Charles Leighton's approach to managing acquisitions is enough to make even the most independent private business owner want to be bought.
"THE ART OF CHOOSING MEN IS NOT nearly as difficult as the art of enabling those one has chosen to attain their full worth." Though it's his favorite saying, Charles M. Leighton isn't quite sure who first uttered it, or why. No matter.As he sees it, the sentiment applies neatly to the managers of nearly a dozen companies he has acquired, and who now work under him. The corporate overseer of this collection is in Acton, Mass., and is known as CML Group Inc., of which Leighton is both the "CML" and the chief executive officer.
Co-founders Leighton and G. Robert Tod (CML's chief operating officer and "GRT," of nothing so far) have been accumulating others' enterprises for 17 years, and by now have become adept at it. They're not the hostile raiders of today's popular mold, squeezing unwary businesses for quick profit. They don't leverage the assets of takeovers, they don't terminate redundant executives, they don't exploit the public marketplace, and they don't green-mail quaking management. On the contrary, by the time CML concludes its pursuit -- a humanistic quest that can stretch out over many months -- initially dubious founder/owners of privately held businesses not only have been convinced to sell, but are eager to do so.
Products aimed at outdoorsy 35-to-50-year-olds with incomes over $40,000 a year are what Leighton, 51, and Tod, 47, seek in their operating companies. To attract such specialty retailers, most already successful on their own, they hold out the promise that after the owner cashes out, he can continue to rule his domain as if nothing had been changed. Indeed, he is urged to. CML takes over financial control, but prevails upon the former owner to remain as chief executive officer, since he knows how to run the business better than Leighton and Tod do. The way CML couches it, the notion of staying put sounds so appealing that several looking-to-retire founders have been talked into staying on for a few extra years.
CML's relative anonymith means Leighton and Tod must deliver an unconventional pitch to attract such fast-growing companies as haberdasher Britches of Georgetowne (from around $30 million in sales at acquisition in 1983 to more than twice that this year), clothing mail-orderer Carroll Reed ($2 million in 1969 to $42 million this year), and boat builder Boston Whaler (in the red in '69 and now more than $40 million). Although CML's first acquisition, Boston Whaler, was in need of fresh capital when CML took it over, since then the holding company has tried to stick to thriving, positive-cash-flow situations.
Reward's the thing, preach Leighton and Tod, who had done acquisitions for Bangor Punta Inc.'s leisure group before setting off on their own. As students at Harvard Business School in the 1960s, they each had listened to the father of the conglomerate -- Textron Inc. founder Royal Little -- lecture on how to keep good people happy. "The worst thing you can do is buy a guy's business for all cash," Little teaches. "Then the guy quits. He has no incentive to continue to work." When the cash isn't there all at once, one concludes, the guy hangs around to get it. Clock-kit maker Mason & Sullivan's co-founders, Ed and Marjorie Lebo, for instance, bit at the offer of a five-year earnout calculated on book value, plus bonuses built into Ed's executive salary, when they sold to CML in 1970. Britches of Georgetowne's co-founders, David Pensky and Rick Hindin, got $8.25 million up front and the prospect of up to an additional $27.3 million in an earnout based on profits over the next five years. Their salaries, enhanced by incentive formulas hitched to Britches's incremental earnings growth, have been outstripping Leighton's and Tod's, whose bonuses stem from slower-growing consolidated figures.
"If you believe in the entrepreneurial spirit, you have to reward people," Leighton feels. Besides, grousing over others' success would run counter to a takeover philosophy under which everybody benefits -- founders, employees, principals, and public stockholders, not to mention yuppies by the millions. Bonuses, which can exceed salaries for key management of the operating companies, are dependent on annual results of that company only. The distinction prevents a successful subsidiary from being dragged down both in takehome and spirit by the fiscal ennui of its kin. Conversely, no income growth results in less salary; and no income growth for two or three straight years, as a handful of foundering founders found, results in no job.
What with disposing of some subsidiaries that didn't meet expectations, Leighton and Tod are currently monitoring a potpourri of 10 independent specialty marketing companies that collectively have about 110 stores throughout the country, send out some 20 million mail-order catalogs annually, and produced more than $200 million in net sales for fiscal 1986. Founders Leighton and Tod have seen CML's net worth sprout from the original $2 million, which they convinced The Ford Foundation and others to invest based on their outline for a specifically people-oriented holding company in 1969, to a valuation by the over-the-counter market (NASDAQ symbol: CMLI) of over $100 million as of July 1986.
