Cliff Oxford: How Entrepreneurs Lose Control of Their Companies - 'You've Exited But Don't Know It'
Tuesday, March 17th, 2015
When entrepreneurs sell their companies, it’s often like watching the same three TV reruns over and over. You might call them the Good, the Bad, and the Ugly.
The Good rerun is one of exhilaration where the entrepreneur does an end zone dance celebration. They have proven their point, and their idea has been ‘market validated’ with a big fat check to show for it.
The Bad rerun is one where the entrepreneur exhales because it is basically a ‘breakeven’ deal. They get enough money to pay off the bills, get themselves and most of their people a job and then get sucked up in the larger outfit. Yes, for the first time the owner can breathe again, but believe me, there aren’t any trumpets blowing at the closing table. It’s a bad day because entrepreneurs are largely a class of overachievers who want to be validated, and a job with ‘the man’ is a huge downer.
The third rerun, the Ugly, is one of total embarrassment where the entrepreneurs liquidate in a fire sale, or even worse, a posse of predators steals their company out from under them. The posse consists of VC’s, lawyers, hired executive guns, and investment bankers who are all part of the same ilk – shameless and schooled in how to steal a company from a founder legally. You might say this could never happen, but the truth is, it happens every day.
We don’t hear about it too often because part of the posse’s tactics is to legally, financially, and painfully silence the entrepreneur to exile. Here’s how it’s done: With a team of lawyers making $800 an hour, a rate that numbs legal brains like Novocain, they meticulously orchestrate the legal process and paperwork to make the entrepreneur sign their life and company away. While this posse of predators operate with experience and precision, the entrepreneurs they prey on are sitting ducks, because they know very little, if any, of the financial shenanigans of reverse stock splits, down rounds, stock dilutions etc. These terms may sound boring but have massive meaning in a legal document that can take a founder from owning 99% of a company to owning less than 1% in a matter of minutes.
Before the documents dictate ownership, the entrepreneur falls prey to a Shakespearian-like play that comes right out of the posse’s handbook on how to steal a company. Here it is: The VC’s buy a minority ownership of the company, and then soon enough proclaim wrongdoing such as fraud or sexual harassment in the company. It’s barbarians at the boardroom table, but instead of villains, the posse plays the victim card and sets the whole scam in motion. Under the pretense of verifying the malfeasance, they bring in their buddies as hired guns to do an audit, and guess what, they suddenly show up one day as the President and CFO. Someone from the posse always takes the CEO role – usually the guy with the most money.
They look for one thing or one person that might violate the representations and warranties signed off by the founder when the posse bought the first minority stake. With audits and legal claims in hand, they push and isolate the founder as the villain from the company. Many times the entrepreneur doesn’t fully realize he has been exited from his own company.
If all of this sounds farfetched I had a ‘silenced’ entrepreneur come to see me recently in a lot of stress because he was starting to feel like he was being squeezed out of his own company. Not only an entrepreneur, but a healthcare hero, as he created the algorithm for diabetes distribution management. He had worked miraculously for FDA approval – millions of dollars in intrinsic value – and an impressive hospital customer list that made his product the category leader with hundreds of millions of dollars enterprise value.
He had what most fast growth entrepreneurs would die for – a twin flame, an enterprise that could create both enormous wealth and gigantic change to improve the quality of lives. Because of the FDA approval, hospital widespread purchases and healthcare peer reviews, he attracted high profile board members like legendary leader and head coach Lou Holtz who came on board to help a renowned MD change lives and help people. That is all fine and good but there still is a demanding fast growth business to run 24×7. And with no algorithm to tell you when to hire and fire, the MD inventor made a couple of what he calls “doozie” hiring mistakes that threw them off course and created a need for cash to fund the company ’s customer growth as well as the need to bring in professional management.
The Doctor and the board decided to bring in the “pro’s” with a new coach and cash. And this is when Wall Street showed up with cash and a modern day Boss Hog and of course a posse. He remarked, “They treat me like I’ve exited the company that I started.” After reading what he had already signed in a series of financial manipulations that included a 10 to 1 reverse stock split and two subsequent down rounds, I told him the harsh reality, “You have exited the company, you just don’t know it.” The posse was using his expertise with the FDA and his reputation as the public face of the company. However, his ownership had been diluted to practically zero, and he had been pushed off the board with a direct threat of a lawsuit.
As bad as the posse is, the entrepreneurs’ hands are not entirely clean in these silent exits. The need for cash and market validation makes them vulnerable to the wining and dining, jet setting, and head swelling charm of the posse to enter the company in the first place. Entrepreneurs naively believe and see all the upside of continued growth and consider none of the downside if the deal goes south. In other words, it’s a baited duck pond where the entrepreneurs sit.
In the coming weeks, I will provide real-world examples of Good, Bad and Ugly exits. You will not want to miss an episode.
Cliff Oxford is the founder of the Oxford Center for Entrepreneurs. You can follow him on Twitter. Email Cliff at [email protected]
