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…

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What Do I Look at to Manage My Company in its Early Stages?

“Though it’s cold and lonely in the deep dark night I can see paradise by the dashboard light”

Lyrics from “Paradise by the Dashboard Light” – Meat Loaf

A standard tool we develop for companies at all stages is a “dashboard.”  The concept is simple – assemble in one place data which is critical to running your business – like a dashboard, it should be easy to see and understand and not too cluttered.  A dashboard is a tailored piece as the critical information can vary by business – especially depending on your stage of development.  So, if you are an early stage company, here are some key components that should be on your dashboard:

  1. Financial data – while there is a lot that can go on here, my three favorites are cash, trailing 12 months revenue and burn rate (how much cash you are going through each month.)  The latter will give you a view of when you have to hit that old fundraising trail again. If you are generating cash, better yet.
  2. Key Performance Indicators (KPI’s) – usually tailored to each specific business.  The often include items such as unique visitors to your site, churn rates and similar non financial statistics.  As a guide, think of the key metrics you told investors were milestones you wanted to accomplish.
  3. Product development status – key milestones, latest timelines and spend versus budget.  If investors are expecting a mobile app in three months, how close are you?
  4. Organization chart –  this is both a status of filling open positions as well as a brief accountability review to make sure hires are delivering on what you need to move the business forward.
  5. Competition – where are they in product development, funding and in attracting the talent they need?  What message are they sending on social media?  Are they laying out their plans on AngelList or another “crowdfunding” site?  In addition to understanding their position, this will give you a better read of the market (customer acceptance of product; investor’s appetite for your type of company.)  In addition to the information this type of data tells you about your business, sharing it with your board or advisory board displays a level of discipline and increases their confidence in your ability to execute on your plan.  A dashboard is also an evolving tool; as you realize the critical data you need for your decisions, you should feel comfortable changing its components to meet your needs.  It is not a checklist that has to be completed; it is a tool to help you focus on what really matters.

Success Through Failure

Wayne Campbell: No way !

Garth Algar: Way !

From the movie Wayne’s World

 

As difficult as it may be to understand, many believe that the way to success is to experience failure.  So, by design, if you have a fear of failure, it is probably not a good idea to become an entrepreneur.  Many inventors and creative types were not concerned with failure.  Thomas Edison basically considered every failure an experiment and to master a technique or process, you had to do it 10,000 times to reach that level of competence.  Trying anything that many times has to be an exercise fraught with failure, so one view is to consider failure as part of the rocky road to success.

 

But, how does an entrepreneur harness the power of failure and turn it into success?  There are probably five rules to consider in order to accomplish this difficult goal:

 

1. Be honest about admitting to mistakes (failures).  Sincerity trumps most traits when it comes to dealing with your team, potential investors and customers.  Others want to know you considered alternative approaches and perhaps they all did not work. Somewhat appropriately, it is considered as thinking outside the box in order to get the optimal answer.

 

2. If at first you do not fail, try, try again.  The old saying “nothing ventured; nothing gained” comes to mind. Trying new approaches and embracing whatever the results of those efforts are become part of the process when you seek success.

 

3. Understand what went wrong.  You start on this journey knowing something will go wrong, so set up your process so you understand what it is.  Why didn’t prospective customers take to your product?  Why didn’t the product deliver what you expected?  Seek feedback so you understand the “why.”

 

4. Learn from your mistakes.  The mirror to point #3 is using what you understand went wrong to modify your approach.  You have suffered the pain of loss; learn from it.

 

5. Maintain your resilience.  A positive attitude that leads you to understand that this is a process and failure is a teacher and not an enemy, will allow you to put your failure in perspective and see it as just one more step in accomplishing your goal.

 

So yes… “way.”  Failure can be an important part of your road to success.  Learn to embrace it and learn from it.  You, too, can turn lemons into lemonade.

Advise – Not Impose

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?…

From The Producers by Mel Brooks

 

So, I just had my second heated discussion (in three weeks) with another advisor about a mutual client.  Now, believe me, I truly respect the passion that an advisor can have for his or her point of view – I am guilty of that myself at times.  But, I draw the line when I have made my case and a client decides to do otherwise.  It happens and you learn to deal with it.

