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BUYING A SMALL BUSINESS

Tortilla Flap
 

Cofounder jeopardized his control of his 3-year-old company when he fired his partner.
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Doug Foreman's fat-free tortilla chip was a winner, but the partnership he made with his best friend quickly crumbled

In May 1992 Doug Foreman met Drew Westbrook, his partner and best friend, for lunch. Westbrook was planning to discuss his return to their company after an extended leave of absence. But Foreman, the president of Guiltless Gourmet Inc., had a different agenda for the company's sales manager. He fired him.

Though he'd agonized over the decision, Foreman had anticipated neither of its consequences: not only did it jeopardize his control of the $20-million-a-year company he'd started less than three years earlier, but it also would make Westbrook a millionaire.

* * *

As a diner owner in Austin, Tex., Foreman had dreamed up a recipe for a low-fat version of tortilla chips in an attempt to eliminate fried foods from his personal snack menu. His August 1989 invention gained such popularity that he baked chips every night after a full day at the diner's grill. The grueling production schedule left him no time for sales calls, so that November Foreman recruited the help of a trusted friend. Westbrook was a crackerjack salesman for a local radio station. After only two months of selling, though, Westbrook demanded equity in the new venture. Foreman readily agreed, and Westbrook hastily accepted Foreman's offer -- 49% of the company in exchange for $25,000. Foreman formalized the stock transfer on a piece of notebook paper, but he and the company's chief financial officer, Bart Glaser, say Westbrook ponied up only $6,500 of that $25,000 and immediately began to repay himself from company cash. Nonetheless, Foreman struggled to maintain a friendly atmosphere at the cash-poor business.

In May 1990 Foreman sold the restaurant and moved the tortilla-baking equipment to a new bakery and headquarters. The additional capacity called for a sales push, but Westbrook's effort was unimpressive. Foreman, who had to educate Westbrook about the basics of low-fat nutrition, estimates that for every sale Westbrook made to mainstream purchasing agents, there was a matching unsolicited order from informed consumers like the Arkansas-based health-food cooperative that gave Guiltless Gourmet exposure in five states.

As interest in low-fat foods grew, selling the chips got easier. Nevertheless, Westbrook had taken to writing unprofitable orders, and, Foreman says, he made few of the calls expected of him. As Westbrook's to-do list lengthened, so did his string of broken promises.

Foreman kept busy, though. In addition to filling and billing orders and managing his partner's behavior, Foreman was looking for money to fund a $350,000 chip factory that would dramatically reduce costs while lifting production from less than $20,000 a month to an estimated $600,000. He'd uncovered several options, including a deal to make private-label chips for a California company, but financing growth out of profits seemed prohibitively slow.

Sales for 1990 had reached a profitless $200,000, and the company's meager assets amounted to a heat-sealing gun, a bagging machine, and an oven. But Guiltless did have a product with expanding market demand, a jump on the competition, a catchy name, decent graphics, and Foreman's passionate commitment. He figured the whole shebang was worth a million bucks.

At a dollar a share, he could sell 35% of the stock to raise the $350,000. And he would go even-steven with Westbrook. "We would each have 30% and control the company by voting together." Foreman valued their friendship. "What can I say? I was a nice guy." Five percent of the stock was held by people who had bailed them out of cash-flow, accounting, and legal binds.

* * *

Since 1976, John Koerner and John Oudt had been the 50-50 co-owners of Barq's Rootbeer Inc. They had raised Barq's from 16th to second place in the market. The market for Barq's root beer had matured, and Koerner and Oudt were ready to diversify. They were willing to bet on a nascent low-fat-snack-food trend, no matter how the chips tasted. "Diet sodas tasted awful when they were first introduced, too," says Oudt, who envisions a Barq's-Guiltless Gourmet relationship like the Pepsico-Frito-Lay marriage.

Guiltless Gourmet is an S corporation, so rather than investing corporately through Barq's, Koerner and Oudt made individual investments. But no one from Guiltless Gourmet -- including its lawyer, Winston Krause -- was aware that Koerner and Oudt's goal was eventually to merge Guiltless Gourmet into Barq's. Krause, who questioned their commitment, says, "I called and begged Koerner for an exit strategy, and they said, 'We are in it for the long term." Foreman agrees: "As far as I knew, this [original arrangement] was forever."

