Bootstrap Capital

Successful business owners sometimes “collect” assets in their businesses. When a company is producing surplus cash flow, there is little pressure to lower inventory levels or to dispose of old machinery. These assets can be “nice to have” insofar as they are occasionally useful in fulfilling customer requests, but they are usually unproductive and they almost never produce enough incremental cash flow to justify continuing to carry them.

Our experience is that nice-to-have assets are particularly common in the machining industry and consumer goods and other sectors of the economy where returns and consigned inventory are more prevalent. But we have seen this issue in virtually every type of business.

What’s the Harm?
However, since a buyer might be able to put these assets to work or potentially just sell them to recoup some of the original purchase price, don’t these semi-surplus assets just make a business more attractive to potential buyers? In fact, the opposite is usually the case. There are two basic issues which can make it difficult to get a deal done when the balance sheet is full of assets that are really just nice to have.

The first issue is related to asset productivity or the amount of capital a business requires to produce cash flow. When a business carries excess assets, it can be difficult for a buyer to determine just what assets are truly superfluous and how much cash flow is either directly or indirectly related to each of the assets that are only marginally utilized. It may be impossible for buyers to know which assets they could sell, how much capital expenditure would be required to grow and how much the cash flow could be impacted if they sold a few assets.

The second issue relates to the expectations of the sellers. It is our experience that most business owners who collect nice-to-have assets do so because they ascribe more value to them than they really have. That perception tends to produce an expectation that a buyer will pay a full multiple for the cash flow plus market value for the underutilized assets. The business owner’s argument usually centers around all the things the buyer could potentially do with the assets, despite the owner himself never having been successful doing those exact things.

What to do?
Our recommendation is that potential sellers who have a number of un- or underutilized assets should work with an M&A advisor or an operational consultant to sell those assets which are non-critical and to outsource what little work they were doing. If the extra assets are raw materials or finished goods inventory, the owner should systematically sell off the unproductive inventory well in advance of a sale so that a buyer can gauge the performance of the business without the support of the unproductive inventory.

The result will be not only an immediate influx of cash, but also a more understandable business with better financial metrics that, consequently, is more readily sellable.

Bootstrap Capital
If you know of business owners who have waited too long or are fundamentally unwilling to eliminate the extra assets they are carrying on their balance sheets, but are still interested in selling their companies, please consider introducing them to Bootstrap Capital. We can structure our due diligence to understand the productivity of a company’s assets and are willing to craft a transaction that enables a business owner to recoup the latent value in some of his/her nice-to-have assets.

It is common for business owners who are thinking about retiring or selling their businesses to consider establishing an ESOP. The allure of the tax savings that can result from a sale to an ESOP seems particularly strong to business owners who have owned their companies for a long time and are facing significant capital gains tax exposure. Add in the evidence that employee-owned companies perform better than their counterparts, and an ESOP becomes an intriguing option.

What’s the Catch?
There are reasons, however, why approximately 70 entrepreneurs and family business owners sell their companies outright for every single net new ESOP formation. Selling to an ESOP might actually cost more in professional services fees than an owner would incur in a simple sale, because the costs of both seller and buyer (the ESOP) are born by the company. And then there are the ongoing administrative costs for such things as the annual valuation and the ESOP trustee.

There are other costs, too, if the owners choose to implement an ESOP in what we believe is the “right” way. We have seen ESOPs that have worked unbelievably well and others that have failed miserably. While there are many factors that influence an ESOP’s effectiveness, one of the most powerful is the company’s culture and the relationship between the owners and the rank and file employees.

Gratitude
In the situations where the ESOP worked well, almost without exception, the owners showed a genuine sense of gratitude for the employees and believed that the ESOP was as much a way to reward them as it was to achieve liquidity.

Our observation is that, in these situations, the owners naturally take the time to educate the employees about the business and its basic financial results, as well as how their day-to-day efforts affect the company’s share price. Doing so can require a daunting investment of time and resources, but our opinion is that it is a crucial step in getting the employees to really act like owners and to to realize the associated jump in performance.

To the contrary, when the owners view the ESOP as something akin to a necessary evil that stands between them and their tax savings, things tend to break down. When the owners do not embrace open communication and instead limit themselves to the statutory minimum amount of disclosure, the employee-owners can actually become more suspicious of management than they otherwise would have been. And should the company hit a rough patch, particularly one that causes the annual valuation to decline, the employees’ willingness to go the extra mile might disappear just when the company needs it the most, triggering a damaging and self-perpetuating downward cycle.