Though these were different advisors and clients, it was the same subject- providing liquidity for an equity-type plan in a mature private company.  First, let’s expand a bit on the issue.  Many owners receive advice that some type of plan which provides economic rewards for performance based on an increase in the value of the business is a good thing.  There is nothing wrong with that concept and the use of this technique (usually in the form of stock options) by public companies is rather widespread. But, public companies have a distinct advantage.  Those receiving the options can turn around and sell the underlying stock in the public market with no further cash outlay on the part of the company.  This is one of the advantages of being public.  It is when the company is not publically owned that the “rubber hits the road.”  Now, when that option is exercised in a private company, what does the new shareholder do to get liquidity?

So, why the heated discussion?  Well, in both cases, the other advisor stated that without liquidity, such a plan really had no value and when my clients in both cases weighed the risks and decided against liquidity, both advisors became adamant about it being required.  Both of my clients were ready to abandon their plans though they both felt they needed some type of plan.  When I asked each advisor how they would handle the liquidity requirement, one said that company A could borrow money to buy the shares back, the other suggested that company B could give the company the right to buy back the shares, when appropriate.  As my 8 year old granddaughter would say “really?”  Banks love to make loans where all the money that is borrowed goes right out the door to a shareholder and a shareholder is happy to wait until their company is good and ready before they buy back their shares.

So, let’s forgive the fact that I felt neither advisor had thought through then consequences of their advice (they did not account for themselves), it was them imposing on these clients a solution that almost caused the clients to abandon a technique that would help them grow their business.  By the way, we got rid of both advisors, developed an equity-like plan and a bonus plan and met the objectives the clients wanted.

So, if you are confronted with advisors who impose rather than advise, please be careful.  Advisors come and go, but you are stuck with the consequences of their actions.

Don’t Forget What Got You Here

“Whatever you do

Do it good

Whatever you do, do, do, Lord, lord

Do it good”

Lyrics from Express Yourself – Charles Wright & the Watts 103rd Street Rhythm Band

So, I recently completed a two-part blog on Disruptive Technologies entitled “For Mature Companies Only” with some pointers on what mature companies should be aware of in their markets and steps to deal with this issue.  My points concluded with the fact that as a mature company, you are probably a market leader which gives you a competitive advantage. Being one who can dwell on the obvious, I had assumed that mature companies would not trip up on the basics.  Doing whatever you do “good” is a barrier to entry for others.  My recent consumer experiences now give me cause to reflect on the basics and issue this reminder to not forget what got you to become a market leader in the first place.

My first example was an established credit card company with a reputation for outstanding service. An errant (in my view) charge appeared on a recent statement.  I have been a card member since 1970 and I did something I had done only once before – I questioned the charge.  I subsequently submitted the required paperwork all dutifully prepared with extensive detail and documentation.  I then saw the response from the vendor to the credit card company which was basically a statement saying they thought I owed the money.  This was accompanied by a notice from the credit card company that they were reinstating the charge.  Like Vinny Gambini, I thought I had presented a “lucid, intelligent, well thought-out objection” only to be overruled.  After a few phone calls and convincing somewhat to just look at what I previously submitted, the vendor conceded the charge was incorrect and it was reversed.  In my eyes, the stellar reputation of my credit card company was tarnished and will be remembered at renewal time.

My second case actually involves two well-established home goods companies in our area.  Both have great reputations for customer service and for us, we continue to shop the old “bricks and mortar” way versus online.  We have always appreciated the chance to see the products first hand and to ask questions before we buy – things which are difficult to do online.  Well, on a recent Saturday, we went looking for a particular item.  Getting someone’s attention in either store was virtually impossible. We were patient as it was a little busy.  The staff was cordial as we waited for assistance, but it felt a bit like being on hold when you call and hearing that dentist’s office music while being reminded periodically that someone will be with you shortly. We waited both places in excess of 30 minutes and finally left.  Reluctantly, we turned to online shopping and completed our purchase.  No sense in sinking costs into brick and mortar if you are not going to staff it properly.

So, the punch line here is simple.  Mature companies look for sophisticated ways to prevent disruptive companies from penetrating their space.  So, why make it easy by forgetting what got you there in the first place – like solid customer service?  There are sufficient threats from disruptive companies in your space; do not add to your risk by forgetting the basics.

Be Careful When Issuing Equity

Vinny Gambini: You were serious about dat?  Quote from My Cousin Vinny

What prompts this blog comes from a conversation with one of my partners recently.  He had been served with his first subpoena on a client where we had only offered some tax advice.  Fortunately for us, it had nothing to do with our work, but the story was not the same for the Company.  It appears that the Federal authorities were interested in the company’s equity issuances – who got what, when and what paperwork had the Company retained.  They were looking for violations of Federal securities laws and the fact that they were seeking our documents indicated their probe was pretty thorough.

