No mistake is wasted if you learn something from it. I think some of the greatest lessons I have learned have been from failures. The key is resiliency and having a learning mindset. I love sharing stories about deals that taught significant lessons, and today I would like to share a story with you about a client named Paul.
Paul and the Family Affair
Paul came to the Harbour Club in Mallorca in October 2017. After the course, he’d already done a few distressed deals when he came across an engineering company through a networking event contact.
After Paul had given his 30-second elevator pitch about being a business investor and during the open networking part of the event, he began to talk with a commercial mortgage broker. This broker told Paul that his next-door neighbor had had a turbulent time with a newly inherited business. She really wanted to sell. So, they set up a meeting.
Paul was introduced to Deb. She’d been happily married for just over ten years. Her husband, Keith, set up and ran a successful engineering business. Then, at the age of fifty-two, he unexpectedly passed away.
“So aside from the lessons that I learned about the business, this deal also taught me how not to write a will because he’d left 20% of his business to her and 80% to his two children from his first marriage. Then he’d left the family home, 80% to her and 20% to his two children.”
Not having a clue about either engineering or running a business, Deb was thrust into a difficult situation. Before his death, Keith had been very much involved in running his business. He brought the business in, managed the customers, and ran the factory that made copper components for various industries. He died ten months before Paul met Deb. She had been trying to keep things afloat but, with no marketing, sales had started to decline. There was a good repeat order book that kept the family alive, and the business was still profitable, but if things had continued as they were, it wouldn’t have been long before the business would have started to slip into a loss-making position.
The personal situation was much worse. Deb and the two children, aged seventeen and nineteen, didn’t get along. She didn’t have a high opinion of them either. The sons wanted her to put the house up for sale and move out, and for them to take their 20% when the property was sold. She wanted to keep the home where she was happy and enjoyed living there. She wanted to sell the business so that she could have a nest egg as she didn’t have any other source of income.
The logical thing, of course, would’ve been for Deb and her sons to swap, whereby she would give them her 20% in the business in return for them giving up their 20% claim on the property, but they really didn’t like each other or speak to each other. The atmosphere was quite difficult.
The business had revenues of about $2.24 million, and it was making about $260,000 profit. What interested Paul were the assets. The business owned its factory, which was worth about $460,000. The machinery to produce the copper components was worth about $330,000. There was a residential flat next door to the factory that was worth about $165,000. The children were living there rent-free, which annoyed Deb because they held wild parties there every weekend. The business had about $200,000 worth of cash in the bank and $100,000 worth of stock. So, despite its declining sales position, it still had some interesting assets. It was debt-free, and there was more than enough money in the bank for working capital, etc.
Paul had a good meeting with Deb and agreed to meet with the two sons. Their motivation was different in that they wanted her out of the house. They thought that the property was worth about $800,000, so their 20% would be worth about $80,000 each. They also recognized that they didn’t have the experience to run the business. They wanted their dad’s legacy to build the business back up to its more prosperous times so that then they could sell it, from which they could obviously benefit. They recognized that the business probably wasn’t worth much at the time because, as a going concern, there was no leadership, no sales, and no customer service.
Paul did a deal whereby he took equity to resolve the problem. He prepared the business ready for sale, recruited to get the right people in place, and released some cash to give the sons something to play with. To resolve Deb’s situation with the property so that she could still live there, he released some cash for her as well.
He structured the deal so that the sons, who wanted somewhere to live, were gifted the residential flat next door to the factory from the business.
So, at the ages of 17 and 19, they now had a property of their own, mortgage-free. Paul gave them some cash out of the business account, $25,000 each, which attracted a corporation-tax liability. He then mortgaged the property to release some further cash. To get the mortgage, he needed to put a deposit of $90,000 down, which was taken out of the business account. What was left from the mortgage balance was used to pay Deb a lump sum to buy her shares out of the business and to leave some working capital in the business. Once all that was completed, Deb swapped her shares in the business for the shares in the property.
After doing the deal, Paul promoted the production manager to general manager to run the factory, including the job floor. He hired a sales engineer experienced in the industry who had developed trusted relationships.
The plan was to get the business ready for sale, but Paul found working with the two sons was quite difficult. They were immature in their outlook, and their vision was different from Paul’s.
What Paul Learned
Paul ended up selling his share of the business back to them for cash, some up front, some on deferral. He said:
“Now, I could’ve held it. I could’ve built the business. I could’ve sold it for more than I did, but I think it would’ve been quite difficult working with them because of their different views and vision for the business.
“I learned how to use a company’s assets to buy a stake in it. Because I felt a loyalty to the commercial mortgage broker for finding the deal in the first place, I used him to mortgage the commercial property to release the cash. In hindsight, I should have lined up a property investor prior to doing the deal who would have bought the building, maybe at a slight discount, and then leased it back. I wouldn’t have required the $70,000 deposit to get the mortgage and would have still resulted in the same sort of cash result.”
Paul learned a lot of lessons. He realized that, if he’d taken proper tax advice, he could have structured the company’s cash differently to reduce the corporation tax liability. He might have been able to leverage more of the assets, like the machinery and the stock, which were worth a few hundred thousand dollars, to create enough cash to buy the sons outright. He said, “I would have owned 100% of the business, which would have given me the control and ability to do what I wanted to do with it.”
Paul’s gone on to do more than thirty deals since doing the Harbour Club course. Some have been simple; others more complex like this deal. He said, “The smallest deal I’ve done is $150,000 revenue business, and the largest is a $17.6 million revenue. I’ve also done a couple of mergers, and I’m currently in the process of building several agglomerations.”
Aside from the lessons this story taught me about business, this deal also taught me how not to write a will! Learning how to do good deals takes time and dedication. There will no doubt be learning opportunities presented along the way. Make the most of each lesson learned!