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The Takeover

The story of how you can lose your business the same way you build it--one day at a time.
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As Sue Mackarness of Transworld Teachers discovered, you can lose a company the same way you build it--one day at a time

There was a chill in the air the evening Neville Fridge stepped into Transworld Teachers for the first time.

As far as almost anyone knew, he had come to the school that night in February 1994 for the same reason the 40 or so others, most of them either corporate refugees or recent college graduates, had: to hear the school's founders, Sue Mackarness and Christopher Notley, pitch their system for teaching English to students in other countries. The owners, a married couple, displayed the combination of strengths that had meshed so effectively to make San Francisco­based Transworld an innovator in the four years since its founding. Notley, a natural marketer with a booming voice, spun stories about graduates' overseas adventures. Mackarness, an accomplished teacher, explained the school's curriculum in her upper-class British accent, before turning the floor over to an instructor who conducted a demonstration lesson. Fridge, like the others, jumped right in, pretending to be a foreign student.

He wasn't actually considering enrolling in the program, as the couple knew. He was a consultant who had come to see them that night, after being contacted by an investor in their business. After the session, he joined them for beers at the English-style pub next door. Was it true, as he'd been told, that they needed someone to find them a professional business manager? They nodded wearily.

Fridge could not have arrived at a more critical time. Although Mackarness and Notley had boosted sales to $550,000, they were exhausted. While the school's enrollment was at an all-time high, so were expenses. And except for one eight-day vacation, the couple hadn't had a break. "We were just too burnt out to be effective," admits Notley, who spoke candidly to Fridge about the need for better financial controls. Less than two weeks later, Fridge had indeed found a business manager for Transworld: himself. Fridge seemed a godsend as he set about making the hard decisions required to get the company's finances in order. Mackarness and Notley were ecstatic. "We thought our problems were over," says Notley. "He was bright. He was a Harvard guy. I didn't think it could get any better. I thanked my lucky stars that he had come into our lives."

Just five months later, Notley and Mackarness would be even more grateful to Fridge for leaving their lives. By then, though, it would be too late. Transworld Teachers would have become a victim of their bitter power struggle.

"If your business depends on you, you don't own a business--you have a job," writes consultant Michael E. Gerber in The E-Myth Revisited. "And it's the worst job in the world because you're working for a lunatic!"

In that respect, the collapse of Transworld Teachers is entrepreneurship's oldest cautionary tale: the story of founders whose passion for what they're doing matters far more to them than building a business. As a result, they fail to detect that their growing company is developing distinct needs, above and beyond what they can naturally give it. They remain ignorant--blissfully, at first--to such pressing organizational requirements as formal planning, defined responsibilities, and financial controls. "We always thought of it as just our little mom-and-pop store," says Notley. Often such founders begin to address a company's growing pains only after a series of unsettling events: a serious financial loss, a key employee's defection, even a worrisome health problem.

No one trauma mobilized the founders of Transworld Teachers. Ultimately, they just got too exhausted to contend with the constant unpredictability: How come, with revenues soaring, they couldn't pay their rent? Since they lacked an understanding of how their business actually worked, everything just seemed to come out of nowhere. "We said to each other many times over the years, 'Despite us, Transworld grew to be very successful,' " Mackarness says.

Successful, that is, by the definition most start-ups apply: Mackarness and Notley had defined a market need, created a service to satisfy it, and kept the organization afloat day to day, all while maintaining an informal and free-spirited environment. What they hadn't done, and what they needed a professional business manager like Fridge to do, was to make profits an explicit goal, help focus employees' efforts, and create a workable blueprint from the plans Notley carried around in his head. In many ways, Mackarness and Notley had been fortunate to reach that vulnerable point--at which many businesses quietly implode--without finding themselves under assault by a major competitor, say, or badly weakened by low morale.

Sadly for them, their luck was about to change.

Few founders, no matter how badly they manage this delicate transition, will suffer for it as much as Mackarness and Notley did. Some may find themselves running stagnant companies, while others endure the indignity of having board members jettison them. In any case, such stories are rarely shared, except by successful entrepreneurs trotting out past failures as if they were old war wounds.

Neville Fridge declined to give his account of what happened at Transworld, saying he preferred to put it behind him. For Mackarness and Notley, it's not that easy.

It was in late 1989 that Christopher Notley convinced Sue Mackarness, a colleague at the vocational school where they worked, that they could create a school at which Mackarness could train others in her more imaginative approach to teaching English as a foreign language. Their classes would be informal and fun, quite unlike the stuffy academic programs they saw. Mackarness, whose appetite for adventure had led her to teach English in 14 countries over an 18-year span, agreed to give it a go. The two borrowed money from family, friends, and friends of friends, and set up shop.

