Case Studies

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The Shell game
 
Many of you are picturing the sidewalk short-con with slight of hand and fast talking. But I’m talking about the public shell (reverse merger) game. Both are fraught with risk.
 
This is the story of John and Larry’s trucking company. They’d done ok and had grown into a good-sized regional trucking company but they were bumping into growth constrictions and just couldn’t seem to make it to the next level.
 
I don’t know how, but they got connected to Lance. Lance owned a OTC public shell that he had re-hab’d, and when he talked to John and Larry, he sold them on the idea that his public shell was the answer to their problems: access to capital, easier expansion into new territories, etc. Rainbows and unicorns, every day.
 
Well, I guess you see where this story is going.
 
It didn’t work out quite as planned. Unless you’re Lance. Lance had an empty shell but now has a chunk of dough and a company in his shell. Lance is doing just fine.
 
But lets get back to John and Larry.
 
Having gone public, their business WAS different — just not in a good way. They still had to do everything they’d been doing for years but now they were dealing more with the public vehicle rather than with actual vehicles (trucks), which would have been great, but they weren’t able to raise any capital. Their stock was not moving and their lack of liquidity and valuation was putting a crimp on their ability to raise capital. Oh, and there’s all of the SEC compliance stuff, you know.
 
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This went on for a couple of years until they asked for help and were told what they were missing: Investor Relations. Investors can’t buy your stock if they don’t know about it. So job number one was investor awareness campaigns to increase their public company profile, liquidity, shareholder base, and valuation. Job number two was connecting them to capital and strategic resources that could see the same vision that John and Larry had, but also had the horsepower to do something about it.
 
Fast forward a hectic twelve months and you find John and Larry executing on their expansion plan through a substantial capital raise and an outstanding acquisition that was immediately advantageous to their fairly-valued public company (ie: former shell) that was now growing and expanding.   
 
I guess it is possible to imagine that John and Larry could have found their way forward without help, but I consider it very unlikely. You can’t be everything to everyone. Find experts that you can trust and let them work their magic or you face a long slog uphill.
 

Risky business

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I wish I could tell you this was a story about a Tom Cruise movie.

 

Instead, this is about two guys named Brad and John. They ran a very busy manufacturing plant and were finding it hard to keep up with the orders. They calculated that a new machine on the floor would be kept busy at least 50% of the time and pay for itself within 3 years.

Their banker was not as excited about the idea. He calculated that the seven digit purchase was impractical at this time and sent them back to the drawing board. 
 

Did you ever know someone that got tunnel-vision when getting a new car? So in love with the model, year, and color that price, features, and terms didn't seem to matter?
If one will not take the time to investigate what else is available, one runs the risk of making painful decisions.

So it was with Brad and John. Their answer was to buy this latest-model machine. Instead of finding other machine options -- they found other finance options.

In the end, the boys rationalized this purchase through a non-traditional funding source that charged more interest over a shorter period of time which made the whole deal much less attractive - but they could make it work. This machine became a "must have" for the boys even if the finance terms were poor and the deal more risky.

So the bad deal was sealed at almost double the favorable bank interest rate and amortized over a shorter period forcing the company to run losses where they never had before and worry that if anything happened to a primary customer, they could be in real trouble financially.

Fast forwarding three years and you find that Brad and John had to give up substantial ownership to secure a partner when the shop slowed and they could not maintain the high monthly payments on equipment that was now running only 25% of the time.
 
As it turned out, there were three used machines in the regional market for considerably less money and a several troubled shops operating with that same or similar equipment that would have entertained an offer for equipment, partnering or outright acquisition. The latter choice could have brought Brad and John customers, orders, cash flow and hard to find machine operators.

How do I know this? 

The partner that got a big piece of Brad and John's company for a song? Well, he had hired the Packard Group to help him fill in some of their gaps in manufacturing capabilities. Not strategizing significant purchases can be terribly expensive. The cost of planning is always a rounding error when weighed against significant purchases.
 
Risky business indeed.

 

 

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The person most likely to defraud your company is:

 

In a recent discussion on fraud, I was reminded of how common criminal behavior is by employees, especially during hard times or company transition.

 

Example 1

A long time, trusted, key employee was caught in a diversion fraud that they initiated shortly after the owner announced his retirement and the transition plan for the company. The key employee rationalized their criminal behavior with this statement: “(Owner) was selling out and cashing in. I’ve been a loyal employee for 21 years, how else could I cash in?”

