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Anatomy of a Merger
In 1992, distributor Ralph Cahn started to rethink his business. It was the first step in a process that would lead to a dramatic career move.
First in a series BY KATHERINE L. HOUSE
For nearly 12 years, Ralph Cahn's small distributorship, Word Products in Mountain View, Calif., provided him and his family a good living. He started the business after a long career in the retail industry and a short one selling office supplies. Cahn thrived on outside sales, and his new distributorship concentrated on computer and office supplies. The firm profited nicely because personal computers were revolutionizing small businesses. Later, Cahn would branch into forms and other business printing.
But with the 1990s came the recession in Northern California. Cahn and other small business owners faced the same dilemma. His 1991 sales declined to less than $300,000, down more than $100,000 from 1989 levels. The advent of office superstores and other discount clubs had cut profitability on computer supplies so much that printing was the only way his company survived.
Cahn began to wonder if a small distributorship was right for him. At 58, he had worries common to business owners nearing retirement age. His two daughters had pursued careers outside the printing industry, and Cahn had no one in place to run the business if he became incapacitated. He worried that such a setback would diminish Word Products' value and thus the value of his estate. The company's only other employee answered the phones and did the accounting but lacked sales experience.
Beyond the recession and increased competition, another economic factor led Cahn to reconsider his future: the rising cost of health insurance. In 1984, he was diagnosed with heart problems. Surgery corrected them, but Cahn's insurance costs began to rise 30 to 35 percent a year. In 1988, costs got so high that he was forced to switch carriers. Then a mild heart attack made it clear to him--and his insurance company--that his condition wasn't temporary.
By mid 1992, Cahn realized that an alliance with a larger distributorship might be best. A year ago last month, Cahn was at the forefront of the growing trend of company principals joining other firms as a sales rep or partner.
Making the Move
This was not the first time Cahn had considered a merger or acquisition. Several years earlier, he thought about buying another company that sold computer supplies. After lengthy negotiations, the deal fell through. He also contemplated a partnership with another small forms distributor, but that too never made it past negotiations.
As Cahn mulled over his dilemma, he recalled the folks at Independent Business Products, a large distributorship in nearby Hayward, California. He had met an IBP employee at an DMIA event a few years earlier and became friends with several IBP employees when he participated in the firm's CFC study group in 1991. At the time, President Ted O'Roke, CFC, mentioned that he was interested in adding reps to help IBP grow.
Cahn began talks with IBP principals about joining their firm, a move that took a lot of soul searching as Cahn looked back on past efforts to grow his company. Although he had hired four outside salespeople over the years, things had never worked out. He was forced to admit that if he could have grown his company, he would have done that by now. He was frustrated, too. It often seemed as if there weren't enough time to sell, despite the presence of a full-time inside employee. He knew that a full-time position with a larger company would allow him to escape collections and other unpleasant tasks. And, like other small business owners, Cahn had found it nearly impossible to get away. In nearly 12 years, he had taken only one vacation longer than a week.
The Negotiations
Hiring Cahn made sense to managers at IBP. The large distributorship had several employees located throughout the San Francisco Bay Area. The company previously had successfully acquired another distributorship. Through acquisition, the company could acquire a seasoned sales rep--and customer base--who would not be likely to open his own distributorship, says O'Roke. Training requirements would be minimum. Also, the company had not had much success in hiring reps away from the majors, many of whom are accustomed to selling larger accounts at lower margins than those targeted by the distributorship, says Mel Digitale, CFC, vice president of sales. IBP remains interested in acquisitions but does not want to acquire a company from someone looking for immediate retirement. Retention of the customer base--and thus fair valuation--is much riskier in such situations, says O'Roke.
In Cahn's case, IBP was interested in learning from his expertise in the office and computer supplies business. Says O'Roke, "Ralph knew more about certain aspects of the supply business than all of us combined." Cahn had built a network of suppliers that offered good prices, quick turnaround and a variety of products that other IBP reps could take advantage of. Perhaps most notably, Cahn had created a niche selling recycled toner cartridges and had a strong relationship with a good vendor for the product. IBP managers had high hopes that Cahn could educate IBP reps in making such sales since the product seemed a natural fit for many of IBP's customers.