Following a tenet that meeting the people behind the business is more revealing than meeting the business behind the people, Leighton prefers a diner over a boardroom for opening discussions with prospective sellers. Thus it was in a Chaska, Minn., eatery that he first sounded out the founders of CML's latest acquisition, NordicTrack, after hearing from an investment banker that the profitable family-run manufacturer/retailer might be acquirable. The company's sole product, a personal-fitness device, sold exclusively through the mail for around $500. That's certainly a stout price to stay slender -- especially for an odd-looking contraption that simulates cross-country skiing without the slush -- but the high-ticket item promised to nestle neatly among CML's upscale offerings. So Leighton arranged to meet with NordicTrack's husband-and-wife founders, Ed and Florence Pauls.
Why should we want to join CML Group and not someone larger and better known? the owners asked cautiously. "Because," Leighton launched into the familiar spiel, "most acquired companies don't have original owners -- but ours do. When larger corporations acquire companies, they say, this is the way we do it, and we want you to do it the same way. You say, damn it, I don't believe in your way; they say, sorry. So you lose the sense that it's your company."
Furthermore, Leighton's standard argument goes, much of a company's worth in the market is predicated on the reputation of its founder, and if he disappears, so might a good price. "With us," he persisted, "you can salt away some equity for your family, and retain the excitement of running the company, and the freedom and self-respect you get as founder. Besides," Leighton continued over the tuna, "it would give you a chance to take vacations once in awhile."
After he departed, the Paulses contacted other founder-sellers to see what they had to advise -- would they do it over again? Well, one subsidiary CEO reported, CML holds meetings four times a year in which all the presidents get together, and each explains the way he does things -- strategic planning, time management, selecting retail locations, employee benefits, directmail techniques. "But," the Paulses were told, "the important thing is, you don't have to do it that way."
Leighton and Tod had studied the Paulses' machine and its patents scrupulously, and toured the plant where it is made. It's a hallmark of CML, though -- and a potentially disastrous one -- that they don't comb the books with such scrutiny. "You can read more about a balance sheet and P&L by meeting the owners," Leighton says, as innocent as a saint. "We take it for granted that the rough numbers they've shown us are correct." Only well after a deal is signed and sealed does CML corporate go through the financials. The reason is so that "the employees don't get nervous over strangers coming in to count the typewriters." In fact, Leighton claims, no employee in any of its acquisitions has had any idea that the business was even on the block, and CML has yet to be stung by a seller's misrepresentation. True to form, Leighton apparently felt comfortable enough after meeting the Paulses that, waiving audit and due diligence, he called them back and said he'd like to make an offer.
The foundation of CML's acquisition program is laying out, before a company is bought, what is going to be done after it's bought. So when Leighton flew in for the next meeting, he brought three typewritten pages summing up the proposed transaction. One spelled out the operating relationships among the people, specifying what the corporate chemistry would be like "so there would be no surprises and we all understand what it says." Ed Pauls, for example, would stay on as executive officer, and an advisory board would be set up on which would serve the two Paulses, Leighton, Tod, and anyone else the owners recommended. The second page set out the components of CML's financial offer. The third contained the fiscal arrangements that the parties would make after the agreement was signed. NordicTrack would use CML's auditor, and even if it was almost impossible to fall off the contraption and break a leg, they would have to show enough liability insurance to protect CML's bank loans. Local accountants would have to be dismissed. If NordicTrack's controller proved unseasoned, they'd have to get a more sophisticated one. Along with all the other subsidiaries, NordicTrack would conform to CML's financial controls, which utilize a zero-cash-flow arrangement in which excess cash is swept from everybody's bank account at the end of each business day and placed in CML's, where it can be redirected as needed. Each subsidiary gives CML its cash uses daily, and its balance sheet and P&L monthly.
Little else in a CML arrangement is standardized: NordicTrack could keep its current benefits package, for instance. And if CML provides corporate staff assistance, there would be no charge back to the individual company. "There's nothing worse than after you join us we send someone out to help with your insurance, and all of a sudden you have to pay plane fare and salary," Leighton explained. Corporate, too, gains an advantage: by not charging the subsidiary, proffered assistance tends to get accepted more readily.
The Paulses owned the NordicTrack building; CML would agree to lease it, but wanted an option to buy later. Could they retain some space upstairs that the family used? Fine, until the space was needed for production.They had a company plane on the books. If you use it for business, you can keep it there. There was a son who was an engineer -- could he get an employment contract, too? "Well, it's wonderful to have the whole family wanting to continue on."