Koerner and Oudt had no illusions about the Westbrook-Foreman partnership. Oudt says, "We saw the potential for shifting ownership in the future and decided to take what we could get at the time." To that end, Oudt, who has a law degree, and Koerner added some nifty terms to the Guiltless bylaws. For Foreman the impact of those addenda was overshadowed by the mountain of cash the company so desperately needed. Impatient with any delay, he yielded on every sticking point.

Koerner and Oudt secured a seat on the three-person board. Only a few decisions -- issuance of capital stock, loans to corporations, purchases of major assets, and amendments to the bylaws -- required a unanimous vote by the three board members. Everything else, including management of such mundane concerns as compensation, hiring and firing key managers, or signing joint-venture and licensing agreements called for a two-thirds majority. However, such strategic decisions as mergers, sale of company assets, and changes to the articles of incorporation needed two-thirds of the voting shares. To gain their second seat on the board, Koerner and Oudt needed to control just 51% of the stock. They further amended the shareholder buy-sell agreement with a pro rata purchase plan that would divvy up the shares of a selling shareholder in accordance with the current holdings of interested shareholders. The cumulative effect of that legal fine print added up to a powerful acquisition strategy.

With the infusion of capital, Foreman negotiated a lease for the new chip factory, purchased equipment, and started to research new products and markets. Westbrook was charged with building a national sales organization and a customer-service department.

Business responded as Foreman had predicted, and by September, with the chip factory up and running, monthly sales were up to $370,000. But Westbrook's deals on cocktail napkins and failure to inform headquarters frustrated efforts to fill and deliver orders. Westbrook explains, "I was taking orders any way I could get them." But Foreman says, "We'd send out an invoice and be expecting $10,000, and we would get a check for a drastically different number." Westbrook couldn't be found to straighten things out, and he refused to use the official sales order form that had been designed to eliminate the troublesome napkin agreements. Worse, the national network of distributors and regional sales managers was way behind schedule, and customer service hadn't developed beyond triage. Foreman remembers that it was increasingly difficult to cover up for his friend. But Westbrook contends he fulfilled his mission. "During the three years I was with Guiltless, I almost single-handedly grew sales from zero to approximately $10 million on an annualized basis," he says.

"We played marriage counselor for them," Oudt says. But by April 1992 it was evident to all but Westbrook that Guiltless Gourmet could no longer afford to subsidize his shortcomings. "There are some partnerships," Oudt adds, "that can't be saved."

At Foreman's suggestion, Westbrook took a six-week leave of absence. While he was gone, Foreman reports, "a wonderful calm came over the organization" that made it crystal clear he had to fire Westbrook. He was prepared to vote with Koerner and Oudt and against Westbrook if need be. But it never occurred to him that Westbrook might sell his increasingly valuable stock. His decision to liquidate his holdings would activate the buy-sell agreement's pro-rata-purchase term and give Koerner and Oudt the opportunity to control more than 50% of Guiltless Gourmet stock.

* * *

In July 1993 Foreman learned that Westbrook had negotiated a price of $10 per share with Koerner and Oudt. Foreman and Krause had navely assumed that those two had no interest in acquiring additional stock. To avoid forfeiting his entitlement, Foreman had to scramble to borrow $1.28 million to buy his portion of Westbrook's stock, 128,000 shares. "It's hard for me to feel sorry for Drew," Foreman concludes. "What he got is not a bad return on $6,500 and two years of selling."

It must sting to see a stable partnership profit from the Guiltless failure. But even Foreman vouches that Koerner and Oudt honestly tried to get Westbrook out of his funk. These days Foreman is proving to Koerner and Oudt that he is up to the task of growing Guiltless Gourmet. Their two board seats and 52% ownership make their approval crucial, but Foreman comforts himself with the knowledge that he is protected by Koerner and Oudt's bylaw addenda. They'll need his vote for a merger. "Hey, if I grow this company and Barq's wants to buy me out, that's a possibility I'm comfortable with," says Foreman. "Everyone has his price."

Last updated: Jun 1, 1994




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