Lessons Learned #1 - The Exiting Founder

A new series which documents some of the more painful lessons I've learned over a decade or so spent in private equity.

Lesson 1:  Avoid investments that include an Exiting Founder

For my firm, without exception, these have been disasters.  Let's face it, the wily old bugger who has built a business over thirty plus years knows exactly when to sell.  The situation is particularly dangerous in a small business, where the processes, customer relationships and commercial judgment tend to sit in the founder's head.

I'll still consider investments with a transition plan that allows a founder to exit over a period of time, particularly if the deal includes some form of earn-out or retained equity stake. 

Comments

[Andrei Vorobiev]

Beautifully put. Concise and convincing.

Still, Warren Buffet - to whom we all listen - isn't shy to invest in these "buggers". Say, his utter fascination with Omaha furniture seller Mrs. Blumkin (whom he had to buy out twice!) is very evident from that Snowball book about him that hit the market recently. Also, he bought out a few other businesses that were run by charismatic founders who WERE their business...

Which makes me think: Does Buffet know something about dealing with these "buggers" that most of us don't? I have my guess, but what's your take on it?

[GP]

To quote Warren,

"Our favorite form of purchase is one in which the company's owner-managers wish to generate significant amounts of cash . . . [but] At the same time, these managers wish to remain significant owners who continue to run their companies just as they have in the past...

Very simply, we would not want to buy unless we felt the key members of present management would stay on as our partners."

[essay in Cardozo Law Review, 1997]

[Peter]

GP: with that in mind, what amount of equity will you allow owners to sell down while still staying in the business? For example, if I owned 100% of my business now, would you buy 70% from me while still allowing me to be CEO going forward?

[GP]

Peter,
No fixed rule. You have to look at factors such as:
-- how much hard cash will he be taking off the table?
-- how much will be left after the mortgage gets paid off, etc?
-- is he/she already wealthy or is this money going to be life changing? Will it redefine his life?
-- what is the value of the stake being left in the business?
-- what motivates this person? A 65 year old engineer who built a business over three decades is unlikely to change his work ethic because he gets cash in his pocket

I once had a CEO walk away from an equity stake worth $5m because his brother died and he decided life was too short to keep working. Hard to predict that kind of event!!