Food empire – Case Study #1

The idea behind this blog is to discuss legal ideas and concepts for non legal people. One of the best ways to discuss ideas and concepts is though examples. Examples to see how legal concepts and concerns can assume importance in any business situation. This is the first post of my “Case Study” series, where I take a closer look at an actual example from my career. Hopefully, this can help you think of ideas in concrete terms.

A couple of years ago, a client of mine had given my reference to friend of his, lets call the friend Mr. X, who was looking for a lawyer. Mr. X gave me a call and set up a meeting. Usually, when someone approaches a corporate law firm, they already have a pretty clear idea of what they want to do and how they want to do it, and are only looking for a lawyer to create the necessary documentation to put their idea into effect. This usually makes the lawyers job easier since, barring a few cases, it gives the lawyer very clear instructions, and reduces the effort (and cost) expended on an assignment. However, this also deprives the lawyers of any opportunities to use the grey matter, so I personally look forward to those rare occasions when a client comes to us with a blank slate. This was one such occasion.

Case Facts:

Mr. X runs a moderately successful business, manufacturing and retailing food items. This is a small scale family run business that he has created. Mr. X is engaged full time in this business and he has no other job or businesses. Mr. X had, at a social gathering, met someone who was some superstar investor. Imagine a Peter Thiel, or a Sean Parker from the Facebook story. Supposedly this investor has a history of investing in various businesses and taking them to new and great heights. Mr. Investor also managed to get Mr. X’s interest. He is now offering to join the business as a 51% partner, and has promised that together they will turn the business into a great success. Acting quickly, as anyone with a great opportunity ought, he called his good friend who recommended to him a lawyer, me, and now here’s Mr. X sitting in my conference room.

First things first:

As with any transaction, the first thing a person does, or at least to my mind should do, is start asking questions and start fleshing out the finer points and nuances of what is sought to be achieved. The main idea was clear, the investor would invest some amount of capital to acquire 51% of this running food business, and would then help the business grow. Great! But what does that really mean? Both for Mr. X and the business.

The 51% question:

Sitting in my conference room, Mr. X was the 100% owner of his own business, the captain of his own ship, the master of his own destiny. Now any business man dreams of his business becoming the next Walmart or Amazon, and when Mr. X had learnt of the past successes of this serial investor, he had immediately seen dreams of his own business becoming a huge success. But what he hadn’t fully thought through, I found, was the implication of someone else becoming a 51% owner. Now as a reader this may have already struck you when reading the facts. Give away 51% of anything, and you no longer have the majority, you are now only a 49% minority holder. At 50% you would be equal, but 49% and you aren’t even that. Suddenly the new investor is, for all practical purposes, the owner.

Is this a bad thing? Well not really. 51% in reality, in my opinion, is just a number. There are huge corporations out there where no one owns 51%. I remember reading that the single largest shareholder of Microsoft is the Vanguard Group holding a whopping 8.4%. That’s right, 8.4. Not even 10. The man running the show, Satya Nadella, holds roughly 0.02%. So there is more to how a business is owned and run than just ownership percentages. Sure, you may not be the owner but that is less important. How a business is run, and more importantly how much money you personally can make from a business is determined by many many factors, other than just shareholding. but does that mean 51% is insignificant? Certainly not. At 100% you were the boss, at 49%, you probably aren’t.

The Operations question:

The next thing that needed discussion was how the business would be run. While Mr. X was today running the business to the best of his abilities, the Investor was coming in to make it something bigger. Whether or not he would be able to was a question for later, but the fact is that he would most likely run things differently. In fact, the reason he was taking 51% ownership was most likely so he could run things his way with minimal interference, and 51% helps do that. Again not necessarily a bad thing. Mr. X running the business his way had got the business to a particular position. If the business had to be in a different position, certainly something had to change. Richard and Maurice McDonald may have come up with the golden arches, but they didn’t build the McDonald’s that we see on every corner today, Ray Kroc did. And he did it by doing things differently. It may be argued that being a small part of something huge is better than being a huge part of something small. So another factor for Mr. X to consider was how would the business be run, and more importantly for him, what would be his role in the running and day to day operations of the business. Would he be the CEO, or just another employee? Add to that, what would be his liability. What part of the business would he be responsible for? As part owner, if the business runs into legal trouble, would his neck be on the line?

