Structuring the Sale of a Company

I wanted to create a quick and timely post to fill in some blanks about how a company might structure an investment from say, a Private Equity Fund. Reading my description of a Balance Sheet may help.
First, let's assume that if you are large enough to attract the attention of a PE Fund, then you are already Incorporated with an existing Share Structure. This Share Structure typically has two classes of shares, Common and Preferred. Common Shares are voting shares and usually where the value of a company is reflected as price per share.
Preferred Shares are non voting shares, but in some instances (especially involving outside investors) can contain all of the company value in the form of asset backed interest bearing shares that must be paid before any dividends are paid to common shareholders.

If a PE Fund wanted to invest in an existing incorporated coffee company, they would set up a separate corporation with a common share structure that reflects the final ownership percentage. The fixed assets of the original corporation would be held within this company as security to offset the cash investment of the PE. For example, if the ownership is 50/50, and the value of the company is determined to be $1,000,000 and the PE fund wanted to invest a further $1,000,000 , the common shares would be split 50/50, and the preferred shares would be set up so the cash infusion of $1,000,000 would be offset by a balance sheet entry of equal Preferred Share Value, and the Fixed Assets brought into the new corporation would also be offset by $1,000,000 balance sheet entry of Preferred Shares.

If the PE fund wanted to invest more than the value of the company, but the existing owner didn't want to give up more than 50% ownership, the common shares could still be distributed 50/50, but the PE fund could have more (even all) Preferred Shares. The value of the Preferred Shares would be secured by the balance sheet assets and a Shareholder Agreement drawn up to protect the investment by precluding dividends until Preferred Shares are converted to Treasury Shares or retired. The original owner could also completely cash out the value of the original company balance sheet by selling the assets to the PE fund, and the transaction reflected by placing the whole value in Preferred Shares owned by the PE fund. The common shares could still be distributed 50/50. In this instance, the PE fund may also have provisions written into a Shareholder Agreement that would permit the conversion of Preferred Shares into Common Shares if some "triggering" event should occur. Last, some investors may look to have a "shotgun" clause written into a deal which permits either party to submit an offer to purchase the other party's shares which must either be acted upon, or the recipient of the offer becomes compelled to purchase the other party's shares under the same terms that were offered.

Believe me, the Devil in any deal is in the details. No matter what anyone says, only the parties involved actually would know how any deal is structured, but more often than not, the stroke of a pen leads to unintended consequences.

10 Questions With BGA Chair Jason Dominy

Coffee Kings: You are very active in all areas of social networking and are a dogged promoter of Batdorf and Bronson, the BGA and manual brewing in and around the Atlanta area. To some it might seem that coffee IS your life. I know there’s a lot more to you than work. Tell me about the things in your life (family/friends/hobbies) that make working long hours easier.

Jason: I have to say that spending time with my wife is my favorite thing, and I mean that. She's really my best friend, and hanging out with her doing anything is pleasurable. I also own a MINI Cooper S, and we love taking rides in it, especially in the mountains on the curviest of roads, as fast as we can. We are members of a local MINI club, and do drives and scavenger hunts with them frequently. I also love playing disc golf, and do it every chance I get.

Coffee Kings: You’ve distinguished yourself among your peers for your skills, work ethic, knowledge and welcoming manner. Those are all skills that make not only great employees but also excellent owners. Do you have any aspirations for owning your own shop one day?

Jason: I started off in coffee by opening two coffee shops. I remember the amount of stress and challenges that came along with that, and I'm not interested in getting back into from that perspective. One of the great things about my position now, is that I take all of my coffee experience over the past 14 years, and use it to help others opening coffee businesses. Each one is a project with great consequences, so I take pride in helping them as best I can be successful in their coffee business utilizing the things I would be putting into practice as a shop owner myself.

Coffee Kings: I’ve been a little critical and skeptical about manual brewing, something you are deeply passionate about. Tell me about your participation in the US Brewers Cup Championship and whether you think it can achieve what the Barista Championships has relative to improving the quality of the products served across the industry.

Jason: I am a huge proponent of manual brewing for several reasons. One, I love the fact it brings back a level of focus and communication between the barista and the customer. Second, I love the taste of properly manually brewed coffee. Third, It's easy to do, and allows you to brew lots of different coffees quickly. I think currently there is alot more bad manually brewed coffee than there is good, but I know that you could say the same for espresso. And all we can do as coffee professionals is train as many fellow baristas as we can as how to properly brew it, and how extraction works.

