Design the Company for the Long Term

“Nothing truly worth doing in business can be achieved in a quarter, a year, five years, or even a decade. Design your company for the long term.”
Mike Rice, dean of UAF School of Management

Mike Rice’s many gifts include an extraordinary intellect, a disciplined understanding of risk management, and an ability to look deep into the unknown. Mike built from a kit and piloted an aerobatic plane, reconditioned and piloted his Cessna L-19 “Bird Dog” (an Oshkosh award winner), and is a recognized astronomer and deep space photographer. In the 1980s, Mike’s day-job was dean of the University of Alaska Fairbanks’ School of Management. In that role, he led the school to its first AACSB accreditation. Mike also served for nine years on our firm’s board of directors.

In March, 1989, I called Mike and explained that I had all but decided to leave Unisys for an entrepreneurial opportunity. I was hoping I could get his feedback before I took the final step. Mike replied, “Tim, let’s not do this over the phone; catch the first flight up to Fairbanks tomorrow and we can visit at length here on campus.”

The next morning, I arrived at the dean’s office well before 8 am. Mike greeted me enthusiastically, but he didn’t extend a hand to shake; his sleeves were rolled-up and his hands were deep into his bleeding-edge color printer. This early color technology used a heat transfer method that had left his office with a scent of melted crayons. While he tinkered, we quickly discussed the impact that color had in a world of grayscale. “I am suffering the inconveniences of early color adoption,” Mike said, “because it is my job to be persuasive. Color differentiates, and in business or a budget competition, differentiation matters.”

As Mike wiped his hands with a towel, he asked, “Tell me all about this idea of yours.” I stayed at a high level, “Jon Peacock extended an offer; 50% ownership of a business with $9M in annual revenue. I have put some of the details in this document, but the analysis only goes so far when there are many unknowable variables. Emotionally, it is hard to leave Unisys after a decade. Yet, I’m not sure I can refuse the offer.”

Mike thumbed through my supporting documents, and then laid the package down. “We may find more in conversation than in this hard copy. Give me some background on the transaction.”

I explained the long-distance telephone company, GCI, had settled their legal case against Alascom, which produced an infusion of cash. The GCI leadership was using their proceeds to expand their communications services, and they made an offer to buy TransAlaska Data Systems. However, they were not interested in TDS’s computer store division. As a result, Peacock structured a three-party deal to acquire the carved-out MicroAge stores. The working capital seemed in order. National Bank of Alaska agreed to provide a $1.1M borrowing base using AR and inventory as collateral; and GCI agreed to extend a $400K loan. Jon and I would soon execute the stock purchase and loan agreements, and personally guarantee up to $1.5M in debt. Mike listened, and waited for me to come up for air.

“Tim, recap your high-level plan, but in your thumbnail description answer these three questions: What business are you going to be in? What type of clients will you engage? And what is it that those clients value?”

With a level of enthusiasm, I summarized our intent was simply to provide IT hardware, software and managed services to businesses and institutions in Alaska. Our plan was to rapidly de-emphasize our retail presence. We were convinced that connected, open architected IT solutions were going to supersede proprietary IT systems. We were determined to focus our efforts up-market, and emphasize IT service delivery. The target market, I asserted, valued the process improvement and productivity gains that were enabled by technology. Our firm would be positioned as an extension of our client’s IT resources, and therefore we would provide faster access to process improvements and productivity gains. I added that our cost structure would allow our price to undercut the proprietary solutions vendors.

Mike nodded his understanding, and added, “I sense your enthusiasm – and frankly, I think you have already decided to take the leap. What stands out about your description is you have selected an industry that has the potential for a decade or more of high double-digit growth.”

“Now” Mike said, “Let’s talk about more important details than your current business plan. What kind of business do you want to build? Are you building a small business that is intrinsic to your lifestyle? Or are you focused on developing a scalable business model and increasing shareholder value? A lifestyle business focuses on absolute principal control, is built around and dependent on the personas of the principals, and the objective is income maximization. Alternatively, building share value through development of a highly scalable model is an entirely different journey. For instance, that type of business will not be advantaged by absolute control. Before you start developing a plan to build your business, you have to decide what you intend to build.”