Bootstrap Capital
In certain situations, we strongly believe that an ESOP is a logical and effective way for entrepreneurs and family business owners to monetize the value they have created. In other cases, due to a need for more immediate liquidity or a cultural mismatch, for instance, an outright sale usually makes the most sense. In these situations, please consider introducing your clients to Bootstrap Capital. We are seeking opportunities to provide liquidity to small business owners and to honor their legacies by investing in and growing the companies they have founded, nurtured and developed.

Many entrepreneurs understand that, in order to maximize the value of their businesses, they will have to become nearly expendable. But even if they are able to build an organization that thrives without their constant attention, they may not appreciate that their work must continue until every employee is as unimportant and interchangeable as possible. Some owners may even exacerbate the problem by transferring their own responsibilities to only a few key employees in the name of succession planning.

Gauging Institutionalization
When we evaluate a business, we try to determine how much of its value is “institutionalized.” Much of the analysis is calculating how much a few key employees contribute to the company’s overall performance. But a secondary analysis evolves around how well the company has systematized its activities and how well it records and accesses information. In other words, we evaluate the extent to which the company’s processes and systems will help a new hire get up to speed and replicate a departed employee’s performance.

Similarly, one of the ways we improve our portfolio companies is to institutionalize their value by, for instance, developing processes, fostering collaboration and, when possible, adding redundant expertise. We lower the risk that the company could become dependent on the so-called “tribal knowledge” of a small number of indispensable employees and increase the likelihood that we can replace even our highest performing people.

Addressing the Problem
We routinely find businesses with one sales person who delivers a grossly outsized share of the revenue or a key engineer who is the only person capable of designing client solutions or driving the new product development efforts. In small companies, this key employee risk may be unavoidable, as it can require unattainable scale and resources to address properly.

In these cases, there are a handful of ways that owners can mitigate the risk and begin institutionalizing the value of their companies. Some tactics lower the risk that key employees will leave, while others reduce the impact in the event that they do so anyway.

The best way to keep the key employees is to increase their incentives to stay. Common approaches include (i) having the employee purchase equity – either directly or in exchange for a reduction in cash compensation or (ii) making an equity or deferred compensation grant that vests over several years.

Combining equity ownership with relatively punitive repurchase rights if, for instance, an employee departs prematurely can provide a powerful incentive for an employee to stay, as well as a mitigating increase in value per share for the remaining equity holders, if the incentive is not powerful enough.

Bootstrap Capital
Bootstrap Capital can work with owners to share the risk associated with employee retention and other issues that result from a failure to institutionalize their company’s value. If you have clients who would like to sell their businesses but are worried about how a buyer will view their own importance or that of a few key employees, please consider introducing them to Bootstrap Capital. We are willing to be creative in structuring a transaction that could allow them ultimately to get more for their companies.

When a business has just a few customers, it usually means that it has great relationships with them. There is usually a strong personal relationship that cements the business dealings, both of which may date back many years, or even decades. As a result, the owners are confident that their customer relationships are durable and will last long into the future.

So What’s the Big Deal?
It is our experience, however, that business owners tend to overestimate the permanence of these relationships and underestimate the risk that their customers could leave them for the competition.

For starters, as business owners age, so too do their counterparts. Few are fully prepared for the day when their contacts and friends start retiring and leaving their responsibilities to a younger generation of employees who may not be such loyal customers.

Fewer still have a contingency plan for the possibility that their primary customer could be acquired by a company that has historically done business with their competitors.

And even fewer have an adequate answer for customers who ask them to share their succession plans. An increasing number of sophisticated businesses include a discussion about succession planning in their periodic account reviews with key entrepreneur-owned suppliers.

For some business owners, this line of questioning may be the first indication that their relationships are more vulnerable than they thought and that customer concentration could be more than a theoretical risk that academics have cooked up.

The Buyer’s Perspective
Other entrepreneurs are not lucky enough to get this kind of wakeup call, and see the ramifications of customer concentration only when they try to sell their businesses. Buyers know that transactions can be disruptive to a business and that a change of ownership alone can be enough to cause customers to evaluate their reliance on a company.

Therefore, when a small number of customers account for large percentage of revenue, buyers lower the price they pay in order to account for the additional risk they are assuming.

Remedies
The only foolproof remedy is to increase sales to a larger base of customers, but this is often unfeasible or even impossible. In those cases, owners can partially address the issue by utilizing long-term contracts. But this approach is imperfect, because no contract is bulletproof, the cost of enforcement can be prohibitive (in terms of actual cost or reputational damage) and, in order to coerce a customer into entering such a contract, a supplier may have to make material concessions on pricing or other terms.

Bootstrap
The principals of Bootstrap Capital understand that, in order to have customer concentration, a company must first deliver value and demonstrate the type of responsiveness upon which great relationships are built.

