It’s not supposed to work this way, is it? Somebody has got to lose, for someone else to win, right?
Well, maybe not.
“So tell me again how this deal is going to work,” I asked the CFO of a growing mid-size technical services business here in San Diego. “It’s a little hard to believe.”
Floyd, the largest single shareholder and CFO of the company he co-founded with three other people, smiled at me.
“Well first of all, you have to understand that the only reason this deal is possible is because none of us were looking at the exit sign,” Floyd began. “We spent no time or energy trying to figure out how to make such a deal happen. None. We focused all of our attention on building a great company.”
I wanted to hear more about that. “What is your definition of a ‘great’ company, Floyd?” I asked.
He replied, “A great company is comprised of a group of committed teammates who care more about company success than individual recognition. A great company is one that grows profitably. A great company is one where the staff feels respected and challenged, where the work isn’t easy so the accomplishments mean a lot. A great company is one whose customers really enjoy interacting with staff and highly value the services or products delivered. A great company is one that thinks really long term. Decades. Its leaders have a sense of responsibility for the legacy that will succeed all the current employees.”
“Well, you don’t ask for much!” I said.
“I think I ask for what everyone should ask for,” Floyd replied. “And because that is what we set about to build, ignoring the Big Pay Day thinking that many entrepreneurs can become intoxicated with, we created the opportunity for this perfect transaction.”
“What makes it ‘perfect’?” I asked.
Floyd took a deep breath. “First of all, nobody leaves. All the employees are not only retained, they now have much better career prospects than we could have created on our own, because we had to take on debt each time we expanded. The debt was repaid through favorable customer contracts that guaranteed profitability, but we had a limit to how much liability our balance sheet could accept and still satisfy the lender’s covenants. The acquiring company wiped out our debt and is providing growth capital to allow us to double our expansion rate. The acquirer is a public company trading at fourteen times earnings. They offered us eight times our projected profit, so they not only get a foothold in our market that they needed badly, they make a 600 percent return on capital in the form of company valuation improvement. Our founding investors are getting ten times their cash investment returned to them after five years. Our newer investors who became shareholders last year are getting four times their cash returned. Our middle managers, all eight of them, receive a surprise check for a quarter of a million dollars, and a 33 per cent raise in pay.”
“Slow down!” I exclaimed. “That’s incredible!”
“And there’s more,” Floyd said. “Since our acquirer is buying our company because it is a truly strategic fit for their growth, we will have the pleasure of creating 400 new jobs in the next three years, based on identified customer demand that simply was waiting for us to be able to build new facilities to serve those needs.”
What a story. Nobody loses. Everybody wins: employees, shareholders of both companies, vendors, customers and America at large. This is a rare occasion to be celebrated loudly. But does it have to be so unusual? Why do 85 percent of acquisitions fail to even meet a modicum of success, let alone the incredible grand slam that this story describes?
From what I’ve seen, the majority of M&A mistakes are made because of two things. First, the acquisition is not properly evaluated with objectivity and a thirst for finding the truth. Second, the sellers have had their eye on the exit sign so intently and for so long, that they created a pretty façade which covered a flawed business. And the hopeful lottery players spent most of their time selling sizzle and negotiating the deal, rather than creating the fundamental underlying value of the business.
Floyd and his colleagues avoided these errors. They were having a ball building a sound business with a tight team. The buyer found them. And that is a lesson for anyone who aspires to increase the value of their ownership in a business.
Build a great company. The opportunities for a perfect transaction then take care of themselves.
Friday, April 22, 2011