The Price of Friendship – Part 2
In almost every article we write, we seem to talk about the uniqueness of the performance marketing space. There aren’t many other areas where one person or a pair of people can start from almost nothing and create not just a mulit-million dollar company but a multi-hundred million dollar one in a matter of years. The company at the heart of this article did just that, but in what should have been a success story, theirs has ended in divorce. Despite growing a company to more than $200 million revenues, one that attracted the attention of outside investors with one infusing $150 million, the two founders no longer talk. The road to acrimony didn’t take long, and unfortunately for them, in many ways it came down to not really knowing how the other would react in a circumstance that only a few get to experience, i.e., personal wealth at the expense of outside investors.
As mentioned in Part 1, while the two founders’ work relationship began in 2000, the end of which arguably begins February 12, 2008 when they receive the money. We see from the suit that the co-founders had (via rough rounding) 41.8mm shares and 34.2mm shares respectively for a 55/45 split. It’s easy to think that they aren’t speaking because of that, because one is jealous the other made more. But, having spoken to the co-founder who filed the suit, it was originally 50/50. But, in the first few months, the work load wasn’t quite 50/50, so he offered to lower his share. He did so thinking it would be appropriate, keep them balanced and motivated, and that it would be repaid on some level in the future.
The timing is important, as it added to a key piece of the drama. When their transaction closed in February 2008, the economy hadn’t gone sour, but there were some clear signs. Luckily, it didn’t impact the transaction, but the valuation became a central point of contention once the proverbial shit hit the fan. The company didn’t take a hit the way that the broader markets did, but they certainly didn’t grow the way they expected, and that growth played a significant factor in their obtaining a $430mm post money valuation. The investors couldn’t change the market, but they could try to make the most of it. Here that meant applying pressure to the founders and finding a way to dollar cost average down the investment. The result was a non-cash financial exercise where they basically put a hold on 25% of each founder’s shares. Instead of $2.81 per shares, this block will be $2.00 should the firm decide to buy them. On paper at least, the firm now had managed to reduce the average price "paid" to $2.50.
In practical terms, the new option agreement means that even if the founders could find another buyer for their shares, say someone who post market recovery wanted to pay $5, they would still only get $2 for that 25%. More importantly, this 25% ever so subtly starts to drive a wedge between the founders without their really knowing it. Prior to this new agreement, any proceeds from stock sales were split 55/45 automatically. If one founder had a buyer, the other founder received their relative percentage. Not so here. If the fund wanted, for example, to buy that 25% from one founder, the other founder didn’t have any claim. They agreed to this not without considerable pressure and stress, but it didn’t impact their actual ownership and it made the fund feel whole.
We are now in August of last year. The economy has stayed sluggish. The minority shareholder of the two founders has not worked for the company for more than a year choosing to pursue other activities. The majority founder has struggled to try to lead a revival in growth but has faced headwinds at every turn. The discussion with the fund turns towards having them take control of the company, buying out the founders remaining shares. The offer is $.46 per share or roughly $35 million total, a far cry from the $2.81 paid 15 months prior. The founders reject the offer, but discussions apparently continue, as towards the end of the month the private equity firm offers $5 million more, also rejected. The follow-up offer interestingly has them potentially buying 100% of the majority founder for $.53 and only 25% of the other founder’s shares.
Almost a week later, it looks like the second founder decided instead of selling to double down. Realizing that he could be a true minority, he comes up with a plan to buy out his partner who has shown a continued interest in fully liquidating. He agrees to sell to his long-time partner for roughly the same price per share as contained in the last offer. He could sell only 75% of shares in this scenario but the math works out. He would still walk away with the same amount, well north of ten million dollars, because he wouldn’t have to split any of it. All seems fine. He lets the fund know he will be accepting an offer from his partner, who will now have 50.4% of the company and the ability to come back in and try to grow it to its full potential. Yet, a few days later, it appears his partner changes his mind and accepts a new offer from the private equity guys. Not wanting to lose control they raised their offer to him to $.76. This creates a higher effective yield given that he has to split some (42.8mm shares. 75% or 31.1mm shares he splits the proceeds 55/45.) It was $4mm more than the offer from his partner.
This brings us to the suit. The one co-founder who sounded like he was going to sell to the other co-founder has now entered into an agreement to sell to the fund, using his partner as a stalking horse. The other founder didn’t create a company with hundreds of millions in value to give up easy. In addition to alleging corporate mishandling of the deal and claiming damages, a suit would also give his partner the ability to break off his deal with the fund. Why might he want to not go through with the sale to the fund? Because his co-founder had found a way to make him more money if they both sold to a different third party. The deal with the third party would pay them $1.00 for their shares, netting the co-founder who wanted to sell for $.76 an extra $10mm. An added benefit, all shareholders and option holders in the company would get to participate. Long-time employees who had been waiting for a liquidity event would be included, not just the founders. Oh, but the law giveth and it taketh away.
By arranging for a higher offer and suing his partner in hopes of making it easy for him to take this new offer, he also put himself in a bind. His co-sale rights are severely impaired during such an action. So, when it looked like his partner would not change his mind and take the higher offer, the co-founder decided stop the suit, which besides offering the out, he also believed in namely that the company as a whole, its board especially, did not act in the best interest of the firm and all minority shareholders. And, so here we are today. One founder let the other believe he would sell to him only to leave him at the altar for $4 mm more, a fraction of his total wealth, but leaving a guaranteed $10mm on the table.
Is this a tale of true colors coming out? Perhaps it’s a tale about expert manipulation on the behalf of the savvy private equity firm, or some combination of the two. It certainly is a one in a million story on so many levels, a tale of true success but loss. It might be one reason why so many caution against going into business with friends. May we be so lucky to have an eight figure blow-up, but no amount of money can buy back a good friend.