Consequently, we are willing to structure acquisitions in a way that allows sellers to participate in, and reap the reward from, a well executed post-transaction customer retention plan. The end result can be a fulsome purchase price.

If you have business owning clients who would like to sell, but are concerned about how buyers will react to their reliance on a small number of important customers, please consider introducing them to Bootstrap Capital. We can be constructive and creative in dealing with this common issue.

Many business owners believe that their kids are as passionate about their businesses as they are. In some cases, the children may have actually told them as much. So, they assume that their kids will someday take over running the company.

Our experience is that few of these owners adequately communicate their expectations and test their children’s understanding of what their responsibilities would be. Others don’t realize that the kids are just telling them what they want to hear. The result can be a disorganized or inopportune sale of the company when it finally becomes clear that a family succession is not possible.

Why Not?
Clearly, running or even working in a family business isn’t for everyone. But many owners inadvertently stack the decks against themselves. Owners who engage their kids only to help solve the problems in the business, may inadvertently leave the kids with a lopsidedly negative view of the business. And those who don’t engage their kids at all, perhaps in an attempt to shield them from the stresses of entrepreneurship, miss an opportunity to pique their kids’ interest in the business.

Even in small businesses still run by the founding entrepreneur, succession from one generation to the next must be planned and executed over many years. Owners need to help their children develop a broad array of skills, expose them to multiple functional areas, test their ambition and leadership capabilities and teach them to be appropriate risk takers. Owners who engage their kids during this preparation phase, even if this happens when they are employed outside the family business, will know long before a crisis develops whether their kids will be capable stewards of the companies they built.

Surprises
However, even when an owner is doing almost everything right, there can still be surprises. After all, as long as the founder is still available to answer questions and is taking an active interest in the business, it is impossible to simulate a complete succession. And when it is obvious that an owner’s dream is for his/her child to take over running the business, it can be difficult for the kid to offer a competing point of view and risk disappointing his parent.

Other times the owners ignore even the most obvious signs. We have known owners who thought they were communicating effectively with their children and were correctly gauging them as ambitious future leaders, but who failed to recognize that the children were never the first ones into the parking lot in the morning or the last ones out at night.

Consequently, it is important for business owners to work with an experienced third party who can objectively review the succession plan and evaluate the children’s desires and capabilities to run the family enterprise.

Bootstrap
When a family succession is suddenly not an option and the decision is to sell the company, Bootstrap Capital can help make the transition more palatable.

For starters, we are comfortable with the sellers rolling over a significant amount of equity so that, for instance, they do not have to completely exit an attractive investment just because of a succession timing issue.

We are also comfortable having family members remain in the business and to continue their professional development. We understand that the non-standard career tracks in family businesses can make finding employment elsewhere challenging. And we also value the unique perspectives about the business that family members can provide.

Over the years, we have worked with many advisors and investors who suffered from the Only Affliction. Whey they saw a buisiness that was producing anything less than a few hundred million in revenue, they would report to their partners that the company does “only $x million in sales.” Many of these people had never done anything entrepreneurial and most had never run a company. They had no idea how difficult it is to achieve even $1 million in revenue. They had no idea how much risk, how many odd tasks, how much ingenuity, how many sleepless nights it takes to get a business off the ground.

Trained to be Negative
Once an entrepreneur has done all the hard work to build a business, it is tempting to criticize the final product. Consultants are trained to find and fix problems. Private equity professionals are trained to look for ways to improve the businesses they are buying. And investment bankers are trained to anticipate all the objections potential buyers could make about the companies they are taking to market.

So often this training develops into an impulse to focus on the negative. They see businesses as having “only” so much revenue, “only” so many customers, “only” so many products in the pipeline, “only” a couple great engineers. Compounding the issue is that few of the professionals suffering from the Only Affliction have ever tried to grow a company, let alone build one from scratch. As such, they have little appreciation for the intensity of the effort required to create a profitable enterprise.

Entrepreneurial Heritage
The principals of Bootstrap Capital have founded and run several businesses and appreciate all the skill and instinct that are necessary to build a business of any size, to employ and lead people and to deal with the myriad issues that pop up every day.

We don’t see businesses that are “only” so big. We see the achievements of the entrepreneurs who launched the companies. We respect the legacies they built and we seek to continue the great work they started.

Our experience is that these heritages are valuable assets of the companies we acquire. When we preserve and celebrate the cultures and histories of our portfolio companies, we are not just honoring the entrepreneurs and families from whom we purchased them. We are also protecting our investment. When we preserve the legacies of these businesses, we give purpose to our mission and get dividends in the form of employee focus and loyalty.