From the start, the work was intense. Their typical day ran from 8 a.m. to after 9 p.m. and often didn't end there. "Our home was a kind of continuation of the school, really," says Mackarness. Money was so tight that they sometimes shared a paycheck. Still, before long, the business started growing. After only its first year, enrollment nearly doubled, 390 students graduated, and more than 80% got jobs overseas. And there was another good omen: referrals accounted for almost 40% of new students.

Mackarness's curriculum was partly what set Transworld apart. Unlike other programs, Transworld's focused on how Americans learn most effectively--through the use of everyday language and short intensive programs stressing class participation. Tom Kane, a visiting scholar at Harvard University who also works without pay at a competing language school, credits Mackarness with having pioneered that type of training in the United States. "Her course book was excellent," says Kane, who notes that schools across the country have since copied her teaching methods.

For his part, Notley, with a background in theater, thrived as a salesperson. While competitors stressed classroom content, Notley marketed the teaching certificate as the first step in an overseas adventure. He filled the company's brochures with pictures of graduates and the postcards they dashed off from exotic locales.

Part of what drew people to Transworld was its laid-back, upbeat class atmosphere. Housed in downtown San Francisco in a gingerbread-style Victorian with a rooftop area for hanging out, the school was nestled among bustling cafÉs and sat atop a pub, where students and employees often socialized. As with many start-ups, hierarchical lines were blurry, and procedures for handling the dozen employees were nonexistent. "We tried to do things for people when we could," says Mackarness. "We would take them out for a meal or have them over to our house for dinner." When Mackarness and Notley tied the knot, a year after they had started the business, several employees attended their wedding. The staff was so close that Notley would drive teachers home at night, and the couple regularly received letters and cards from staff members. "Many, many thanks for being so understanding and for teaching me so much these last couple of months," wrote former teacher Robin Niemeyer. There was relatively little turnover among teachers. Some left to travel but came back to work at Transworld when they returned.

Former students also stayed in touch. "When people came back into the country, they would always come by, hang out, want to just sit around and talk," says Notley. Some dropped by and left with jobs. In 1994 former student Michael Fix showed up at Transworld without a job or a place to live. Mackarness hired him to manage the guest house for foreign students, giving him a rent-free home. Later, he worked in admissions as Notley's assistant. "As far as I was concerned, it was one big happy family," says Notley.

But the trouble with families is that there are no secrets. In 1992, when the couple's personal life started falling apart--Mackarness's father died, Notley's twin sons were having problems, and the pair's marriage was shaky--the staff knew it all.

Partly it was obvious because Notley felt no need to hide problems from the staff. Wanting to help his kids, he hired them to paint the school. Shortly after, he fired them for failing to show up. And the staff could hardly avoid knowing about Mackarness's father, who had been a local radio personality and a familiar face at the school. Even if the staff missed the obituary, they couldn't have overlooked the 30 pounds Mackarness quickly shed from her petite frame. "Unfortunately, our private lives spilled over because we were hit by so many things at once," she says. Though the two kept their battles over personal spending to themselves, the staff couldn't help deducing that Transworld was short on cash. The couple frequently asked them to come up with low-cost advertising schemes and to help find investors.

The Transworld clan extended beyond the immediate family of employees, trainees, and immigrant students. All the outside investors--who got financial updates on an ad hoc basis--were relatives, friends, or acquaintances. The founders' parents lent money. Steve Swire, who was dating Mackarness's best friend, says he invested without bothering to calculate the potential return. Another outside financier, Colin Morris, invested as a favor to Mackarness when her father was ill. Having served as Transworld's business manager for more than a year, he well knew how long it would be before he could expect a return. Still, he put in $20,000 in return for 26.2% of the company's equity. "He felt sorry for me. He said, 'You don't need more stress. The business needs more money,' " says Mackarness. She doesn't let what happened later color her gratitude. "Colin did it as an act of friendship," she says firmly. "And I'll always be appreciative of that."

In Transworld's formative years, the founders' easygoing style seemed to be working. Revenues rose to more than $300,000 in 1992. By 1993 the company had $550,000 in sales. Notley and Mackarness didn't concern themselves with profits--not that there were any. For them, financial obligation meant signing paychecks.

