TVG

“I have a great plan to grow my company, but my investors won’t let me do anything that jeopardizes their quarterly dividends.” Sarah (not her real name) didn’t strike me as a hard-charging entrepreneur, but in just five years, she had turned an idea into a seven-figure, profit-producing machine.

To launch her idea, Sarah needed capital, which she raised from three individuals, each of whom bought 20% of the company. Do the math, and you quickly see that Sarah owns 40%, and her investors collectively own 60%. “Yes, I knew what I was doing when I gave them control, but I was confident my idea would be successful and that I could buy them out when the time was right.”

That was the theory, anyway. Mid-way through year two, Sarah was paying dividends to her investors, and they have grown comfortable with that cash flow. She explained, “They’ve already received back two times their original investment, but they won’t let me buy them out, nor will they let me reduce the dividends to reinvest in my growth plan.”

“It sounds to me like you just haven’t offered them enough for their equity yet,” I said, assuming she had already realized that. “Well,” she said, “I know it sounds crazy, but I don’t think they want to sell at any price, they really do seem to be comfortable with what I am returning to them.”

Like Sarah, most early-stage entrepreneurs assume that once the business gets to a certain point, the investors will happily accept a buyout, leaving the founder with control. But that doesn’t always happen when the business is successful. Often, the investors see the potential for more growth and/or get comfortable with the dividend stream and want to stay invested/

Short of making a ridiculous offer that she can’t afford anyway, Sarah doesn’t have many good options. I suggested she consider a partial buyout, whereby she acquires 11% from the investors, which would leave her with majority control. Yes, she might have to overpay for that 11%, but from a cash flow standpoint, overpaying for 11% is not as problematic as overpaying for 60%. I suggested she pitch this idea to her investors as a diversification play: tell the investors they get to monetize some of their original investment and redeploy it elsewhere, while leaving them a nice chunk to reap the rewards of future growth. If they agree to that plan, Sarah will have the flexibility to reallocate cash that had been used for dividend payments back into growing the company more rapidly.

Now, I can’t say this plan will work—it all depends on how tough a bargain the investors want to drive, assuming they have any inclination to sell. But the moral of the story is this: when taking investor money, always, always, always have predetermined ways to buy out those early-stage investors. Your business may never get to the point that you are paying dividends or face the need to redeploy cash that has been going into dividends. But if and when the time comes that the founder’s direction for the company differs from the investors’, there needs to be a defined path to force the decision. If you can’t ditch your investors, you might end up in a ditch.

 

Tennessee Valley Group

Jim is an attorney (non-resident status with the Missouri Bar) and though he no longer practices law, he has read and negotiated enough legal documents to fill a cargo tanker. He has an MBA from Harvard Business School and knows how Wall Street and private equity operates. Jim is a Tennessee Supreme Court Rule 31 listed general civil mediator with tons of experience helping business owners (large and small) work through sensitive problems to achieve winning results. He is the author of "Home Run, A Pro's Guide to Selling Your Business, Seven Principles to Make Your Company Irresistible."