As far as the Brewers Cup, I think it's a good start. I had some issues with how it went down in Houston in terms of judges calibration, but this was their first year, and for the first year, I thought it was done well. It's definitely a great launching point for a competition that could be really cool to see. I'm all about seeing baristas pushing each other to brew better coffee. I really do think it will encourage baristas to learn to brew better coffee. I think the challenge is that baristas don't understand exactly what the judges are looking for in a cup of coffee, what a Q grader is looking for. I know it will get better, and the organizers will take a look at what went well, and what needed improvements and make positive changes.

Coffee Kings: I know you’ve conducted some research about the level of income baristas around the country are achieving. What do you hope to do with the results and what is your opinion of the barista income in the USA?

Jason: I wanted to show that baristas wages are relatively the same across the US, and baristas can improve their wages by investing in themselves. I believe that baristas don't make enough for what they do, what they put up with, and how much time they invest into themselves and their career.

Coffee Kings: One of the things I think is an obstacle to growing the BGA into an influential entity within the industry is an impression that unless you compete or intend on competing, there is nothing for you within the BGA. How do you address the concerns of working baristas and make them feel as valued as competitors.

Jason: I have never competed in a barista competition. I have no desire to compete in one. At one point, I was the only Executive Council member who was not either a US Barista Champion, or at least a Regional Champion. The BGA has always been for me a guild for all baristas, not simply ones who compete. I've never noticed a focus on competitors, it's just that most of our logos and branding shows up around competitions. I do not agree that if you're not a competitor there's no value for you. Because there has been for me in all my time as a BGA member, and being able to be more active in shaping the BGA, and now becoming the chair, proves that point. At Camp Pull-A-Shot, there were tons of great baristas who are not competitors, taking advantage of just one aspect of what the BGA has to offer. The BGA is for ALL baristas, and shows no favoritism.

Coffee Kings: I’ve noticed over the past 4-5 years especially that there appears to be a segmentation of coffee companies with several being promoted as either the best, freshest, most exclusive, highest quality, hippest etc, etc. I seems to me that most of the praise is focused on a few, where there are literally dozens achieving the same quality without recognition. Is this phenomena concerning to you? Tell me about one or two excellent companies who deserve more attention.

Jason: I will agree that historically, the roasters who speak the loudest get heard the most. I will also agree that there are tons of great roasters all around the country that don't get tons of attention. I blogged about this just today. I think roasters that should get more attention are PT's Coffee, Klatch Coffee, and Kaldi's Coffee.

Coffee Kings: What is the participation rate of BGA members in the election process? Do you think the rate of participation harms the ability of the BGA executive to move the association in new directions?

Jason: We had great participation in the past election, some of the best we've had. We also posted up a survey that allowed us to hear from the membership on a larger level, and we have taken all of the feedback to heart, and are acting on it. I feel like we totally understand what our members are looking for in the BGA, and are working as hard as we can as volunteers with full-time jobs and multiple other involvements in the industry, to make it happen.

Coffee Kings: As an international member I can vote for executive positions within the BGA but not regional representatives. Are there any plans to create a seat for international representatives on the executive board in the future?

Jason: We have spoken about an international BGA rep, and have been working on creating that position, who it would be, and what that would look like.

Coffee Kings: You’ve been supportive of the Coffee Common initiative held at the TED Conference in Palm Springs, something I’m less enthusiastic of. I see the Coffee Common as something dismissive and harmful to the SCAA, tell me where I’m wrong.

Jason: "The rising tide floats all boats."

Coffee Kings: If you could pick one thing that you hope to accomplish this year on behalf of the BGA membership, what would it be and how can we all help to make it happen?

Jason: The things I'm most passionate about are:

making sure that baristas all over feel valued and appreciated, no matter who they work for, or where they live.

I want to see the Certification thrive, and baristas and shop owners see the value in it.

I want to see us value and appreciate all the work that has been done before us on the BGA, and recognize it.
I want to see baristas take better advantage of the education the SCAA offers.
I want to see Camp Pull-A-Shot a complete success again.
I want to see regions better represented under our current Regional Chapter Reps through a new council.
And what can you do to help make it happen? You can volunteer your time mentoring others, helping to create community coffee events, and working hard to make specialty coffee more viable and appreciated where you live.

