Several years ago, I sold my software development company, MED Associates, to a partner corporation, Boatracs. As a successful system consultant and software developer, I was enthused with the idea of the combined companies. However, had I directed my energy more toward the deal and less toward the new enterprise, I might have avoided several mistakes.
Successful consultants should only sell their companies if the deal provides immediate financial advantage. Future earnings may be a factor in valuation, but they should never constitute an element of the sale or a contingent price. The promise of future reward may be very attractive, but gaining it will often lie beyond your reach. My story shows just how bad it can get.
MED Associates designed, developed, installed, and serviced information systems for workboats and their company’s offices. These river towboats, offshore oilfield supply boats, and fishing vessels used MED software onboard for such things as activity reporting, crew payroll, maintenance, engineering, and even grocery ordering. The systems used Boatracs’ off-the-shelf satellite systems to link vessels to fleet shore locations with the MED shore software. After selling several hundred satellite units, Boatracs offered to purchase MED and merge the companies. With comfortably profitable sales in excess of $1.5M annually, the additional MED revenue represented about 20 percent of the combined enterprise.
Having struggled to build the business, I was flattered to be courted for the purchase. Never having carefully considered the value of MED and after struggling for a few years for cash to expand, I was excited about the offer. Boatracs offered $250K in cash with another contingent $250K the second year and 200,000 shares of restricted stock. At the time, Boatracs stock was trading in the $3.00 range. The offer included a four-year employment agreement starting at $120K per year plus bonus. The second $250K was contingent on the MED operation (as a division of the merged corporation) producing the same profits as the year before the sale.
MED became a division of Boatracs and I was awarded the title of Vice President. Over the course of three years, I reported to three different executives each with a different title and job description. Of the three executives appointed over me, one was reasonably versed in the business, another failed to learn it well enough to be effective, and the third showed neither the desire nor ability. Each was eventually replaced by the Chairman and CEO before I was asked to run the combined company in the fourth year. The newly named software division remained in Mississippi, and I traveled regularly to the corporate office in San Diego. A few months after the purchase, Boatracs acquired two other unrelated companies and changed its name to ARCOMS.
Boatracs made immediate and lasting demands on MED. These demands sapped the division’s ability to produce. We were a separate, but not independent, division. Gross profits shrunk and eliminated my second cash payment of $250K. Feeling desperate, I agreed to an additional 100,000 restricted shares in lieu of the second payment. By the end of the second year, the original business model was changed drastically, and the new divisions threatened to become a cash drain. The stock was by then in the $2.00 range and headed down.
At the end of the four years, I continued on as Chief Operating Officer without a contract. Boatracs continued to produce both profit and cash, which was consumed by the two new divisions. In the face of dwindling capital and declining cash reserves, the Chairman sold a significant interest to an investor group. They replaced the Chairman with a former partner who terminated my employment in his first seventy-five days. As the stock had plummeted to less than 30 cents, I took the risk that the new investor group would revitalize the corporation and chose not to liquidate my shares. In June of 2003, the corporation’s assets were sold at auction and its shares are now worthless. My net proceeds from the sale of the company were less than twenty-five percent of the calculated value at the time of the sale.
While I do believe it is possible for consultants to grow their business, attempting to leverage it to the next level through a merger is sometimes a fool’s errand. Follow the list below to avoid some of the common pitfalls I encountered with this transaction:
- Secure an independent valuation of your business before negotiating any sale.
- Ensure that your agreement yields immediate cash or unencumbered stock worth the value of the company at the date of sale. Do not sell for some anticipated or future value of your company as a division or the acquiring company overall.
If you consider violating step two above:
a. Ensure that your merged division operates with absolute independence from the parent corporation.
b. Keep your existing accounting systems separate from the parent.
c. Keep your existing sales force in place and don’t rely on the parent.
d. If you work for the parent, do it as if the company were a customer.
e. If the parent is located in another state, move there. You’re better off commuting back to the division you know than commuting to the parent about whom you know less.
f. Do not subordinate your decision-making authority to any executive or manager other than the ultimate executive authority.
- If you abide by step two, work for the new company with the same vigor and enthusiasm you put into building your company. It will be to contribute to a new enterprise and not to insure you secure the value from your bad deal.
- If you agree to an employment contract, make sure you can walk away at some point and not affect the purchase price of the original deal.
- Never take deferred or restricted stock as part of the purchase price. Do not allow the terms to indenture you to the company in order to receive the proceeds of the sale.