to “step up” if you are looking for that investor who wants you to make their day.

Ownership Style Options for Key Employees

“I don’t like your cuffs, I don’t like your cuffs, I don’t like your cuffs . . . .” Line by Béarnaise from Mel Brook’s History of the World Part I.

When I begin a conversation on ownership type incentives with owners of early stage companies (and mature ones as well), my typical approach is to discuss the pros and cons of various instruments or techniques. I discuss stock options, restricted stock, phantom plans, profits interest (if an LLC), stock appreciation rights, ESOP’s and the list goes on and on. Inevitably, many instruments are met with disdain much like Béarnaise assessment of Count de Monet’s wardrobe in this famous scene. I must admit in most cases I “feel their pain.”

There always appear to be two challenging issues; the first is offering liquidity and the second is taxes. So let me add a little color to each. First, it appears few entrepreneurs are willing to write a check to buy out a partner / employee / shareholder when they need that cash to grow their business. For a sizable amount, bank financing is not a viable option and introducing a private equity player or sponsor is another kettle of fish. Second, spending an inordinate amount of time structuring the best tax position is not always worth it as it is usually the buyer of the company who will determine tax structure. Simple point; we advise that if you are dealing with a Company transaction, you buy assets and sell stock. Since you can’t have it both ways, if a good deal may not be a great tax deal, you will probably still take it. So what to do?

I have used a technique I call an Equity Bonus Plan for a number of years. It has a handful of simple components:

  • It only “kicks in” at the time of sale or IPO: in other words, a liquidity event;
  • You determine in advance a “pool” you will set aside upon achieving certain levels of net proceeds to the owners. Doing it early avoids emotional quagmires;
  • You allocate the pool to employees you choose. Some choose to select key people who will drive the business; others use the “chicken in every pot” method and set aside something for all;
  • Employees vest and have to be employed at the time the transaction is executed; there are also some protective provisions;
  • You can communicate what each person gets based upon certain proceeds without revealing financial results.

This plan has now been popularized (I might say plagiarized but imitation is the sincerest form of flattery) by Chobani who announced earlier this year they were adopting a similar plan. (I sound like Al Gore saying he invented the internet.) Though details are a bit sketchy, it appears it will follow a similar path. The liquidity issue becomes a moot point and while proceeds are taxed using ordinary rates, tax payments coincide with the receipt of cash.

It’s Time to be a Shareholder Not a CEO

Max Bialystock: “So you’re an accountant, eh?”

Leo Bloom: “Yes sir.”

Max Bialystock: “Then account for yourself! Do you believe in God? Do you believe in gold? Why are you looking up old lady’s dresses? Bit of a pervert, eh?”

Dialogue from the Mel Brooks classic “The Producers.”

A few years ago, I was working with a long-time client who followed a very democratic process when dealing with his senior management group who also had ownership through an ESOP. There were 5 key management members but the CEO would really not make a move unless he had unanimous agreement. The company had grown nicely in 20+ years but had started to plateau. The CEO approached me about getting an outside board member. He knew things had to change, but he was not sure what to do and felt some independent insight might be a solution.

A couple of years earlier, the CEO of one of my clients had sold (I can do a whole blog on that story), and he was looking for a board seat. While both CEO’s were highly technical (PhDs from top schools), the one who sold was more aggressive and I was reluctant to introduce him into this very democratic environment. After warning both sides, I arranged a dinner. The client who sold asked for some basic data and was very prepared. After exchanging some small talk, the potential board member began interrogating my current client. His basic line of questioning was simple; why was the democratic CEO not acting like a shareholder and avoiding decisions that could increase shareholder value? Did he not realize his fiduciary responsibility? The above noted dialogue came to mind and there wasn’t enough room under the table for me to hide; and after dinner, I felt I had to apologize to my current client for my experiment. To my surprise, he looked at me and said, “Your guy is right; we have to change our point of view.” Long story short; my former client ended up joining the company and becoming a change agent, including helping them with a successful IPO.

I tell that story because I recently met with a good friend of mine who is a middle market investment banker. In many ways, we see the same issue with the need to change the mindset of many of our owners so they can take the steps to maximize the value of their company, especially if they are thinking of an exit. The most successful solution is to build a strong management team who can take over. We both agreed that while our roles were different, getting CEOs to think like shareholders was a key part of what we had to do to help owners. This is especially true if the CEO is perceived as being one and the same as the company. Getting this point across is particularly hard when CEOs point to others who have tried it and failed. Steve Jobs and Apple come to mind.

