The other day I flew home beside an entrepreneur I’ll call Gary. After learning that I write about selling businesses, Gary was quick to share his horror story about selling his company to a large organization.
It turns out Gary got his start by producing a single event for IT consultants. He used the success of that first event to parlay his enterprise into a series of four event properties profitably generating close to $5 million in annual revenue. Gary’s success caught the attention of the CEO and founder of a much larger conference company.
The CEO courted Gary for months and eventually convinced Gary to sell his business. Instead of offering Gary cash for his company, however, the CEO offered to pay for Gary’s business over five years based on its performance as a division of the acquiring company.
The acquirer was much larger and enjoyed pricing discounts from hotel chains and travel companies. Gary figured it would be easy to meet the profitability thresholds in his earn-out agreement and get paid much more for his business under the CEO’s plan than if he sold it for cash to someone else.
The first few months went well enough, with Gary getting some access to additional resources and benefiting from his new parent company’s scale. Then suddenly, without warning, the acquiring company filed for bankruptcy protection, the CEO was replaced, and Gary was left standing in line with the other creditors trying to salvage what was left of his business.
In a recent piece for The New Yorker called The Sure Thing, Malcolm Gladwell documents how enterprising entrepreneurs prey on unsuspecting business owners. Mr. Gladwell’s article was in part inspired by a study, From Predators to Icons, written by French scholars Michel Villette and Catherine Vuillermot.
Mr. Villette and Ms. Vuillermot analyzed the careers of successful entrepreneurs such as Bernard Arnault, the founder of luxury-goods conglomerate LVMH, Ingvar Kamprad of IKEA and Sam Walton of Wal-Mart fame. Their primary thesis — along with that of Mr. Gladwell — is that celebrity entrepreneurs succeed by taking advantage of situations in which they have a clear upper hand and virtually no chance of failure. Like a lion attacking an aging antelope.
The article presents an interesting contrast to the classic stereotype of the entrepreneur as the Indiana Jones of the business world, swinging from one impossible predicament to the next, MacGyvering his way out of situations with little more than a safety pin and a broken transistor radio.
In The Sure Thing, Mr. Gladwell recounts the story of how Ted Turner, then the bootstrapping owner of a single TV station in Atlanta, acquired the Atlanta Braves for $1 million down. Lacking even the down payment, Mr. Turner the predator found that up-front payment on the balance sheet of the club itself, which allowed him to, in effect, acquire the team using its own money, virtually guaranteeing himself a spectacular return on cash invested.
The article provides a playbook for the hunter, but a cautionary tale for the business owner considering selling his or her company to a hungry entrepreneur long on charisma and short on cash.
Here are four ways predator acquirers hunt for businesses:
Vendor take-back. In a vendor take-back (VTB), the acquirers ask the seller to finance whatever part of the deal is too risky for their banker. If the acquirers destroy your business, the bank is first in line to get paid, and you’re left owning a severely impaired business.
Earn-out. The acquirers tell you they will help you grow your business as a division of theirs. They promise all sorts of treats in the courting process and often turn coat once the ink is dry on your deal.
Share swap. Instead of offering you cash, the acquirers pay for your shares in stock that vests over a period of time. Great if the shares go up; disastrous if the acquirers’ stock tanks before your equity vests. You’ve traded your share of a company you control for one you don’t. I know a business owner who sold his business in return for stock in a public company that was trading for $17 a share only to see the stock price drop to less than $2 a share before he could get his money out.
Buying just enough. Another tactic acquirers use is to offer to buy a controlling interest in your company while leaving you holding just enough stock — 40 per cent or 45 per cent — to ensure you will not walk away when things get tough. Then you’re left as an employee and minority shareholder to carry out the acquirers’ dirty work — squeezing suppliers, dehumanizing employees and nickel-and-diming customers — so the buyers can ratchet up the profitability of your company only to flip it to someone else.
If you agree to be eaten by a predator, just make sure he pays full price for his meal.
Special to the Globe and Mail
John Warrillow is the author of Built To Sell: Turn Your Business Into One You Can Sell . Throughout his career as an entrepreneur, Mr. Warrillow has started and exited four companies. Most recently he transformed Warrillow & Co. from a boutique consultancy into a recurring revenue model subscription business, which he sold to The Corporate Executive Board in 2008. He is the author of Drilling for Gold and in 2008 was recognized by BtoB Magazine’s “Who’s Who” list as one of America’s most influential business-to-business marketers.