Sandy's Soapbox
For the CEO and the people remaining in the company, a partner cashing out is a wake-up call-- and very informative if taken seriously.
Personal Crisis
If the investor is cashing out because of a personal crises, then there's little business information to extract. Things happen, people need money on short notice. Similarly, people often want to emotionally distance themselves and cash out, even if there isn't a good business case.
Or, an investor may be cashing out because of a non-compete agreement or a potential conflict of interest. Here, being affiliated with your company may hinder their work in other areas. If they are starting their own publishing outfit, or ramping up their freelancing, these are valid reasons for them to leave, without indicating a loss of faith in your company.
Nothing you can do in these cases but pay them a pittance (since they're in hardship) and wave bye-bye. Or make good and avoid burning bridges. Your choice.
But if an investor is cashing out as their business decision, it's time to reassess your own company. There are three categories to tackle here.
Liquid Times
If the company has just received a large chunk of cash-- buyout/acquired, culmination of a big project, IPO -- this is a prime cash-out opportunity. It reflects well on the business. And, cashing out when the company is liquid is easier on the company, then if they have to acquire new debt to cover the cash-out.
In fact, that might be a good time for everyone to consider cashing out. The alternative is to stay in with the hope that the business will continue to grow and provide future cash out opportunities.
Flat Times
If the business is stable or flat, any time is equally fine to cash out. In this case, it doesn't reflect poorly on the business. Often an investor may think they can shift their money to something with a higher potential reward, but even then you shouldn't worry. A stable business may not be an investor's first choice, but it's a great state to be in for the business' owner.
Warning, Trouble Ahead!
Unfortunately, in the gaming niche, businesses often fail. Cashing out can be a vote of no confidence. It's bailing out before trouble hits. Here's how to try and guess the warning signs.
Investors cash out if they think the company will lose value. They'll cash out even if they get less than their original investment. So if they're losing money by leaving, take a good look at your company future.
A common form of this is when investors realize that the company has mismanagement issues, or cannot meet the promises made at the time of the original investment. I personally think this is very common, simply because most people doing a start-up are optimistic and engaging in presenting an aggressive and promising future, but few teams are able to achieve the necessary (and often boring) business steps required to realize that future.
Or put another way, some people are better at selling themselves or selling a dream, then actually selling product to customers.
In rarer cases, it can be that the market itself changed, and the investor does not feel the company can adapt quickly enough. Again, a good wake-up call for the saavy company.
Alternately, the investor may be worried about future liability issues, and is cashing out to distance themselves when the hammer eventually falls. If the investor is a 'Cassandra', often giving advice but not being listened to, your company may be facing this future. Again, consider this a wake-up call.
Finally, the investor may wish to distance themself from the company and their actions. Some investors may wish to distance due to stance. As an example, a devout Christian may wish to leave a company that decides to market to Satanists. This would fall under the case of "not necessarily trouble", or personal choice.
However, since the investor was original enamored of the company stance, a change in stance that distances original investors may also end up distancing existing customers, and that needs to be weighed accordingly.
More often, however, an investor or partner may wish to distance to avoid being associated with an incompetent company or an entity that puts forth a public relations presence they see as negative.
At its simplest, this can just be to avoid barside questions of "how you can be associated with those bozos?" If the answer isn't 'because I get a lot of money', then presto-- you have a combination of the 'personal reason' with the 'loss of faith'.
Alternately, the company may be taking an approach that the investor feels is foolish, but the company feels is sound. The investor, by staying, stands to not just lose money, but also lose industry credibility by remaining with an unsound entity.
For example, an investor in an full-spectrum 5%-off-MSRP game store may wish to leave if they decides to drop everything but card games and try to be the lowest discounter around. Strong disagreement with the future business strategy is a subtle beast. It raises issues of how the new direction was decided, whose voices were heard, how strong the business case is.
From an investor's point of view, it points out that their money is no longer in what they originally invested in. So the company itself should consider 'recourting' its investors. A failure to retain an investor is a vote against the new direction. Such a vote can be countered by finding a new investor that supports the new direction, however.
Getting this sort of negative vote by an investor leads to the obvious conclusion. Any lost investor should be replaced by a new one. If you can't get investment into a new direction, the company needs to ask what investors are thinking, what the company is missing.
In summary, cashing out:
- May not reflect poorly on company
- company doing really well and briefly liquid
- investor needs cash, has emotional dislike, or has external contractual need
- return not seen as good as investment elsewhere*
- affiliation seen as a negative/wish to distance*
- Warning sign for company
- investor expects company to go downhill
- investor fears liability
- return not seen as good as investment elsewhere*
- affiliation seen as a negative/wish to distance*
How To Handle It?
Since a lot of gaming companies have 'family and friend' investors, and any sane company will ask its founders to all kick in cash when starting up, what happens if someone wants to cash out? Very few companies have bundles of cash ready to repay investors. So if we're not in the lucrative 'company flush with cash' case, we need to think this out.
