I Take It Back!
Today, Richard Warner's Web design business, What's Up Interactive, is a phoenix rising from the ashes. Burned by a disastrous merger, Atlanta-based What's Up was nearly destroyed.
In early 2000, at the height of Internet mania, Warner, now 47, was living the dream. His $2 million, 20-person firm had outgrown his basement (and his bedroom, kitchen and den), and he had buyout offers from three different companies. He chose carefully, then struck a deal with a Nasdaq-listed media conglomerate.
The $2.5 million sale marked the beginning of the end. Three months later, Warner was at the bargaining table again, trying to buy his company back. "It was obvious that [the business] was not going in the right direction," Warner says. "I offered to give them all their money back and all their stock back, but they said 'no.'"
Up in Smoke
Now just an employee, Warner had little control, but he couldn't quit. "My net worth was wrapped up in the company [stock], I had a strong noncompete [agreement], and I was watching the business that my wife and friends and I built evaporate."
By March 2002, things had gone from bad to worse. The stock he received in the buyout was nearly worthless, and half of the employees had been laid off. Just as Warner was about to call it quits, the new CEO called and offered to sell him what was left of What's Up. Annual revenues were down to just $800,000, and termination notices had already been mailed to the remaining employees. Warner had to scramble. "I was prepared to offer a lot of money for the company," says Warner. Friends advised him not to pay anything. In the end, he bought back What's Up for $35,000 cash in a transaction that took less than four weeks to close.
Warner's story is not uncommon. A wave of M&A activity swept through every sector of the economy between 1990 and 2000, leaving many entrepreneurs-now employees-stranded in the wreckage of their former companies. "Buyers always say they'll pay a premium price and they won't change anything," says Ben Emmons, vice president of Sun Capital Partners Inc., a private equity firm in Boca Raton, Florida, that finances management buyout transactions. "But the [economic] synergies they plan on rarely materialize, and the companies blow up."
When that happens, founders must choose between buying the company back and walking away. But buying back in is not always as easy as selling out. The first thing to do, says Emmons, is to take stock of your personal finances and the true financial condition of the company. "You have to ascertain what you can finance, how much you'll have to borrow, and what the capital structure should look like."
Warner was fortunate: The repurchase price was small, and he was able to raise money from personal funds and friends. "It always works best if a founder can buy it back on his own," says Emmons. But when that's not possible, there are plenty of places to turn to for help.
Pick Up the Pieces
"The sources of money for buyouts come from private equity funds and lenders that specialize in senior secured loans or mezzanine loans," says Mark Bonenfant, a partner at law firm Buchalter, Nemer, Fields & Youngerin Los Angeles. Lawyers like Bonenfant can recruit and lead the team of accountants and bankers that may be needed to finance the purchase and piece the company back together.
A private equity firm could also take the lead in these transactions and bring its own team of experts. In such a case, however, the entrepreneur may not end up being a majority owner. "A [private equity] fund is looking to invest in equity, and they'll put up 30 to 45 percent of the purchase price," says Bonenfant. But for that, they get the lion's share of the stock. What's left for the management team could be just 5 or 10 percent.
A private equity firm, of course, is a financial owner and is investing in management as much as in the business. This may mean the entrepreneur is free to manage the company on a daily basis but will still be accountable to a strong board.
But even the largest equity fund won't do the whole deal. "The balance of the purchase price can be financed through one or more layers of debt," says Bonenfant. Buyout debt will probably come from a finance company or a large bank. Look for a senior debt lender and a mezzanine debt lender. Each requires different loan terms: A senior loan will be secured by the assets of the business, while a mezzanine loan is unsecured but may require you to pay a small amount of additional stock as a "kicker."
Devil in the Details
It's easy to determine how much debt the business can afford. A mezzanine loan is directly related to the company's actual cash flow. A senior loan may also depend on the value of assets, including accounts receivable and inventory. Of course, cash flow still has to support payments for all loans.
"A senior debt instrument will probably be equal to two or three times EBITDA [earnings before interest, taxes, depreciation and amortization], while mezzanine financing could add another two times EBITDA," says Bonenfant.
Buying back a company is a securities transaction and may fall under the purview of the SEC. This is especially true if the seller is a public company or is going through bankruptcy-both conditions that affected Warner as he repurchased What's Up Interactive.
A regulated transaction may require you to file special disclosure forms to assure a fair transaction, advises Bonenfant. If the buyer is also an officer or director of the company, he may have a fiduciary duty to the current shareholders. This situation creates a conflict of interest, which could jeopardize the whole transaction.
Happily, Warner rescued What's Up through fast action and clear thinking. He also credits strong relationships with managers and executives in the company-many people wanted to see him succeed.
Last year, What's Up billed $1.1 million, and it's on track to see 50 percent growth in 2004. Warner couldn't be happier. "When it comes back to you," he says, "you appreciate it more than you ever have."
1.Overconfidence: Because you built the company once, you can do it again, right? Not so fast-rebuilding a company can be much more difficult. Be careful to calculate valuation based on current conditions and not pie-in-the-sky forecasts.
"Entrepreneurs often pay a lot more than they have to because they believe the business can grow more," says Ben Emmons of Sun Capital Partners Inc., a private equity firm in Boca Raton, Florida. But if you are already involved in negotiations for the company, chances are, the seller wants out. You may have more leverage than you think, so drive a hard bargain.
2.Hero syndrome: You may think of yourself as the knight in shining armor who's charging in to save the day. Don't count on employees to join you in that fantasy. In fact, employees may see the pending transaction as a further disruption, and they may worry about the future. "A buyer may have to earn back the respect and loyalty of the employees," says Emmons. "Repurchasing the company may rekindle the same angst that the employees had when they heard that you were selling."
3.Irrational exuberance: Passion for your work is healthy when the company is yours. If someone else owns it, be careful not to let emotions dictate your actions. If your reasons for buying back your company are based more on emotion than on economics, you may be better off starting over from scratch. "Buyers need to get an advisor-a party in the middle that does not have an emotional attachment," says Emmons. "You need someone who can focus on getting the deal done."