I responded that I assumed Jon and I both intended to optimize share value and build a scalable model.

Mike suggested, “You two need to spend time exploring the virtues of each alternative, and then make a choice.”

Then we discussed the structure and leadership. Mike knew both Jon Peacock and I very well. Yet, he asked me, “How well do you know Jon?”

I started by saying that I knew Jon only briefly, but it seemed recently we were bumping into and hearing about each other everywhere we went.

Mike smiled and said, “Despite the efforts of many, it took you guys long enough.” Apparently our meetings were not happenstance — Allan Johnston of Wedbush Morgan, Marv Andresen of UAF, and Mike had been trying to get us connected for some time.

I went on to say I knew Jon’s background and met his family.

Mike let me know his question was trying to get to a different matter altogether. Mike explained, “The principals of a start-up are much better off if they are each experienced, competent, well-networked, and have common principles, work ethics, and values. You both bring that to the mix. What is interesting about you two is your distinct, complementary skills will lead to a natural division of roles and responsibilities. As critical, you must have the discipline to avoid the partner conflicts that destabilize a business.” Mike shared that he knew many businesses destroyed by the principal’s inability to manage differences. Mike finished, “Give each other lots of space on insignificant issues. And remember, most issues are insignificant.”

The subject changed. “Tim, it must feel pretty good to think that you may soon be your own boss?”

I agreed whole heartedly.

“Well then.” Mike said, “You may not much like my next recommendation. To paraphrase an old legal bromide, ‘A principal that elects himself as the sole board member has a fool for a director.’ Now that you two have achieved a position of controlling ownership of a small enterprise, vote your shares and constitute a board of directors. And I would not add your paid professionals to the board. Find well-networked board candidates who have experience and distinct areas of expertise – who will express their opinion. The benefit is you and Jon will leave the day-to-day tactics once a quarter, and consider the strategic issues that will better ground the tactical execution. The process of preparing for your quarterly board meeting will be an advantage; knowing that you will be vetting material issues and ideas to a group of directors will clarify the mind. The board meetings will add a healthy level of accountability to the performance objectives outlined in the prior meeting.”

We turned our attention to the importance of articles of incorporation and bylaws. “Tim, nothing truly worth doing in business can be achieved in a quarter, a year, five years, or even a decade. Design your company for the long term. Common principles, work ethic, values along with distinctively different skills and separate but coordinated areas of focus can create a long honeymoon, but these are no substitute for a well “constituted” corporation. Two principals each owning 50% of the common stock with an unadulterated set of articles and non-cumulative voting means you will reach consensus on material decision. When minority shareholders are introduced, super-minority rights in the articles of incorporation are the next step to maintaining an apolitical leadership environment. A good constitution will keep everyone constructively focused on the market; success in part will come from time over market. Longevity happens by design.” As Mike talked, I took a lot of notes.

Finally, we discussed capital requirements. Mike started by saying, “I was glad to hear that you guys believe there is adequate working capital. That is most critical. The business is highly leveraged, and the AR portion of your borrowing base will programmatically fluctuate with sales. There will inevitably be sales disappointment curves that affect working capital. Here is just a small piece of advice: a small enterprise runs on the sources and uses of funds statement, not the P&L statement. At this juncture — cash is much more important than profits. Cash is king. Get a good handle on what preserves liquidity – what causes cash to flow in faster and flow out only when necessary. Get rid of assets that convert to cash, unless these serve a better purpose on your borrowing base equation. And see if the bank minds if you are a week early or a few weeks late with the aging report. In humor and borrowing base management, timing can be everything.

I flew back that evening and met with Jon Peacock the next day. We covered a list of items ranging from (1) lifestyle versus shareholder value, (2) division of responsibility, (3) structuring a board, (4) designing the corporate constitution, and (5) working capital and cash preservation. Jon Peacock had a similar list, and we quickly realized we were already in full agreement before our conversation started. I left Unisys, and we soon closed the stock purchase and loan agreement with GCI/TransAlaska, and the loan agreements with National Bank of Alaska. I immediately called the first name on our board candidate list, and Mike Rice accepted Jon and my invitation to be our first director.

©2009 Ancala Equity Partners / Timothy P. Fargo all rights reserved
Next Week: Recovery from the brink.