To spare the acquiree the bulk of the legal fees, CML has its own lawyers write up the paperwork. Leighton insists that they bend over backward to be fair. "Every time we write an agreement, we read it as if we were they. We don't tell them when they have to come to work, what their vacation time should be. They're successful people, and we understand where they're going, so we don't like legal agreements that demand if they sneeze, they get beaten." To that end, CML scraps contract boilerplate by the pound. "When someone joins us, for them it's the only time. They haven't read 55 purchase agreements like we have, and they don't know those phrases are standard language. They might find it offensive."
The terms of each CML acquisition are custom-tailored to the business involved, according to balance sheet, operating history, and maturity, but until NordicTrack, most of the previous ones were a variation on a cash payout usually based on book value. This time, however, Leighton proposed that a merger be effected via a swap of stock -- 1.2 million shares of CML's common for all of NordicTrack's. CML couldn't guarantee a floor on the stock value after the deal was signed, he explained, and because tax advantages dictate that the Paulses couldn't sell immediately, they would be at risk for one business quarter, during which period the stock, then around $18, could go down. Recognizing that publicly traded CML stock would likely rise on the merger news, however, the corporation agreed to give the Paulses the stock at its price prior to the announcement of the merger. "I assured them if we have a gain in our stock because of the announcement, they'd get it," Leighton says of the potential profit that in many such swaps would be reserved for the acquirers' pocket.
On the other hand, if they wanted cash instead of stock, CML couldn't offer the equivalent amount, because a cash expenditure would impact CML's P&L adversely. Bookkeeping standards require that the difference between the purchase price less the book value be carried as goodwill; as an intangible asset, it would have to be written off against CML's earnings -- much to the consternation of its stockholders.
The Paulses decided on the stock, and, as expected, in the week of the merger news, CML stock shot up several points to its all-time high, over $22, giving them a gift of several million dollars, on paper at least. Then the price receded in an overall market decline. As to their final take, the jury will be out at least until the end of the period of combined operations that the Internal Revenue Service requires to qualify as a "pooling of interests," which is a tax-free transaction. After that, the Paulses can cash in their chips like any other stockholder.
NordicTrack's employees just missed the eligibility date for participation in CML's corporationwide stock purchase plan, established, Leighton says, so that employees as well as executives share in the greater good. In 1983, just after the company went public, long-termers among CML's then-800 employees were given several hundred dollars' worth of stock as reward for faithful labor. But the gesture almost backfired. The stock certificates read "par value 10?," and, Leighton still shudders, "they thought we were giving them a dime's worth."
Stock deals that bring private companies like NordicTrack into public purview may be a dime a dozen these days, but 100% earnouts are not. The co-owner of SyberVision Systems Inc. last year carved out what is CML's most adventuresome pricing proposition. The seven-year-old videocassette publisher had developed novel approaches to teaching sports on tape, among other things, and needed working capital to exploit them properly. Second-mortgaged to the hilt, its idealistic founder, Steven DeVore, 35, applied to venture capitalists and commercial banks, but deemed the former too greedy, and the latter too restrictive. Then, introduced by a colleague of Leighton's, DeVore relates, "I met Charlie. . . ." The conversation went essentially like this:
Leighton: The first thing we do is buy the company.
DeVore: I don't want any part of that.
Leighton. Look, we understand your market. We are already selling to your type of customer. We relate to the investment, to the time, to the expenses required in building your business.
DeVore: If you're going to buy may company, how will you put a value on it? The goodwill and the R&D and the sweat have to have some worth.
Leighton: Instead of squabbling over what it's worth right now, we'll give you the funding you need to run the company for the next five years, and 100% of the five-year profit will be the sales price of the company. If you went to a bank to borrow a million dollars with your book value of zero, it would be very expensive.We will serve as your bankers. We'll give you a million at our borrowing rate -- slightly above prime -- and no other charges go against you. So you're really getting very inexpensive money to build your own account, which five years from now we'll pay.
And so it was done. Like a TV contestant on a long-running giveaway show, DeVore will get to keep all the profits he can gather in five years. And CML gets to keep the company.
"It's having your cake and eating it, too," DeVore marvels today. "CML said, 'We will bring you our experience, but we will let you manage your vision.' We were able to maintain an individual sense of responsibility and enthusiasm, rather than having some venture capitalist come in, replace the management chain, then sell the company into the slave market." Has it occurred to DeVore that SyberVision may not have prospered by the time the earnout period is up in 1990, in which case he may have nothing to show for his 13-year effort but a super idea for a videotape on how not to sell a business? "The thought doesn't enter my mind. What does enter is, What am I going to do with all that money when I get it?"