The Existential Crisis

The most important point however, to my mind, that we discussed was “why?”. Why was Mr. X doing this transaction? What was Mr. X hoping to achieve? Did he want to cash out? That’s as good a reason as any. You work for years building something, and some offers you a good chunk of change to take on a part of it, why not. Never underestimate the value of some cash in your pocket. But if you are cashing out, why not just sell the full 100%.

Or perhaps, like I said, he would rather have seen his business grow to something big, something more than he would be able to do by himself. If you gave me a hill and told me it was a diamond mine, I would still need someone like a DeBeers Group to help me get the value out. Owning 100% of the hill will at best give me a long trek to a better view. Similarly if he was unable to take the business to new heights, and the investor would, that’s also a good reason. And if neither was the case, was he then needlessly giving away something that he needn’t have.

Also why 51%? Would he have been better off giving 49% or even 50%. Retain control, while taking the help of the investor to achieve the same growth. But then would the investor have been interested?

Also, what is the ultimate plan? Did he plan to be in business with this investor forever? Did he plan to eventually sell out? Or maybe after a few years, buy out the investor and regain control of his business.

Other Factors:

There were a few other factors that needed more thought, like what is the business worth, and what is the fair price at which he would sell the 51%? Would he sell from his stake, or would the investment go into the business? Sell your stake and you get paid but the business doesn’t get any cash it may need to grow. If the investment goes into the business, the business gets a massive injection of cash, but you don’t get paid upfront, and you need to think about how you get remunerated going forward.

What about deadlocks? What if the investor decided to take the company in a detection you didn’t want it to go? Started making inferior even harmful products, or branching into new and risky businesses, how do you stop him, or if you can’t, how do you get out? Deadlocks are a huge subject in themselves, and I could write a whole post just on deadlocks.

So what happened?

So what was the outcome of that meeting, you may wonder? Nothing. I opened my big mouth and talked my way out of a paying job. Mr. X decided there was so much he hadn’t fully thought through, he needed more to fully think about the decision. The last I heard from my client was that he had shelved the investment and was running the business himself. I cannot say for sure what happened? Perhaps he used some of what we had discussed and changed his mind. Or perhaps he had decided to go ahead anyway but the investor decided not to invest. All I know is he didn’t go ahead with it, and I didn’t get paid.

What is the lesson?

All joking aside, it is easy to judge Mr. X. If you only read this post, you may think Mr. X is a mediocre business man, easily swayed by a smooth talking stranger into giving up his business, and jumped headlong into a deal he didn’t fully understand. I mean, who doesn’t know what 51% means, right? But I don’t agree. Firstly, running of a business to any degree of success is an achievement in itself and needs to be respected. There are enough and more stories of startups that don’t make it. Further, to my mind, anyone who runs a business needs to be mindful, not only of the nuts and bolts, but also of the big picture. And as with any business proposal, you have to act quickly. He was presented with a proposal, considered the proposal to the best of his ability and made a decision. And, as with any decision, you are entitled to change your mind as you are presented with more information. I have seen on more than one occasion, the contours of a deal completely change mid discussion. Nothing is done till its done. And, again, 49% is just a number, your documents and laws can provide you with enough rights to protect yourself and your business.

The lesson here for any entrepreneur or businessman is when you receive a great proposal, you should spend some time to think though not only what is obvious on the face of it, but also what all it might mean for you and your business. And if you can, talk though the proposal with someone playing devil’s advocate. Even if you don’t have a lawyer or other advisors, just someone with a fresh perspective will help you think things though and might catch something you may have missed. And if you do hire advisors, give them the liberty to tell you why you may be wrong, even if you have spent time and money getting to that point. And lastly, if you do hire a lawyer, pay the man!

-V