So as in all things entrepreneurial, it is not easy. You have to stay involved sufficiently to help ensure your vision is executed but not so involved that you are seen as the only one who can run the show. As another good client of mine always said, “Says easy; does hard.” So all I ask is when you go into the office tomorrow, ask yourself if you are acting more like a CEO than a shareholder. Realizing there has to be a change is the first step on the road to your goal. This client (and others I had) did and had great success. With the right mindset, you can do the same.

Why and How Entrepreneurs Should Network – Part II

“Grandpa, walk like you have someplace to go.”

This admonishment from my 5 year old granddaughter (courtesy of my son I am sure) is my reminder that we have to do things with a purpose. And networking is not some random act that results in us meeting a valuable contact; it is a “process.” In Part I of this blog, I provided some background on networking and why I thought it was so important for entrepreneurs. In this second part, I will hopefully provide some helpful techniques.

First, find the right place to go. While it is great to bump into someone at a social event who may allow you to “advance your cause,” I prefer to increase my odds by frequenting events that increase my chances of meeting the right people. We do business with early stage tech companies, so MeetUps, hackathons, FinTech and similar events are popular places for us to be. For more established owners, we frequent business groups, bank and other service providers’ events and small networking groups. With some research and purpose, you can increase your odds by being in the right place.

Next, as the Boy Scouts say, be prepared. In advance of going to a session, see if you can secure an attendance list and set an objective of meeting one or two key people on that list. If there is nobody on the list you want to meet but you are new to the process, go anyway. If the group is right, you will come to appreciate the practice. You should also be prepared for your “pitch.” If someone asks (and they will) why you are there or better yet, what can they do for you, have your short elevator pitch ready.

Third, learn how to break the ice. A simple “Hello, my name is…” works remarkably well. Weather, sports and family are also good topics but they should be of real interest to you. Today, most people are familiar with networking so they are prepared to respond. Ironically, while you might be there with a specific goal in mind, you should begin by asking why they are there and what you can do to help them. If you are genuine (this is the golden rule) the path to your goal may be longer but will be rewarding. I am fortunate to have relationships with a good number of contacts, so for most events, I leave with the task of connecting someone I just met with a contact. But that is fine; I do not mind that someone might remember me as the “person who helped them to connect.”

Finally, follow up. Make sure you under promise and over deliver. If you said you will try to get your new contact a meeting, call and arrange it and close the loop, even if you are not successful. My rule of thumb has always been to not attend a networking event if I don’t have some time set aside for follow up.

So in summary, networking is not just for sales people or professionals; it is a way of life today. Do it with purpose, stay genuine and use hints like the above and you will be surprised as to what can happen.

Why and How Entrepreneurs Should Network – Part I

“You can observe a lot by watching” – Yogi Berra

When I was gathering my thoughts for this blog, I happened to mention it to a good contact of mine at one of the accelerators who proceeded to hit me with a handful of very salient points that I had not even considered. So after reflecting, I decided to make this blog a “two parter” – this first part will provide some background on the process and make the simple case for why I think entrepreneurs should learn to network. Part two will provide some simple guidelines.

In my mind, there are two aspects to networking – the first (and more difficult) is assembling a list of meaningful relationship contacts. The second is to stay in contact and cultivate those relationships – aptly called “working the Rolodex.” My focus in these two blogs will be the first.

In the days of quill pens (and no social media) some of us thought that getting out and meeting people might be a good way to expand our businesses. When I first started to do what today is called networking, there was no process. So as Yogi said, I observed a lot by watching; I saw what worked and what did not. At first, I believed this was a skill you were born with like natural athletic ability because for some, striking up a meaningful conversation seemed so natural and for others it seemed awkward and painful. But observe I did, and I learned from others’ mistakes and successes. At one point, I thought I had found “the process” that I could use but soon realized that one size does not fit all. I came to the conclusion that while there were a few techniques (that sounds so clinical) that seemed to work, a few helpful reminders were the best I could do and I would have to play the rest by ear.

Today, I attend a good number of networking events from MeetUps, to accelerator events to general business venues where entrepreneurs of all types can be found. As you might imagine, since networking is a key part of earning my livelihood, this process has a real meaning for me. In fact, you might say I have become somewhat of a student of the process – and I am a student because I continue to learn. Each event has positives and negatives and some just end up being an enjoyable night out. All are learning experiences.

So let me just say why I think networking is so important. Simply stated, all the planning and positioning and methodologies we employ to either get a job, find financing or locate that key partner seem to get trumped by the old “I know a guy” phenomenon. Those seeking investment know this best – the universal advice for getting your deck before an investor group is to have a “warm introduction” to that group, also known as a network contact. So the second part of this blog will focus on how you light the fire. And make no doubt about it, your contacts are the fuel.