We constantly offer advice to startups and almost every conversation centers around the granting of a “piece of the business.” The methods of distribution range from seemingly innocent letters promising some poorly described ownership to actual stock sales.  Virtually every conversation is peppered with the advice to get a lawyer involved and yes, we are “serious about dat.”  The sale of shares or equity can become subject to Federal jurisdiction, as was the case here, and you do not want to be on the wrong side of that transaction.

I am not a lawyer, but in laymen’s terms, the government is always interested in two aspects of any equity deal.  First, is whether or not the investor has the means to sustain a potential loss and, second, is if the investor was provided sufficient information to make a decision.  If you have been following the evolution of “crowdfunding” you may have heard the term “accredited investor.”  This is how the SEC and others define the first part of the equation – can the investor bear the loss?  The famous poster child scenario for this is the mythical widow from Idaho who has $10,000 in life savings being persuaded by a “boiler room” salesman (a la “Wolf of Wall Street”) to invest it all in a tech startup.  That is a no–no.  The second piece is what the SEC struggles mightily with and that is the issuer providing sufficient information to make a decision.  They are trying to come up with something between a Prospectus (a tomb seen by many as one of the most difficult documents to understand) and a pitch deck.  I fear this debate will last for some time.

The sale of equity is not the same as selling someone a used car.  In the former, you have no real understanding of expectations on the part of the buyer.  They may think they just purchased the “next Google” or are expecting dividend checks to start flowing next month; thus the need to communicate the “risk factors” that should serve to temper those expectations. In the latter, people just expect a mode of transport which will get them from here to there.  There is risk in equity that should not be taken lightly.

So, please, if you are involved in the issuance of any type of equity instrument, do not do so without appropriate legal counsel. You probably would not sell your house without doing so and your equity is probably worth a whole lot more.

For Mature Companies Only – Part Two

Ace Ventura: “I have exorcised the demons . . . this house is clear.”  From Ace Ventura – Pet Detective

In my prior blog, I outlined a few ideas around why mature companies should remain vigilant regarding the potential for Disruptive Technologies (which are not always technologies) in their industry.  It all sounded a bit ominous, and I did promise to help “exorcise the demons,” so I will provide you some actions to consider.

We all know that change is inevitable and best practices involve embracing that change.  They key is to prevent that embrace from becoming a stranglehold.  So, to help address the impact of disruptive technologies, mature companies should consider the following five steps:

  1. Develop a positive attitude toward innovation.  Get out of the office, stop gathering only where flocks go (like the standard industry trade show) and free up younger staff to explore the world of innovation and social media.  Appropriate MeetUps (you can even form your own) are a good starting point.
  2. Visit accelerators and incubators.  These are the new bastions of disruption and, the more you know, the better off you are.  Today in the NY Metropolitan Area, many of these groups are being formed around industries – food tech, ed tech, fin tech.  Visit them and get involved.
  3. Revisit you brainstorming/strategic approach.  Challenge basic assumptions and make sure those barriers to entry and differentiators remain in place and enhance them. Review your SWOT – there are solid reasons why your business has endured so make sure you remain focused on them.
  4. Know what your competition is doing.  It has never been more important to know this and by scraping data from the internet and social media, your horizons will be expanded and you will be able to counter new threats.  Keep in mind, the market is usually waiting for the market leader to embrace an emerging technology and, in doing so, you can retain a strong competitive edge.  Don’t be afraid to take advantage of your market position.
  5. Follow the money.  There are billions of dollars available to fund new ideas.  There is also data available on what is getting funded for you to review.  Many established and technology companies (like Google and AOL) have their own venture arms and on a daily basis, complete deals which are “disruptive” to their own disruptive technologies. Many start ups seek to partner with the industry leader to use that positioning to further develop their own growth strategy.  Be ready to take advantage of it.

So, my advice is simple.  Do not put your head in the sand and ignore what may be developing around you.  The success of these disruptive technologists cannot be ignored and I would bet if you reflect back on what you did today, you will see at least one example of how they have altered your actions as a consumer.  Embrace the change and use your strengths to maintain your position of leadership and your company will continue to prosper.