People suffering from the Only Affliction have difficulty seeing these benefits and instead focus on all the perceived shortcomings in these great companies.

Bootstrap Capital
When a business owner is seeking a true steward for his/her business, Bootstrap Capital can provide a great solution. A key factor in the path we set for our portfolio companies is the impact it will have on their cultures and the people who built them. Change is a fact of life, but it is important to us that it not unnecessarily impact the heritage, values and people that are key to a company’s success.

Bootstrap Capital, a private investment company, has acquired Clear Automation, LLC from its founders. Clear Automation is an industrial automation technology integrator that specializes in designing and implementing robotics, machine vision, line tracking and custom programmable solutions. Founded in 1990, the company has a history of driving cost and efficiency improvements in a broad range of industries, including cosmetics and personal-care products, medical devices, electronic components and automotive parts and assemblies.

Partnering with the Company’s Founders
“With 26 years in the business and close to $100 million in designed, built and installed automation, this company has major growth potential within its industry,” said Franco DeBlasio, Operating Partner at Bootstrap. “We hope to continue to grow Clear Automation’s capabilities and expand to include other industries.”

The Bootstrap Capital team “is thorough, but arrives at decisions quickly, which made for a smooth process,” said Derek Dibble, CEO of Clear Automation. “They have the vision and the resources to take this business to the next level.”

“With Bootstrap Capital as the new owner, the employees and customers are in good hands and the company’s future has never looked better,” said Ron McCleary, President of Clear Automation. “I look forward to working with the Bootstrap team to grow the business.”

About Clear Automation
Clear Automation (www.clearautomation.com) was founded in 1990 by Ron McCleary, with Derek Dibble later joining him. With a staff of 27, the Clear Automation team has more than 300 years of combined experience. The company maintains a client base in a multitude of industries.

A total of 85 percent of Clear Automation’s business comes from repeat customers, and the company still partners with its very first client.

About Bootstrap Capital
Bootstrap Capital is a private equity firm that respects the accomplishments of bootstrapping entrepreneurs and seeks to honor their legacies. We grow the companies they built and celebrate the legend of how they built them. We acquire and operate small business services and distribution companies at a point in their evolution where they could benefit from a change in ownership.

Our approach is to build our portfolio deliberately, providing day-to-day leadership for an extended period of time after making an acquisition. We provide turnkey succession plans for owners seeking to retire. We work with founders who are striving for the next wave of growth. And we can right the ship when a company has gotten off course.

When entrepreneurs are slowing down, but their children are not yet experienced enough to succeed them, some business owners seek non-family CEOs to bridge the leadership of their companies to the next generation. But finding the right person to be a temporary steward of a family business is much easier said than done.

When the Kids Aren’t Ready
With more people starting families later in life and children taking longer to settle into their careers, we see many business owners facing difficult succession issues. With increasing frequency, some business owners want to retire long before the next generation is ready, willing and able to take over the day-to-day leadership duties.

Making matters worse, when the intention is to hand the reins to a family member, business owners rarely develop a contingency plan and, consequently, may not have a key lieutenant who could step in and keep the seat warm until the kids are ready.

Limited Options
In these situations, the options can be limited. It is extremely difficult to find a leader who (i) has sufficient ambition and capability to grow a family business, (ii) has enough self-restraint to work within the cultural and resource constraints of the family owners and (iii) is willing to take the CEO role knowing that, at best, the job is being offered on only an “extended interim” basis until the next generation family members finish their apprenticeships.

Moreover, because families typically are not willing to give up ownership, when a family identifies a candidate that fits the bill, he or she often seeks considerable (perhaps even above-market) cash compensation. Therefore, the non-family CEO option can be available only to those businesses large enough and sufficiently profitable to accommodate a generous current compensation package.

For the other businesses, unfortunately, the only truly viable options are for the entrepreneur to delay retirement and gut it out until the children can take over or to sell the business.

Bootstrap Capital
Both options are painful, but when the decision is to sell the company, Bootstrap Capital can help make the situation more palatable.

For starters, we are comfortable with the sellers rolling over a significant amount of equity so that, for instance, they do not have to completely exit an attractive investment just because of a succession timing issue.

We are also comfortable having family members remain in the business and to continue their professional development. We understand that the non-standard career tracks in family businesses can make finding employment elsewhere challenging. And we also value the unique perspectives about the business that family members can provide.

Several years ago, a former business owner participating in panel discussion told the audience, “I never realized how unpopular I was until I sold the business.” He went on to admit that he had not properly prepared for life after ownership, that he had not been aware of how much of his identity was linked to his role as CEO of the family’s business. Of course, the issue was not that he was simply unpopular. Rather, when he was no longer a decision-maker, the company’s employees redirected their inquiries to the new CEO.