Dropping Off The Table

I can't think of another Macro Economic topic which affects our industry, from grower to consumer, more than the Commodity Price for coffee. I blogged earlier this year in support of the possibility that prices still had room to move up, and listed many reasons I believed contributed to increased prices. I feel that we touched the top of the market last week and that we will see a weakening of prices throughout the year. As part of an ongoing series of personal opinions and observations I want to express my belief that coffee prices are due to fall significantly this year for the following reasons.

1. The market price for coffee is to be viewed within the context of commodities in general. Commodities are an investment class which has been on a Bull Run for several years due in large part to the low returns to be had in bonds and notes and the devastation of the equity markets beginning in 2008. Commodities have attracted huge sums of speculative investors employing permissive leverage ratios to force the market up. Recently exchanges have increased the capital requirements for leveraged accounts, which will reduce the participation, thereby reducing the liquidity in the markets. Reduced liquidity means lower prices. The other thing about leverage is that while it is very lucrative in a contango market, when things go backwards, margin calls come in which necessitates selling. The more the price drops, the more margin calls, the more the price drops, the more margin calls...

2. Reports have been surfacing of brokers and exporters hoarding coffee at origin in an effort to keep prices high. While it is impossible to determine how much coffee is being hoarded, what I can predict is that when the hoarders start selling, they will all sell. More sellers than buyers moves the price down at an accelerated rate which feeds developing panic should things turn bad.

3. I perceive a disconnect between a natural price for Commodity Coffee, and the current price. Those of us who've been around the block a few times remember the spikes and valleys, but through the process gain an understanding of what price is a fair representation of the value of commodity coffee. That fair value is not $0.45 or $3.05, but somewhere in between. My guess, and it is a guess, is that an equilibrium price for coffee is approximately $2.00 per pound. In my view, this is not so high as to encourage new and inefficient participation, but not so low as to discourage participation. We can all find a price that feels right to them, but to me $3.05 is not it.

4. As I've blogged about in the past, the relative weakness of the US Dollar is responsible for at least 30% of the current "C" price. If the USD shows any real strength, (not a spike resulting from a flee from the euro) the commodities will drop very quickly. The USD has been weak since the government began printing money in an effort to provide needed liquidity once the credit markets seized. We already know the program referred to as Quantitative Easing will end in June of this year, reducing the money supply. When a government reduces the amount of currency circulating, the value of that currency rises, which is a bad thing for commodities. Also, North America currently has very low interest rates set by each government as a "Key Interest Rate". Those rates are one tool the Federal Reserve or in the case of Canada, the Bank of Canada, control economic activity. If the rates are low the Reserve thinks it needs to encourage economic activity. Moving the rates higher is a sign that activity is picking up and the Reserve needs to control activity by making it more expensive to finance things. The rates also are reflected in the Bonds issued by each government. When interest rates increase, the attractiveness of American Bonds increases making the USD rise. This is of course a very different situation from some Euro Countries that need to raise bond rates to encourage someone to buy them accounting for the risk of default. If the US Dollar index moves into more historical range as a result of any of these factors, the price for coffee will drop to close to the $2 level.

5. I may be wrong, but I think the market participation of the BRIC countries is overstated. Brazil, Russia, India and China are not doubt huge markets, but while they will need rare earths, raw materials and fuel to grow, coffee will need to destroy well entrenched cultural preferences to gain any traction. I understand that Brazil has made great efforts to increase coffee consumption which is intended to support a domestic industry, but there will be no similar efforts on the part Russia, India and China to alter beverage habits of their citizens. When markets like coffee increase unexpectedly it is easy to point the finger at the huge populations across the Pacific Ocean and expect the general public to accept it as plausible. I just don't believe it.

6. Coffee right now is not a good buy, it's a good trade. For the vast majority of participants buying a contract is a trade they expect to sell before taking delivery. In some particularly volatile sessions, traders hold a contract for less than an hour, and in some cases less than 5 minutes. These are the individuals setting the price, and when they feel the better trade is to short the market, that's the way it will move. Reduced liquidity resulting from margin calls will feed the fire.

For these reasons I think we can expect the "C" to find a level somewhere near $2 by the end of the year except in the case of unforeseen weather events. Time will tell if I'm right, but my feeling is when it starts to move down, it will drop off the table.