 

Example 2

When a small business enacted company-wide compensation reduction as they weathered the great recession of ’08-‘11, a minority owner (and family member!) began an illicit side business of stealing inventory and undercutting their own company — then pocketing the money. It came to light recently and the offending family member simply did not want to reduce his family’s lifestyle.

 

Example 3

A businessman had grown a startup to a nice-sized company — all while running it from his truck (and his head). He had done quite well for himself. His advisors routinely questioned him on his level of profit compared to his operation. He finally caved to their insistence on installing security cameras right before leaving for his annual family vacation. He sadly discovered that his best friend (and first hire) had been stealing from him. Apparently, for years.

 

 

So who is the person most likely to defraud your company?
The trusted employee(s) you are most certain could not be involved.

 

As is so often true: People do what is INspected, not what is EXpected.

 

The answer is always “systems” - inventory systems, accounting systems, and security systems. If you think you’re business is too small for such administrative overhead, consider the full cost (emotional, financial, morale, etc) of undiscovered fraud. I've seen 10+ years of theft go under the radar. Fraud eats a significant percentage of profitabliity. In bad years, it drives companies into losses.

 

The Association of Certified Fraud Examiners claim that typical, closely-held businesses lose a median of 5% to fraud. All business owners think it won't happen to them.

 

Also consider this: even if your company only gets a 3x multiplier on profit when you go to harvest your company, the fraud could cost you hundreds of thousands, maybe millions.

   

What would you do if you owned this company...

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What would you do if you owned this company...

 

Paul was in a quandary. He had built up a nice company and captured a decent portion of a rising segment. But looking into the future, he saw trouble ahead. As his segment matured, he forecasted that the segment would commoditize, revenues would drop, and margins shrink.

Like most business owners, dropping revenue and shrinking margins takes the fun out of the game. However, a service segment had emerged. It was in a fledgling stage but showed incredible growth potential.

 

At first glance, Paul thought his options were:

1) Get out now
2) Ride the wave and get out in a couple of years
3) Build a service division

 

What would you do? What did Paul do? 

 

He didn't like any of his options.

1) Selling now would mean foregoing the revenue he could capture for the next several years and, more importantly, the multiplier he could get in a sale after his company grew for the next several years.
2) Option two could be ok if he timed it exactly right, but liked his industry too much to want to walk away yet.
3) His last option was to build up his own service division, but didn't like the idea of "starting over" at ground zero on the service side.

 

But he choose Option 4 after Packard showed him a path to long term growth by acquisition/merger of a smaller company involved in the service segment. One that put a service division, fully formed, into his company. 

 

The hidden cost of acquisition

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Tom was a proud father. After ten years in lesser positions at his business, his two children (Sara and Jim) were to begin higher level participation. Tom did have a lot to be proud about - his mom and pop shop had grown into a multi-million dollar enterprise that was a significant employer in an out-state town and his children had completed college and had chosen to be part of the family business.

 

Now that Sara and Jim were aboard on management, Tom felt they finally had the management bandwidth to pursue growth via acquisition.

 

Sara did the initial research. She called a dozen or more business brokers to compile a list of companies that were for sale. Jim did the initial investigation to determine whether or not they were worth pursuing.

 

When they were 18 months into the search and investigation, one company really stood out. They made an offer and were confident it would be a good fit. Now Tom and the CFO got heavily involved in negotiating and working towards a definitive agreement. Corporate counsel also became active in the process. After almost a year in the making, the seller abruptly walked away from the deal. (Within a year of that, the seller stepped down and his son-in-law held the reins.)

 

Now Sara and Jim were almost four years into this effort. Feeling some frustration and pressure to perform, they focused on another company from the list and an offer was sent. This company had been on the market for awhile and did not seem as good a fit but Sara and Jim knew it could work.

 

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Again Tom, the CFO, and counsel went to work. It was fortunate for Sara and Jim that their CFO caught the discrepancy in the inventory that Jim had missed in his review of the company’s documents. Investigation into this discrepancy opened a whole can of worms and brought to light internal theft and a poisoned culture at this company. A disaster was averted.

 

In looking back, Sara and Jim had spent four years of 100% effort plus travel expenses into acquisition effort. They had brought Tom and the CFO in for 16 months of 35% effort. And don’t forget corporate counsel. 

 

A figure well into seven figures with nothing to show for it and nothing on the horizon.

 

Without understanding the process and tools required for a successful acquisition effort, owners often experience a wasted effort or worse, a terrible acquisition costing far more than the loss of time and resources.

 

Criteria definition, search & research, and the mechanics of transactions — it’s not rocket science but it is critical to executing a successful acquisition.

   

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