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Nation's Business "Finance" February 1999 Buying A Firm With The Boss's Help With the right approach, managers can get assistance from their employer to buy part of the parent company and make it their own. by Juan Hovey Playing Your Cards Right In The Spin-off Game You tread on uncertain ground in negotiating a spin-off with your employer; especially when you want backing of the sort given to H. Joseph Larsen and his partners in their spin-off of SP Pharmaceuticals in Albuquerque, N.M. Above all, you can't antagonize your employer with visions of the glory and riches about to befall you, according to Peter Cowen, a Los Angeles consultant and investment banker The step from underling to peer is tricky; and it gets trickier when the manager needs help from the employer to pull it off. Indeed, you can wreck a deal altogether if you make your employer envious of your potential fortune, Cowen says. "All of a sudden the manager is in position for a big windfall," Cowen says. "The boss sees the chance for that individual to hit a home run, and if the manager wants special help in doing the deal, these issues have to be handled delicately." It is, in other words, one thing to negotiate a corporate spin-off like the one that created SP Pharmaceuticals and quite another to negotiate a deal face to face with your employer, Cowen says. For the latter you need a highly skilled negotiator -- most likely an investment banker -- who recognizes the ambivalence of an employer suddenly addressing a manager as an equal, not as an employee, Cowen says. The investment banker also finds financing for your deal, of course. You also need good legal and accounting help -- lawyers to draft the agreements governing the deal and accountants to do the numbers. To track down the help you need, start with your own professional advisers -- your attorneys, accountants, and consultants -- and check with other business owners who have done buyouts or spin-offs. Bankers are another resource, especially those with holding company investment units like the one involved in the SP Pharmaceuticals deal. Everyone involved in the deal earns a fee. In all, Cowen says, the fees for a $10 million deal might hit $750,000 -- less for a simple deal, more for a complex one. And if some of those fees represent the cost of managing the emotions of an ambivalent boss, Cowen says, don't quibble. The alternative maybe to lose your opportunity to become a boss yourself. Finding Capital Want to start your own business? Need some backing? You may find the help you need closer than you think-right down the hall, in fact, in the boss's office. In the best of all possible worlds, your employer would help by putting up the financing you need. Employers, however, are most likely to offer start-up capital only if they see your venture as a strategic extension of their business -- perhaps producing new products for new markets and one in which they would hold an equity position. But as the story of H. Joseph Larsen and Donald E. Hagman shows, backing of any kind from an employer can prove important when a management group attempts to purchase and split off part of a company-a transaction known as a spin-off or buyout. In early 1997, Larsen and Hagman managed an Albuquerque, N.M., facility that manufactured liquid and freeze-dried drugs for Pharmacia & Upjohn, Inc., and a handful of other customers. Pharmacia & Upjohn, a giant company produced by a 1995 merger and based in Bridgewater, N.J., owned the plant but wanted to sell it. Larsen and Hagman saw a chance to make the transition from employees to employers, but they needed capital. Pharmacia & Upjohn said no to that but the drug maker did offer the partners the next best thing: a long-term contract to buy their wares if they found outside financing. In essence, the offer meant that the partners had half their problem licked, for it gave them a crucial piece of the puzzle -- a customer for their new business, to be called SP Pharmaceuticals, LLC. It also made their search for financing far easier. Going To The Sources Most of the $27.6 million the partners needed for the spin-off was raised from NationsBank Capital Investors, an investment unit of the big Charlotte, N.C., bank that merged with BankAmerica Corp. in September to form Bank of America. Larsen and Hagman put some capital of their own into the deal and became CEO and executive vice president, respectively. A third partner, Fernando C. da Costa --who had been their immediate superior several years earlier, before Pharmacia and Upjohn merged, and had gone on to another position with the parent company -- also invested in the deal and became chairman of the new company's board of advisers. "It took awhile for everything to get put together," Larsen says. "We had Pharmacia & Upjohn people involved from London and Italy and Michigan and even Sweden, and they showed great patience in the negotiations. I don't think they favored us, exactly. They just gave us an equal shot" NationsBank invested in the spin-off because it saw SP Pharmaceuticals as well-positioned to capitalize on the trend toward outsourcing in the drug industry according to Walker L. Poole, then head of NationsBank Capital Investors and now a managing director of Bank of America. In addition, Larsen and Hagman "had tremendous integrity and a good track record with the U.S. Food and Drug Administration," Poole says. "But what we really liked was the supply agreement with Pharmacia & Upjohn. That guaranteed SP Pharmaceuticals a base level of business, and it was extremely important in our decision to back the deal." NationsBank bought stock in the spin-off and set up a revolving loan secured by receivables and inventory, plus a term loan secured by land and other hard assets of the Albuquerque operations. The company also obtained warrants giving it the right to buy additional stock in the future. A Long Time Talking It took Larsen and Hagman the better part of a year to negotiate the deal, and the talks over the supply contract took more time than those over the financing, says Arthur Solomon, SP Pharmaceuticals' vice president of business development. "There were a lot of people involved on the other side," Solomon says. "Nobody was trying to break the deal, of course. It was just that a lot of people wanted to contribute their ideas to the talks. There were lots of conversations going on." But it takes time to do any spin-off, according to Peter Cowen, whose Los Angeles consulting and investment-banking firm, Peter Cowen and Associates, specializes in emerging growth companies. When you negotiate a spin-off with your employer, you also need the coolness of a diplomat, he says. For starters, Cowen says, you can't let your eyes glint too much; your sudden elevation from employee to employer may make the boss envious. (See "Playing Your Cards Right In The Spinoff Game," above) In addition, if you want your employer to become your customer, the negotiations over the price you pay for the buyout may bog down over the value of that relationship, Cowen adds. Why? Any promise from your employer to do business with you gives instant credibility to your venture in the eyes of outside investors and may lead your employer to demand a high price for the backing, Cowen says. Even so, good managers have some advantages in talks with an employer, Cowen adds. After all, who knows more about the business smarts of the management team than the employer? Who would be faster to grasp the merits of a spin-off than the employer? With advantages such as these, a management spin-off may prove an easy deal to do, Cowen says. Investors find management buyouts appealing because they see the cash flow from an ongoing business," he says. "Investors have high expectations for their money. But the more talented the managers, the better their leverage." In the case of the Albuquerque partners, the leverage was their reputation in the pharmaceutical industry, says Bank of America's Poole. Drug companies need suppliers who meet strict manufacturing standards. Pharmacia & Upjohn had set the standards under which the Albuquerque plant operated, and nobody had to tell the parent company about the strengths of Larsen and his management team. Starting With A Head Start In short, Larsen and his partners didn't have to prove their bona fides. They capitalized on their strengths in negotiating their spin-off -- and in leading the company to success since then. "At the time of the buyout, Pharmacia & Upjohn probably represented 90 percent of our revenues," says SP's Solomon. "Now I'm happy to say that it represents about 65 percent of our revenues." "The rest comes from about 30 new customers -- and the company isn't even two years old yet." |
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