Their lack of involvement on that front hurt them early on. In 1990 Leonid Grzhonko and his family were among the many Russian immigrants who flooded the Bay Area. The school offered free English classes for the newcomers, who served as test students for Transworld's teachers in training. So many responded that Transworld--which "was like a family for us," Grzhonko recalls--ended up hiring extra teachers to handle the overflow. "That should have been my first realization that neither of us was very good with money or details or finance," says Mackarness.

Not that there weren't other clues. In the summer of 1991 Transworld acquired a school that taught English as a second language. Mackarness and Notley bought the business at a bargain price. But it took them 10 months to get the authorization necessary to bring foreign students into the school. In the interim, Transworld had moved to accommodate the new school, quadrupling the company's rent, and was paying five or six teachers from the new school, even though the student population there had dwindled to eight. By the time they got clearance, their new language school had almost ceased to exist.

One recurring problem was hard to ignore: Notley's disastrous involvement with the company's finances. "Although Chris is talented and charismatic, he is completely and totally coming off walls when it comes to anything like finance or day-to-day planning," says Mackarness, who sounds as if she's talking about a favorite, if exasperating, child. He rarely recorded expenses and didn't distinguish between corporate and personal funds. Before Fridge arrived, Notley set up a separate banking account for a special marketing program. When the program failed, he used the account as his personal checking account. To make matters worse, Notley promised some early investors absurd returns. One lender of $5,000 got a 300% return on his investment--not that the windfall had anything to do with company performance. "I made all kinds of wild promises," admits Notley. "We just couldn't get bank loans, and we needed quick cash for growing. And if anyone wanted to have blind faith and participate, I felt that was worth rewarding." Notley was also overly altruistic with students. "He was open to any sob story," says Mackarness. "If students couldn't pay their tuition, he'd say, 'Come back and pay us if you can someday.' "

Some did, some didn't. Either way, it didn't much matter. Mackarness and Notley hadn't started a language school looking to strike it rich. For them, being in business was just a necessary condition of following their passion. They fully believed that the force of their commitment, their sheer love of what they were doing, would carry them.

It did. To a point.

"We welcomed him like he was Jesus Christ walking across the water to our front door," says Notley. Not that the bearded Fridge could be confused with anyone but a numbers jockey, given his reserved demeanor and tortoiseshell glasses. Almost as soon as he took up his duties at Transworld, in February 1994, he proved to be a decisive manager.

Almost immediately, he sent out the books to be audited and brought in computers. A few days into his job he fired bookkeeper Tomas Pilar, later accusing him of embezzling. (According to Pilar, the criminal complaint that was filed was later dropped because of lack of evidence.) In accusing Pilar, Fridge confirmed the view that Mackarness and Notley already shared, that their friend Pilar was in over his head. Not much earlier, he had told them they wouldn't be paid for four weeks, despite the fact that enrollments had hit an all-time high and the business was actually positioned to post a tiny profit for 1994. The audit Fridge commissioned revealed that the company had, in fact, been breaking even for the past six months. Fridge assured the founders that they not only would get paid next month but could expect bigger checks down the road.

Given how swiftly Fridge had begun to set things in order, Mackarness and Notley were only too happy to continue playing a hands-off financial role. When, immediately after he started, Fridge asked for equity in lieu of pay, they rejoiced at his long-term interest in their company. It never occurred to them to study their options as business owners: they could have given Fridge nonvoting stock or granted him shares over a period of time, tying the amount to his performance. Instead, the founders awarded him the shares without writing up any shareholder agreement. "We were stupid about that," admits Notley. "We were terribly nave and distracted by what we needed to do ourselves. Everything was by his guidance." Fridge's suggestion that he be called president barely registered with them. "They didn't care what Fridge called himself," says Eric Shaw, Transworld's lawyer. Mackarness assessed Fridge, who's also British, as a quiet, good worker. "He didn't put a foot wrong," she says. "He was exactly the sort of person we had hoped to find. He wasn't a personality. The fact that he was a rather boring, dry little Brit suited us. We had far too many personalities."

And far too many shareholders. Or so Fridge said, as he explained to the founders why it made sense for him to buy out some other minority stakeholders, including Mackarness's stepmother. It was all part of cleaning up the business, the founders figured. Between March and June, Fridge had, in addition to the 20% equity stake he received in lieu of salary, invested an additional $7,000, raising his holdings to 29.6%. That left Mackarness with 19.3%, Notley with 9.2%, Swire with 15.7%, and Morris with 26.2%. It never bothered them that Fridge had rapidly become the single-largest shareholder. Quite the contrary. "We were willing to part with part of the company in return for his getting it on track," says Mackarness. In appreciation for his first 20% stake, Fridge gave them a handsome clock that kept time internationally, says Mackarness, who claims she later found it charged to the company. Then, after Mackarness and Notley revealed their plans to separate in May 1994, Fridge awarded them and himself a $2,000 bonus each. "He said it was to help us with our separation and to get apartments," says Mackarness. "He used his to buy shares."