The company needs to make an offer and negotiate a settlement. An investor will often put forth a starting price, but a saavy company who is one step ahead should consider making the buyout offer themself, to better frame things.
Understanding the investor's motives will help the company pay out the least price while retaining good will with the investor. Good will is very useful in a niche industry where everyone knows each other, but it is not essential. Consider good will a commodity, part of the price.
Investor pessimistic, Company optimistic
If the company feels the investor is personally motivated or is incorrect in their assessment, then in theory they can afford something close to the investor's asking price for the buy-out. After all, they expect business will be good and it's best to just settle up so as to focus on future business. Otherwise, the buyout will suck away time and effort away from actual business concerns.
Perversely, if an investor believes a company is failing, they may be harder to negotiate with, then if the company is flush with cash. Sometimes people negotiate hardest when the stakes are less.
Take the case where an investor put in $10K. Few people will spend a year quibbling over a $50K payout versus $55K. But if the investor wants $5K and the company offers $2K, there's trouble. The investor is already considering their investment a loss, and most people are not good at cutting their losses. They're already writing off the bulk, and a company asking them to lose more ($8K loss versus $5K loss) can trigger combat, even though from pure economic terms the potential is an $8K loss versus $10K loss (if no settlement occurs).
It is worth settling up quickly in these cases beyond just the time lost in negotiations. An investor usually has some level of privilege within the company-- on the Board, voting member, that sort of thing. A disgruntled investor can be quite a nuisance, particularly if they feel they are being treated poorly or are a 'Cassandra'. From their point of view, they must stem the tide of loss until they can cash out; from the company point of view, they may see it as obstructionist actions which prevent the company from moving forward. Yet another support for 'pay up and move on'.
Further, if the company wishes to get further investors, it must either retain some measure of good will with its departing one(s), or else engage in a campaign of denigrating its departing investors in order to project its own aura of confidence.
Investor pessimistic and so is the company
Conversely, if the company cannot afford the buyout, things may actually go smoothly. If the company is doing poorly and the investor is correct, we have a sinking ship. Everyone's in agreement, everyone knows the investor will take some sort of loss, it's just a matter of explaining what the company can afford.
And ultimately, a company in trouble can simply vote 'not now' to a buyout. If the company cannot afford it, that's part of the risk of the business. In such cases, the company should handle the matter delicately, to avoid our earlier 'disgruntled investor syndrome'. A good technique here is to set payout benchmarks and milestones, e.g. "we will pay you a percentage of each book until the total sum is paid".
There is one final tactic a company can use in these cases. It can propose a restructuring or new direction to lift the company into (or back into) profitability. Not only is this a necessary step for a failing company, but it has an added perk. A new direction requires capital. Since the company managed to convince the investor to contribute once, what's to say the investor won't be persuaded to put in just a little bit more, to stem losses and regain value?
Alpha and Omega
Publishing startup founders are often shareholders as well. So the term 'investor' in this column also applies to the founders, later staff, and anyone with a significant stake in the company. These divestment strategies apply not just to outside money, but to eventual retirement within the company.
Face it, most RPG publishers don't have a pension plan. Selling a publishing business is difficult. So the idea of eventually cashing out and retiring is a big problem in this industry niche. Most start-ups don't really think about the eventual end of the road. The usual thought is simply to eke out a living doing work we love. But while the road goes on, sometimes a person's travels end.
If you approach cashing out in the sense of founders divesting, but the company living on, it is possible that the founders could see a return beyond their annual paycheck as the years draw nigh. With this in mind, it's worth drafting formal buy-out procedures in the first bylaws your company creates.
This can be as simple as "equity can be bought out at a rate of 1% annual profit per 1% equity, over the 1 year from when the buyout is announced, with no more than 10% equity payable in any given year". There, you've just capped company losses to 10% of profit (which, I admit, should also be defined, to prevent further argument). And you've forestalled future arguments.
An additional formalism for the by-laws is to mention how equity can be sold on the outside market, if at all. Sure, it's an unlikely path-- how many people want to buy a quarter of another person's publishing company? (if so, email me!) One method is, 'you can sell equity and its associated rights to anyone at any rate you wish, however, once you have a signed deal the Board reserves the right to match the offer within 30 days in order to keep the equity in the company.' This lets the company escape the trap of "you have equity but we can't pay for it". In a good company, equity is not a promise but a value. In my ten+ years of Soapboxing, I've laid out different ways to start and run a company. Now, I've finally written how to exit one. There will be many more columns to come, but I'm ending this column with a pitch. If any publisher is interested in producing a print compilation of my edited and updated advice, feel free to send inquiries to my email. Just my own way to capitalize on my equity in, well, myself.
Until next month,
Sandy
sandy@rpg.net
