A Fast Purchase:
A Financing Model that Worked
“It was character that got us out of bed, commitment that moved us into action, and discipline that enabled us to follow through.”
I was now in charge of two radio stations that were losing propositions. They had been successful in the past, but were now in troubled waters. They were losing advertisers and listeners. And some key employees were putting their resumes out on the street.
I was told to create a successful radio business using two different approaches:
- promoting those two stations and
- growing by acquiring stations in other markets
Promotion in essence meant to establish top-of-mind awareness of the two stations by marketing them every way imaginable. Acquiring other stations was self-evident, but they had to be in different markets. At that time the FCC prohibited ownership of multiple stations in the same radio market.
Once we got the first two stations running profitably, we would be able to use most of the same strategies to increase the value of any new stations we purchased. Since I was a graduate of the University of Maryland with a marketing degree and had several years of experience on the board of a corporation that bought and sold companies in various industries, both “the bosses” and I felt that I was up for the challenge.
The dynamic employees of the radio stations and I were very successful in accomplishing both tasks. Our promotion efforts included:
- establishing a formal promotions committee comprised of five employees (one from each department) that met weekly;
- creating a “Gone Fishing” TV commercial featuring our talent (at the time, a radio station advertising on another media was unheard of);
- creating new, contemporary, eye-catching logos for branding both of our stations;
- producing a monthly publication called “Fanfare” that featured articles about our stations’ activities in the community, both on and off air (and we sold advertising in it to cover the cost of a wide public distribution);
- starting a call-in morning talk show called “The Good Life” that featured the good things about living in our local area (this was a big hit, especially with the local business and government leaders);
- conducting free seminars for our clients and potential clients that presented an in-depth approach on how to effectively use all forms of advertising (presentations were by an out of area professional);
- establishing an on-air sponsored vignette called “The Business Clinic” put on by a Pittsburgh college professor (this became so popular that we ended up syndicating it and selling it to other stations outside of our market area).
On the acquisition front, a diversified holding company that I had dealings with owned two radio stations, one in Lexington, Kentucky, and one in Charlottesville, Virginia. These markets were 430 miles and 247 miles respectively from ours. I talked to them about purchasing their stations. Since these were their only broadcast holdings, the owners did not really have expertise in that industry. After visiting both markets and being impressed with what our capabilities would bring to the management of both of those radio station operations, especially in the Charlottesville market, we soon put them under letters of intent to purchase.
The Corporation Changes Its Mind!
After several years we had accomplished both tasks—we had turned the two radio stations around and were about to acquire two new stations. Then I was dismayed to find out that the stockholders of the corporation had done a complete U-turn and decided that instead of incurring more debt to purchase the additional stations, they would sell the two they owned. We had enhanced their value significantly and they wanted the profit. It didn’t take long for key employees to figure out that something was up. Soon after I showed a potential buyer around the stations, several employees approached me and asked what was going on. I had to tell them, and they were naturally devastated.
They all understood that they were employees, not owners, but after years of hard work they felt they had invested sweat equity in the stations. They were persistent in asking if there was anything they could do to avoid a sale to a new owner. I told them the only way that was going to happen was if we came up with enough resources to purchase the stations ourselves. They asked if I felt that was possible and would I lead the effort.
I understood what I would be giving up if I were to lead the effort. For the last 12 years I had been a key employee of the conglomerate that owned the two radio stations and a variety of other holdings. I liked working in the group. During my tenure there I held a variety of positions, working my way up from manager of accounting for the variety of holdings, to assistant manager of the EDP (Electronic Data Processing) department of the newspaper, to corporate secretary and treasurer of the TV station. I maintained that position while being the vice president and general manager of the radio stations.
We Move Forward
I must admit that I was intrigued by the notion of undertaking a buyout. I’d had a goal of working for myself for many years. I approached the president of the group that I was working for and asked if he would entertain an offer from myself and a group of key employees currently employed at the two radio stations. He said he would not! The consolidator who had approached him and toured the two radio stations was interested in acquiring the stations, was an accomplished multiple radio station owner already, and could handle a deal rather easily.