In addition to sharing equity, the founders shared with Fridge something else they had kept to themselves: their ambitions for Transworld. "We were really impressed with how clearly he saw the potential, despite all the bumps," says Notley, who told Fridge about how he planned to expand around the country and overseas. Eager to keep Fridge's interest, Morris says, "Christopher contributed to enticing Neville by saying what a wonderful prospect there was for this business." Mackarness agrees. "Chris, in his very well-meaning way, told Fridge everything that we planned to do. He said, 'I'm going to make it like the Jazzercize of linguistics and put Transworld schools all around the states.' "

It didn't seem impossible. In the summer of 1994 an article about their industry appeared in the San Francisco Chronicle. It featured a Transworld graduate who had worked in three countries and now taught at the school. Calls from prospective students began pouring in. "It did a huge amount for the school," says Mackarness. "It was the first significant press we had."

As Fridge cast his M.B.A.-trained eyes over the books, he reached this conclusion: Notley was diverting company funds, operating a secret bank account, and destroying or hiding corporate records.

Or so he told Swire, when he presented his findings during a phone call on June 22. "He made a case to me to oust Chris," says Swire. "I saw things improving in the school. So I said I would back him on that." Fridge also asked Swire to persuade fellow shareholder Morris to sell his 26.2% stake. Swire agreed and called Morris without saying a word to the founders. Happy to recover his investment, Morris sold Fridge 26.2% of the company. "It was like Christmas," Morris says. Swire, anticipating what the deal might mean to Transworld's founders, says he set up a safety provision. He claims he asked Fridge to agree in writing that he would immediately offer Mackarness the necessary shares to make her the majority shareholder. Fridge offered her the shares. Mackarness agreed to buy them, but they were never transferred. "I didn't really have all the facts," admits Swire. "It was an error, but at the time, based on what I knew about Neville, he appeared to be the best source of information for what was going on in the school."

Employees, too, saw Fridge as credible. Earlier, on June 22, Michael Fix, Notley's assistant, brought Fridge a letter Notley had written. In it, Notley asked for fees from a placement agent in Korea, requesting that the checks be made out to him. Fix also discovered a cashier's check made out to Notley that hadn't yet been deposited into a separate banking account. "My understanding was that Neville, as the president of the company, the person who cosigned my paychecks, who had also signed my employment agreement, was the person I was supposed to answer to," says Fix. Later, Notley would claim, "I am not computer literate and therefore am unable to access even basic company information." Says Swire: "I don't think he was being nefarious or underhanded. I think he was operating in a way he knew how to operate."

As was Fridge, apparently. On June 24, two days after he had acquired a controlling interest in the company, Fridge took his most decisive action to date. Notley had left the school early, complaining that he didn't feel well. According to a sworn statement Fridge would later file in court, he immediately ordered Fix to confiscate some of Notley's personal files and hire a locksmith. Fridge then posted a security guard to keep Notley out of the building. The guard had a photograph of Notley, in case Notley tried to return. "It was like the movie Wall Street," says Mackarness. "I told my brother in England that I didn't know what was going on. He said, 'I'll tell you what this is: it's corporate buggery; get yourself a lawyer." She did, but not soon enough. On July 8, Fridge held an emergency shareholder meeting, appointing his own board of directors and firing Mackarness. Four days later, Mackarness froze the company's bank account. Fridge then obtained a restraining order, barring both Mackarness and Notley from entering the school. It was set aside when the court determined that only Mackarness possessed the credentials necessary to run the school. Over the next 14 weeks, each side sued the other. Inside Transworld, Mackarness and Fridge jointly ran the school, as their lawyers advised. "It got unpleasant at that point," says teacher Carolyn McRae. "He was trying to pull her name down to advance himself."

Despite their warm feelings for the couple, many employees concluded that Fridge was more competent to run the business. He started meeting payroll, so employees didn't have to delay cashing checks. "He had an aura of credibility about him that made him seem like the better guy to run the business," says Shaw.

