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LA Business Journal
Happy Endings Selling a family business often yields unanticipated results
By AMANDA BRONSTAD Staff Reporter
'Bittersweet" is how Mark Freeman describes the moment he handed over the
keys of his family's 28-year-old business to Dial Corp. in July1998.
Freeman Cosmetics Corp.'s revenues had just topped $75 million, and its
products found shelf space in Rite-Aid and Target stores across the country. The
family sold the Beverly Hills business for nearly $84million; Freeman stayed on
to oversee the operation.
Months after the sale, Dial ousted Freeman. In the hands of Dial management,
the Freeman brand languished, sales fell and, three years later, the consumer
products giant gave up on the franchise and sold it for less than $12 million.
Did Freeman do the right thing?
"Absolutely," Freeman said. "We didn't get a bad shake. We watched a downhill
slide on our brand name, heritage and family name. But at the end of the day,
you sold your home to someone else. It was white and now it's pink."
Last month, Freeman bought back the business, now based in Culver City, for
less than $10 million.
Like most owners of family businesses who sell out to a larger competitor,
the deal did didn't work out as Freeman planned. Yet only one third of such
deals end up in "major disappointment," said Brooks Dexter, senior managing
director of USBX Inc. in Santa Monica. Of those, only a fraction end up in
court.
Of course, as Dexter notes, "There are degrees of what 'success' in a deal
means. Deals that worked, but weren't what was planned, I'd put at about 75
percent." Establishing the satisfaction of a deal depends on a number of
factors, most importantly whether the owner is prepared to relinquish control.
When family history is part of a business, it adds emotions to another wise
cut-and-dried financial transaction. If an owner is not prepared to say goodbye,
the deal rarely works well.
Definitions of value
"In a family owned business, it's a very personal decision that's wrapped up
in emotion," Dexter said. "The valuation to an entrepreneur is a measure not
only of net worth, but of self worth."
It can be a tricky proposition that ends unhappily. Besides emotional ties,
many owners of small businesses are unfamiliar with the world of mergers and
acquisitions and rely on professionals to get the best value for their company,
said Don Howarth, a partner at Howarth & Smith.
Howarth represents the plaintiffs, an Irvine couple who sued their
lawyers at Sheppard Mullin Richter & Hampton LLP earlier this year for allegedly
mismanaging the sale of their company to Viasource Communications Inc. in April
2000.
The plaintiffs were supposed to receive $68 million in cash and stock of
Viasource from the sale of their company, TeleCore Inc., Howarth said. But
after the stock market tanked, they ended up pocketing closer to about $1
million cash a year, he said.
Howarth said the plaintiffs, whose case is pending in L.A. Superior Court, were
victims of the dot-com gold rush, blaming lawyers and accountants who slapped
together lucrative deals with little regard to the fine print.
"They're not going to be savvy about the law or the technicalities of the
law," he said of owners like the plaintiffs. "They are at the mercy of their
counsel. You can't start something in the garage and live and breathe it and, at
the same time, be an expert on how to protect yourself in a merger and
acquisition."
It isn't always the seller that gets bitten.
Several years ago, Simi Valley-based music distributor Tempo One Stop Records
Inc., which did business as Pacific Coast One Stop, was accused of doctoring its
accounts receivables in advance of a sale to National Record Mart Inc., said
Steven Yee, a partner at Yee & Belilove LLP in Pasadena.
Yee represented One Stop's lawyer, who was named in a suit along with the
company's accountants. Yee's client was later dropped from the case.
"This is a problem with buyers," Yee said. "You're getting into something
that's speculative. If I tell you, 'Why don't you buy my bakery business?' you
need to look at my financials. Let's say the business goes south. You've lost
your whole investment and you're a disgruntled buyer."
Lawyers and accountants face large risks, as well.
On Sept. 24, law firm Heller Ehrman White & McAuliffe LLP settled a year-old
lawsuit against the founders of Earl Jean Inc. in L.A., who sold their trendy
jeans manufacturer for $86 million to Nautica Enterprises Inc. in 2001.
Heller Ehrman had sued Benjamin and Suzanne Freiwald to recover $106,907in
alleged unpaid legal bills related to the sale. Terms of the settlement were
undisclosed.
Benjamin Freiwald, in a counter-suit, claimed that because of the deal's
structure, the couple was unable to cash in about $21 million worth of
unregistered stock and that the deal should have been worth closer to$107.5
million, said Allan Browne, a partner at Browne & Woods LLP, representing the
Freiwalds in the case.
"The deal closed, but when they went to hedge the stock, there were allsorts
of conditions and obstacles in that agreement that had never been explained to
him," Browne said. "He would never have entered into this agreement had he known
so much was at risk."
Such contingencies represent about 10 percent to 25 percent of a deal and are
based on stock performance and other factors, Dexter said. If either falls short
of expectations, the situation is ripe for finger pointing.
Delayed payments and payments tied to stock values and company performance
were the norm between 1998 and 2000, when stock prices soared. They are also
particularly common in situations where the seller is desperate to get out or
the buyer wants management to stick around, said Richard Morgner, managing
director and head of mergers and acquisitions at Chanin Capital Partners LLC in
L.A.
"As a rule of thumb, people looking at earn-outs and contingencies are
disappointed," Morgner said. "There are so many extraneous things that are
outside your control."
Since the stock market collapse, owners of family businesses have become more
skeptical in negotiations, Morgner said. Many want cash, not stock. If
there are contingencies or earn-outs, they will base them on revenues, rather
than earnings, which involve more subjective accounting, he said.
Freeman declined to disclose how much he pocketed from the Freeman Cosmetics
sale. But he said the money allowed him to start two more companies, one of
which, pH Beauty Labs LLC, acquired Freeman Cosmetics last month.
"It was prosperous to the family," Freeman said, looking back at the Freeman
Cosmetics sale. "It gave us an opportunity to get back in again."
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