I went to the current radio station treasurer and the corporate secretary of the two radio stations to see what they thought of me leading a group of current key employees and purchasing the stations. Both thought it would be a worthwhile avenue to pursue and said they would be interested in becoming stockholders in the new venture. Their endorsement increased my interest in pursuing this opportunity. Then we went back to those key employees who had asked me if there was anything we could do and asked if they would be able to come up with some money to back such a quest. They assured me they would not only do their best to help secure funding, but would also come up with some funds of their own.
Armed with this new support, I again approached the president of the group that owned the two radio stations and asked if he would reconsider such a proposal. He felt that he had a conflict of interest since he didn’t want to sell to his friends while still representing the current shareholders, so I was shut down once again. He assured me that he would re-employ me at the corporation’s TV station where I had served as treasurer and secretary prior to being asked to manage the radio stations.
It Takes Three Strikes!
I’d been turned down by the president twice. However, ever since I started playing baseball at eight years old, I have used a three-strike rule. So I asked the treasurer of the two radio stations if he would join me in approaching the president one last time about selling to us, the corporate secretary, and a group of key employees of the two radio stations. He agreed to do so.
We met with the president of the group in his office the following day. The president of the company was, and still is to this day, my best mentor and a first-class gentleman with genuine concern for everyone who crosses his path, no matter what their position in life is. However, due to the difficult position I was putting him in, he pounded on his desk and said in a definitive firm tone that if I put $2.77 million on his desk in a week he would give us our shot. Otherwise, he never wanted to hear about the idea again!
That meeting had taken place on a Wednesday morning. I immediately called the corporate secretary, who also served as a human resource director for the radio stations and informed her that we were given the green light to move ahead with our plan. We called a meeting for the next day (DAY 1) that included myself, the treasurer, the corporate secretary, and ten key employees of the two radio stations.
DAY 1. Held a meeting to lay out the plan to raise $2.77 million within a week:
- Asked attendees to consider investing as much money as possible.
- Told them that I would need their help in soliciting funds from three categories of people:
- People who had money and had an interest in, or knowledge of, radio;
- People who had money;
- People who had knowledge of, or interest in, radio.
- Explained that we should buy the stock of the existing corporation to have an advantage over the current perspective purchaser who was only going to buy the assets of the company and not assume any of the liabilities.
- Described how we would need to restructure the existing capital of the corporation to include three types of stock:
- Preferred stock, attracting investors who might have had money invested in certificates of deposit that at the time that were earning only 3 to 4% return;
- Common Class A stock, to be sold at a discounted
price to current employees in exchange for their cash,
and for their sweat equity going forward to make the
radio operations work;
- Common Class B stock, to be sold to outside investors looking for a share in the overall return, should we be successful.
- Solicited the group to figure out where they would secure the money to commit to such an investment and asked them tell me how much money they each would invest by lunchtime, that Friday (the following day
DAY 2. Identified legal issues and was advised by my attorney:
- In order to shortcut a lot of red tape and legal expense, I needed to file a private placement memorandum with the Securities and Exchange Commission limiting us to approaching 50 nonqualified investors who had a net worth under $2 million and investment experience. The attorney gave me standard solicitation forms to use.
- The current bylaws and current capitalization of the existing corporation authorized enough capitalization to accomplish our equity raise needed. But we would need to revise the capital structure to allow for the three classes of stock.
- The corporation was established to do anything lawful within Pennsylvania.
- The legal cost for this type of proceeding would be approximately $15,000. I gave him the go-ahead to accomplish that process.
DAY 3. Did some preliminary math, met with key employees, and formalized solicitation plans:
- Knew the financial position of the existing corporation intimately, and knew that it had near-cash equivalents of $600,000.
- Decided to pursue bank financing for two thirds of the purchase price.
- Decided that the minimum investment we would entertain would be $25,000.
- Learned that four employees could invest more than $25,000; three could invest $25,000; three could not invest; and three would each put in a third of $25,000.
- Crafted the list of investors in the previously mentioned three categories, established available meeting times and got on the phones for appointments.
DAYS 4 & 5. Wrote a detailed business plan.