DeVore is getting more than meets the eye. Not only will he have had easy access to working capital for five years at cheap rates, but assists from CML's wide-ranging operating, marketing, and financial experience, gratis. If things work out, in the end he'll be offered a job -- with continuing incentives -- to stay on. If they don't, CML likely will be out its advances, but DeVore will be debt free: CML not only guarantees the bank borrowing of its subsidiaries, but releases the founders from personal business indebtedness as well, converting it to an obligation of the business.
That kind of posture was what appealed to Britches of Georgetowne's Pensky, who had never heard of CML until CML launched an aggressive 18-month campaign to win the hand of the fast-growing clothier. "I was tired of having my own money on the line while the business decisions were getting bigger," explains Pensky. "We were becoming a management-size company without management in place. We needed something other than entrepreneurial spirit. [Leighton and Tod] are interested in finance, and I'm basically a retailer who loves retailing. What [the acquisition] has done is enhanced our decision making because we're free from capital worries. You have a tendency not to do so much when it's your own money on every decision. It has enabled me to grow the company and take risks that as we got bigger I had become reluctant to take." No longer personally liable, Pensky fuels the company's internally funded growth with borrowing from Britches's own local bank, where funds are separately maintained (unlike other portfolio companies to which corporate CML itself loans short-term money taken from cashflow sweeps).Thus Pensky can well conclude: "We are very much still owners of the company. There's hardly a change."
Fine for them. But, persuasive as it is to selling founders, CML's decentralization doctrine can lead to trouble in operations that aren't running quite so smoothly. Indeed, what with one recalcitrant unit or another, CML has been struggling to increase consolidated profitability ever since it started. "If you make good acquisitions, letting management have its way works," agrees Fred Wintzer, retail analyst at Alex. Brown & Sons and an attentive student of CML's public performance. "You cannot buy into a business you don't understand unless you buy management. But if you buy a bad property, you've got a problem. It's difficult to turn around a division that's gone sour, because top management never completely understands the business they bought." True enough: in 1985 alone, two subsidiaries were divested, two mail-order catalogs discontinued, and one factory closed; in '86, CML already has disposed of two more acquirees.
And recently a sales downturn set in at the catalog operation of New England clothing-retailer Carroll Reed, whose namesake founder had retired. The crowded mail-order scene was under rapid flux, but, left to his own decisions, Reed's CEO stuck to its heretofore winning catalog of dowdy clothing, with its hayseed copy and pastoral settings. Since CML isn't about to rescind decentralization policies that allow subsidiaries to follow their own plans until the figures prove them wrong -- essentially making sure they are hanging themselves before it attempts to loosen the noose -- it suffers delays between a bad decision and the reporting that discloses it. Reacting laggardly, corporate CML now is hiring professional models for the catalog, banishing cows from the cover, and upgrading the color printing. "It was a different ball game, and we didn't keep up with it," admits Tod, who has yet to be advised that the days of pleated plaids are gone as well.
Indeed, CML holds to decentralization so stubbornly that it won't even exert collective clout on behalf of an individual company. "Company A ought to be able to crack its own deal and not have to bring the other guy with it," insists Leighton, nonetheless quickly adding that some synergism can be effected. For instance, a developer might be advised, "Look, if you want Britches in your mall, how about giving us a good location for Carroll Reed?" But that's about the extent of collective action. And decentralization will pay off should something go awry in one sector -- a computer breakdown at a mailing facility, for example, which would tie up a centralized setup. At CML, the rest of the individual companies could keep operating without a hitch.
Again, by maintaining separate operations, CML is in a position to enhance its treasury by spinning off such cynosures as Britches of Georgetowne or Boston Whaler, and bringing them public, as many a lesser holding company has done before it. Even though stockholders would stand to gain by such tactics, it's hardly likely under Leighton and Tod's empathetic administration. For one thing, says Leighton, "if you go public, life becomes different. Operating people may not want to spend the time on Wall Street answering bloody questions -- what's your return on investment, or samestore sales growth, or all the things they look for that we don't use in our own management system."
There's an even more compelling reason they won't be setting up their acquisitions for public spin-off. If they did even one, Leighton realizes, "that would be the last time we'd get a well-thought-of company to join us on our terms. Every time we sought a new company, we'd have to pay a premium price." And that's not their style.