Cahn continued to contemplate the move. He didn't want semi-retirement and he didn't want to sell his business and walk away. He loved selling and wanted a full-time job. He wondered if he would feel a sense of loss in giving up the company he had built by merging with a larger company. Gradually he realized that even though he had been Word Products' sole owner for nearly 12 years, he wouldn't be upset if the Word Products name were absorbed into a larger firm.
Both sides began to talk about what they expected out of a merger. "You need to get a good feel for a person and for his business," says O'Roke. "And, that person needs to see what your business is like. There has to be absolute trust. If I didn't trust someone like Ralph, I wouldn't enter into an agreement. And, both parties have to be willing to bend a little too." He likens the acquisition negotiation process to the negotiation of a forms management contract. Before taking on such a contract, the distributor and the prospect must discuss many logistical details.
Cahn viewed the sale of his existing business and employment by IBP as two separate deals. Health insurance remained a major concern. IBP managers assured Cahn that he would have medical coverage. They found a way to insure him immediately despite his "pre-existing condition." In exchange, Cahn and his wife would have to change primary care doctors since IBP participated in a health maintenance organization.
Eventually, Cahn exchanged customer lists with O'Roke. They found virtually no overlap in accounts, which simplified negotiations. Otherwise, valuation would have been more complicated to compensate for the percentage of business within an account handled by Cahn versus IBP. Also, accounts would not have to be reassigned or redistributed by IBP.
Keeping the Mountain View office or one nearby was important to Cahn. That suited IBP managers, since several IBP reps work outside the Hayward headquarters. Cahn knew that he could not integrate himself into another office full-time after having so much freedom, privacy and quiet for so many years. O'Roke agreed that Cahn could operate a separate office as long as he maintained a certain level of sales. Cahn, however, would not need an office as large as the one he leased in Mountain View, since there would be no need for warehousing. Word Products' inventory would be shipped to Hayward if the deal were consummated. Cahn said he would look for a new office a few months after the merger took effect.
Cahn's only employee had planned to go back to school full-time. Cahn and IBP gave him two months' notice since IBP employees could handle his responsibilities. Cahn and IBP split the cost of the employee's salary. IBP bought Cahn's inventory of computer supplies and office equipment, including desks, file cabinets and phones. Cahn agreed to a 5-year non-compete contract if he were to leave IBP. IBP offered Cahn a stock option in the company, although Cahn has not exercised it yet. In addition to the commission Cahn would be paid on sales, he would earn a certain additional percentage of sales for three years in lieu of a goodwill payment for his business.
Cahn would be able to rely on two inside employees at IBP for placing orders with plants and maintaining phone relationships with customers. Cahn agreed to spend two mornings each week at IBP's Hayward office working with employees and familiarizing himself with new systems.
Although Cahn was relieved to be free from many administrative duties, there would be more pressure to sell. He would report to a sales manager at IBP, and there would be sales quotas. Selling, now more than ever, would be his primary responsibility. Cahn also knew that having a sales manager would force him to be better organized and focused.
As negotiations evolved, both sides had to be sure that the plan was financially advantageous. Cahn concluded that if his sales increased modestly or remained flat, he would be better off as an employee of IBP. If his sales increased dramatically, which seemed unlikely as long as he continued as Word Products' owner, he would be better off on his own. O'Roke was pleased that IBP would be able to add more than $300,000 in sales within the next year.
After months of negotiations, the two parties signed the agreement, which took effect on Feb. 4, 1993. As the deal was being finalized, Cahn learned it would cost $17,000 a year for a health insurance policy for him, his wife and his young employee as Word Products' owner. To keep his policy at all, the insurance company continued to require that he retain his sole employee. Such monumental costs helped convince Cahn that he had made the right decision.
But the next few months would not be easy. Cahn needed to notify his clients of the change and familiarize himself with new order entry and billing procedures. He would need to become accustomed to working in a busy office part-time and interacting with a sales manager, things he had not done in many years.
Katherine L. House is Managing Editor of FORM Magazine.
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