- Went home Friday night and over the weekend produced a 51-page comprehensive business plan consisting of: an executive summary, resumes of principals, history, the market, financials and projections, and the structure of the purchase. This was the single most important document in the whole process. It would be the “selling tool” to attract investors and to secure the bank financing needed to bridge the gap between the $365,000 employee funds committed, the $600,000 in near-cash corporate resources, and the $2,770,000 purchase price. So the real value of this document could be thought of as $1,805,000! With it, we actually ended up raising $1,815,000: $1,400,000 in bank financing, and $220,000 from outside investors purchasing Class B stock ($10,000 more than what we actually needed to accomplish the purchase). The extra $10,000 and a small portion of the $600,000 was used to cover the related closing costs, filing fees, and legal fees.
DAY 6. Conducted potential investor meetings:
- Received every response from: “We are very excited to participate” to “You’re paying too much for the deal,” to “So you want me to give you this money without any guarantees for success?” to “NO!”
DAY 7. Achieved bank financing and held more investor meetings:
- The Treasurer and I met with the president of the bank.
- Met with two technical lenders of the bank who poured over our formalized business plan in excruciating detail.
- Met again with the president of the bank along with the two technical lenders discussing all the pros and cons of financing the deal at the level we were requesting which was $1.4 million.
- Met with both the chairman and president of the bank who put their final seal of approval on the loan commitment. This was based in large measure on the fact that the radio station treasurer, the corporate secretary, and I had good relationships with the bankers and were well recognized, important community players in the local economic development scene through a number of volunteer community service efforts at high levels.
- Conducted more potential investor meetings.
D-DAY. Finished investor meetings and met with the president:
- Finished conducting potential investor meetings.
- Presented the president with signed commitment letters representing $2.77 million.
Here’s why I think we succeeded. The entire process to overcome the seemingly insurmountable task of raising $2.77 million in a week must be envisioned with clarity at the onset. It must be tactically well thought out and developed with professional advice. You must employ rigorous and resolute effort. And it helps to have very supportive individuals surrounding you. Some challenges may seem impossible. Don’t give up on the notion without at least giving it your best shot. Sometimes you have to feel that you are testing the “impossible” to determine what’s possible.
The business plan will be your most valuable sales tool in order to raise needed funds. First, you should share this plan with all of your inside participating business owners. Get their buy-in to the written plan. Have them understand the way you expect the business to operate on a daily basis and what role each of them will play. Have them fully understand the structure of your anticipated financing sources. Bring them to the understanding that the more they contribute as participating owners, the less outside equity and outside demands there will be on the business.
Once you have your business plan in place and you have identified the key players you will need, you will need to raise the capital to implement your plan.
Give your team members assignments. To participate in the plan, they should examine their own financial wherewithal. They should contact their banks as well as their families and friends to discuss with them the opportunity they have before them. They should, as a result, come back to you within a specified period of time (perhaps 1–2 weeks) and give you an approximate amount of invested capital that they will have available.
If you are setting up a sole proprietorship, partnership, a subchapter S corporation (S corp), or a limited liability company (LLC), a small capital raise may be all that is required. If, however, you need to raise a significant amount of money, you may need to exceed the number of investors allowed in an S corp (75 at today’s writing) and may need to look at a regular C Corporation structure. This mechanism will allow you to attract more investors, thus increasing the level of investment you may achieve.
A Partnership, Sub S Corporation, as well as an LLC, although limited in the number of investors, passes the income and tax on to the individual owners instead of being taxed as an entity. At first blush, this may sound like a preferred option. However, upon closer study, it may not be. The owners will pay individual taxes on their share of the profitability of the business unit without necessarily receiving any distribution from their ownership. They may have to come up with personal funds to pay for the additional taxes created and passed on from the business.
In a regular C Corporation, the business unit will pay all the taxes on its own profitability. This does not relieve the owners from ever paying taxes from the business unit. If they receive dividends from the business, they will pay tax on the dividends that they receive. And if they sell their ownership position for more than what they paid for it, they will pay taxes on that gain at the time of the sale. If they held their ownership position for less than one year, they will be taxed on the gain at their personal tax rate for ordinary income. If however they held their ownership position for more than a year they will be able to get more favorable capital gains tax rates on the profit.
As described in our purchase of the radio stations, when you establish a new corporation, you have the ability to set up different classes of stock. In order to be attractive to most types of investors, you should set up three classes of stock:
- Class A Common Stock to be offered to your participating employee investors.
