“I have so many plans 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 four 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. By year two, Sarah was paying dividends to her investors, and they have now grown quite 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 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.”
Most early-stage entrepreneurs assume, like Sarah did, that once the business gets to a certain point, the early-stage investors will happily accept a buyout leaving the founder with control. But when the business turns out to be successful, investors might not accept a buyout if they see potential for more growth and/or get comfortable with the dividend stream, as in the case with Sarah.
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 some of the cash from dividend payments back toward growing the company.
Of course, I can’t guarantee this plan will work, it all depends on how tough a bargain the investors want to demand, assuming they have any inclination to sell. But the moral of the story is this: when taking early-seed investor money, always (and I mean always) have pre-determined ways to buy them out. Your business may never get to the point that you need to redeploy cash that has been going into dividends. But if and when the time comes that your direction for the company is different from your investors, you need a process to force the buy-sell decision. If you can’t ditch your investors, you might end up in a ditch.
JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. Jim is the author of Home Run, A Pro’s Guide to Selling a Business. https://www.amazon.com/Home-Pros-Guide-Selling-Business/dp/1599329239 . He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The principles above are true, but the story, names and fact patterns are changed to preserve the parties’ identities.
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