The Risk of Winging It
Without a number of activities or other roles that are completely independent of the activities of the business, business owners stumble through their transitions to life after ownership. Over the years, we have even seen some former owners struggle with depression. Buth we have watched others smoothly segue to this new phase in life and never look back.

When we encounter business owners who can describe only vague expectations of their lifestyles after they sell their companies, we get concerned that they are not serious sellers and may end up holding onto their enterprises. In these cases, we proceed with caution. Unless a seller is fully committed, both parties could end up investing significant time and money, with nothing to show for it. And one way we gauge commitment is the specificity (and passion) with which an owner describes his or her future.

Developing a Plan
We recommend that business owners who are considering a sale of their companies should first work diligently on mapping out the pursuits that will replace the sense of self and the fulfillment that comes from running a business. While a noble pursuit, spending more time with my family simply doesn’t cut it. Our experience is that, after years of being in charge, most business owners need to be solving problems and driving measurable improvements in some sort of organization.

Some examples of how we have seen business owners fill the void created when they step down from their leadership roles include joining boards of other companies and philanthropic organizations, taking on civic projects (whether for local governments or other communities, such as a homeowners association or a country club) and writing, for instance, the great American novel.

Bootstrap Capital
The principals of Bootstrap Capital have sold their own companies and made their own transitions to life after ownership. In fact, the founding of Bootstrap Capital is at the core of our strategy for managing the transition. As a result, we are keenly in tune with the issues business leaders face when they decide to sell their companies, as well as many other nuances of transacting in the lower middle market.

In situations where a business owner is working through these issues Bootstrap Capital is, at a minimum, a patient counterparty and, even better, frequently a constructive partner in helping him or her through the process.

In our discussions with business owners, not long after we learn about a company’s business model and its most basic financial metrics, the conversation turns to the topic of value. We ask the owner, “How much do you think your business is worth?” Or we ask the broker, “How much does your client want for it?” The answer is frequently a lot more than what we think we could pay for it. Admittedly, we do not always see as much value as the ultimate buyer does, but sometimes the entrepreneur is simply asking for much more than the business is worth.

Why?
Our experience is that there are many reasons for this bid-ask spread. For one, entrepreneurs tend to be more optimistic than most people and place more value on future opportunities than potential buyers do. Also, owners have strong emotional ties to their companies and have trouble putting less-than-extreme values on their “life’s work.” However, a less intuitive phenomenon that we see is what we refer to as “The Interest Rate Paradox.”

In the Interest Rate Paradox, the puzzling effect we see is that, after years of having nearly all their net worth invested in a risky, illiquid and smaller-than-micro-cap company, some entrepreneurs cannot bring themselves to sell their companies until the point that investing 100% of the after-tax proceeds in U.S. Treasury securities would yield enough interest income to fund their lifestyles. This paradoxical trap keeps them tethered to their companies far longer than necessary, with an illogical bias preventing them from selling.

It is true that, after (i) retiring and giving up a salary, (ii) paying off the company’s debt, (iii) paying capital gains taxes to the IRS and (iv) reinvesting the net proceeds in a lower-risk, diversified portfolio, a business owner should have lower expected cash flow. But over time, that cash flow should undoubtedly be more than the yield on Treasury securities.

Financial Planning
We encourage business owners who are considering, or are in the process of, selling their companies to work with a skilled financial planner to map out their future cash flows under several scenarios. Over the years, while we have seen sellers who, once they had done the analysis, realized they needed to keep the business for several more years, we have also seen owners who, once they realized that the proceeds would be more productive than they had anticipated, decided to take their businesses to market.

It’s not clear why some business owners become victims of The Interest Rate Paradox, but we can say that many are able to make much better decisions once they have worked with a financial planner.

Our sense is that it is simply human nature for someone who is facing the prospect of relinquishing control to seek extreme risk reduction. Since selling a company is one of the more emphatic ways to give up control, it stands to reason that, upon a liquidity event, some business owners will seek extreme reductions in the amount of risk they are taking. Said another way, entrepreneurs place incredible value on the control they have over the risks they face in their businesses. When they have to give it up, they sometimes no longer want to take any risk at all.

Bootstrap Capital
Bootstrap Capital’s principals are in tune with the Interest Rate Paradox and many other nuances of transacting in the lower middle market. In situations where a business owner is working through these issues, Bootstrap Capital is, at a minimum, a patient counterparty and, even better, frequently a constructive partner in helping him or her make an informed decision.