Broke and unable to afford a prolonged court battle, Mackarness and Notley settled out of court as quickly as possible, which meant forgoing a noncompete agreement. Still, after running up $43,000 in legal fees and spending $40,000 to buy Fridge's shares back, they had their school back as of September 23. Now divorced, they tried to rebuild their program by expanding--and escaping--to Prague. Last September they gave up and filed Chapter 7 bankruptcy, liquidating their assets. Notley remains in Prague. Mackarness, who is unemployed, resides in San Francisco.

Fridge wasted no time getting back into the industry. Shortly after settling with Mackarness and Notley, he opened New World Teachers. A number of Transworld staffers went with him. Kane, who visited both schools while researching his book, notes, "New World Teachers was a photocopy of what I had just seen over at the other place." Mackarness claims that both the curriculum and the marketing materials of New World Teachers borrow too heavily from Transworld. "It looked like New World Teachers was using her curriculum," agrees Kane.

When you enter New World Teachers, it's hard to miss the engraved elevator doors. They portray pioneers bearing flags labeled "The Spirit of the West." A few floors above, Fridge sits at his desk, a cheap plywood school table. Though he refuses to discuss Transworld, he expounds on the demand for overseas English-language instructors.

Around the corner, Sue Mackarness sits in a cafe, smoking a long, thin Capri cigarette. She's never been inside the school where five of her former employees run a business using a curriculum she insists is hers. If she could visit, she would see remnants of Transworld Teachers. Pictures of smiling graduates line the halls. Huge maps plaster the walls. In one classroom, a graduate of Transworld critiques a teacher trainee. She is writing furiously as the trainee tries to coax a group of immigrants to join in the same kind of role-playing exercise Mackarness used.

Former Transworld employees eagerly discuss the challenges of running a new company, having been instructed not to talk about their former employer. Robin Niemeyer and Suzanne Mankin hired all the trainers at New World--something they didn't get to do at Transworld. They also hold board seats. "It's the first time I've been in upper management and have a say in the direction of a company," says Niemeyer. "That's exciting."

Recounting the past, Mackarness chooses her words carefully, ever the patient teacher. She seems composed, apparently no longer enraged by the loss of her company. "I have been in the industry 24 years, and I expect to be in it for the next 24," she says. Her brown eyes twinkle at the absurdity of everything that happened. "It had its comical moments," she says. "The whole cast of characters was such a horror." She picks apart every mistake she and her ex-husband made: not tracking expenses, getting too close to employees. Understandably, she saves the harshest criticism for Fridge, the business manager who was supposed to save them. In retrospect, she says, they should have seen what was coming. "But when you're desperate," she adds, "you don't look at red flags."

Stephanie Gruner is a staff writer at Inc.


Resources

Few small-business owners will fail to recognize at least some aspect of their entrepreneurial selves in Michael E. Gerber's The E-Myth Revisited (HarperBusiness, 800-331-3761, 1995, $15). The easy-to-read follow-up to Gerber's first book, The E-Myth, illustrates various entrepreneurial personality types and demonstrates how founders of growing companies often destroy their own businesses.

Convinced you should share equity with employees? Call your lawyer first. Then consider adding these legal references to your library: Start-up Companies: Planning, Financing and Operating the Successful Business, by Richard D. Harroch (Law Journal Seminars-Press, 800-888-8300, 1985, updated through 1996, $149), is a two-volume loose-leaf guide designed for both lawyers and entrepreneurs. It's updated twice a year and includes detailed legal guidance covering everything from incorporating your company to issuing stock. It also includes sample forms, such as a restricted stock-purchase agreement for employees. For a simpler legal reference book about documenting key business decisions like issuing stock, check out Taking Care of Your Corporation, Volume 2: Key Corporate Decisions Made Easy, by Anthony Mancuso (Nolo Press, 800-992-6656, 1995, $39.95). It comes with a computer disk of sample forms, such as stock-issuance resolutions. Also, the National Center for Employee Ownership, in Oakland, Calif., is coming out with a revised edition of its book Equity Based Compensation Programs. For $35, it gives both legal and practical advice about various types of nonqualified stock plans, such as phantom stock. Call the center at 510-272-9461, or check out its Web site.

TOM KANE, Worldwide Teachers, 266 Beacon St., Boston, MA 02116; 617-262-5722 72

NEW WORLD TEACHERS, Neville Fridge, 605 Market St., Suite 800, San Francisco, CA 94105; 415-546-5200 72

CHRISTOPHER NOTLEY, International TEFL Certificate, Spanielova 1292, 163 00 Prague 6 - Repy II, Czech Republic; (42 2) 301 9784 72

Last updated: Apr 1, 1997




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