Wednesday, March 28, 2012

Giving up Control - Exactly What that Means

I talked about the "turd on the table" recently.  We didn't like the valuation we received - i.e. that was turd #1.  So in our next round of fund raising (from the same group, which frankly was a mistake) from the very beginning they said they didn't want to take any more equity because they knew I didn't like the valuation.  This time they wanted to give us a loan.  I'll talk about that in another blog entry.  But at the time, that seemed pretty reasonable to me (i.e. I didn't take it as a turd).  BTW, at this point, they owned 10% of the equity in the company and their loan would have bought them another 10%.  So when we went to sign the papers, knowing full well that we were about to receive turd number 2, so we went into the room holding our breath.

Like I said, they said "we don't want to take any more of "your" equity, we just want to give you a loan for $xM with the following terms (blah, blah, blah)."  Then...they said "and we want control."  I didn't realize you could own 10% of a company and have control! can!

Because I disliked the turd so much, I ended up providing a bridge loan to the company to buy us more time.  After several rounds of discussions, they assured us that our interests were aligned and that control wasn't an unreasonable thing to ask for...that we would work together to make decisions.  Since they were "friendlies" we agreed.

Control means that they could make decisions that they couldn't otherwise make.  Play this company forward a little and the PE firm struck a deal to sell our company.  Remember that asked for a valuation of $xM originally and settled on 50% of $xM.  Remember they only owned 10% of the company of this point.  The Private Equity firm had bundled our company with another company, so it wasn't clear exactly what they were selling our company for, but the package deal (i.e. the price for both companies) was rumored at more than 5 times $xM (or 10 times what they valued us at).  We assumed they were getting about 2 times $xM (4 times what they valued us at) for our company in the deal.  But...before they executed the sale of these 2 companies, they wanted us to sell our remaining shares at the original valuation (50% of $xM).  I explained that I understood that they were the ones that got a premium, but that we might share in the value that we created to that point.  In other words, if the market valued us at $xM, they should pay us $xM for the shares at this point.

In our board meeting, we asked what would happen if we found a buyer for the company (we knew 2 companies that would be interested) at 300% of what they were offering us (i.e. that was the market value at this point).  They said "we'll block the deal."  The entire board gasped and instantly realized that they could in fact block a deal like this...not legally (because legally you have to do what's in the best interest of all of your shareholders, not you as the one with control), but since they had control, they could.

They ended up blowing the deal over their greed.  They had control, but they didn't own 51% of the company...yet.  I'll talk about the 51% rule in another blog entry.  So they could block us from bringing them an offer, but they couldn't sell the company without our permission.

Lessons of the day.  First and foremost.  Don't give up control!  Future lesson - don't sell 51%.

Post a Comment