- Class B Common Stock to be offered to outside investors with money to invest who do not need an immediate return on their money. They stand to make a significant amount of return on their investment in the future if the business is successful.
- Preferred Stock for those outside investors who need a current return better than their investment in certificate-of-deposit type investments that they may be currently holding. (Preferred stock can also have other provisions. For instance, much is not callable. And it can be convertible at the choice of the holder.)
Under this structure, you can charge a different price for Class A common stock than you do for Class B common stock. This is justifiable because your key-employee participating owners are going to be the ones to actually make the business plan work. This should give them the enticement needed to invest in the plan and to give the outside investors, and yourself, some assurance that they will be there to carry out the plan to its end. Full disclosure of the different stock types and prices should be given to all prospective investors that you will be approaching.
The particular model that we used had a price on the Common Class A Stock equal to one half the offering price of the Class B Common Stock. Immediately upon implementation of the plan, both Common A & B had the same value. One of the provisions prohibited the sale of Class A Common for a three-year period. Another provision for our Class A Stock was that it would only be worth 90% of its calculated market value at any time after that if the employee owner wanted to sell to us. Class A & Class B Common Stock had to first be offered back to the company for buyback. If the company turned it down, then it would be offered for sale back to current owners of the same class of stock. After that it could be acquired by current holders of the other classes of stock before being offered to the general public.
The preferred stock would receive a semiannual dividend pre-approved in the bank loan document, or other debt instruments, that would be two or three percentage points above the going CD rate and callable by the company after three years at a 10% premium; after five years at a 7 1/2% premium; after seven years at a 5% premium; and after ten years at no premium. These premiums are necessary to protect the investor from an early cancellation of the preferred stock, thereby limiting the length of time that they would realize a higher percentage return on their investment.
In this structure, you have to determine how much capital you hope to ever raise by class of stock. This must be disclosed to the government (federal and state) at the time of your incorporation. You must also determine the number of investors you want to own each class of stock. This will give you some idea of the minimum investment you will need from each individual investor to achieve your goal, while keeping within the maximum number of investors in each class of stock.
Stock filings are required both by the federal Securities and Exchange Commission and state securities and exchange commissions. The rules and limitations regarding your particular capital raise may vary for each state and do not necessarily conform to the federal standards. Therefore, your attorney must guide you through this very arduous process. Keep in mind that the more investors and dollars you need, the more regulatory red tape you could have.
Once you have your structure in place, you will then need to have a plan about which potential outside investors to approach. Sit down with your current employee participating investors and develop a target list. Divide this list into sections. As mentioned earlier, we listed people that we knew that:
- had money to invest and an interest or knowledge about radio;
- had money to invest; and
- had an interest or knowledge about radio.
Obviously, the first group provides your best opportunity. The second group can be a tough sell. The third group may contain some diamonds in the rough. They are interested in your particular business, but you may not always guess right as to who has money they may be willing to invest.
Divide up the initial contacts among all of the employee participating investors based upon who can best approach them to determine if they have an interest. For potential investors who express interest, have a core group consisting of yourself, maybe your two top officers, and anyone in your business unit who has a personal relationship with that potential investor. Approach each one and sell them on becoming an investor (either common or preferred). Keep the bank, the seller, and other interested parties apprised of your progress. This will help keep the deal on track and keep the employee participating investors excited and committed.
Your attorney can help you establish your entity by helping you achieve legal standing in the state your business will incorporate in. In addition you will need to establish legal standing with the government as well. Your attorney can be instrumental in handling a fictitious name filing that ensures the name you select for your business entity is not already taken.
Your attorney can also help you to get both a federal and state tax ID number. Once these filings have been made you can legally conduct your fundraising efforts for the necessary capital.
“If you’re prepared to invest in a company, then
you ought to be able to explain why in simple language that
a fifth grader could understand, and quickly enough
so the fifth grader won’t get bored.”
—Peter Lynch, Beating the Street
We raised money unusually fast. We also had very strong connections in the local business community—including with our bank. I advise you to begin building connections now, even if you don’t plan to start or buy a business any time soon. It will also let you contribute to your community and meet new friends. Our model is one that succeeded. You may be able to adapt features of it to your situation.
In the next chapter, you will see how we employed the strategy of building value through acquisition to multiply the value exponentially in the radio station business.