The Anatomy of a Sale--Ours

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We arrived at Brodsky's office on the Brooklyn side of the East River at about 11:30 a.m. on May 25, scarcely 24 hours after the official announcement of the sale. It was a gorgeous day, and the view from Brodsky's window of the boats on the river and Manhattan beyond was stunning. For the next two hours or so, the four of us talked about buying Inc. I should say Koten, Brodsky, and Kaplan talked about it. I mostly listened. Pretty soon, certain things became clear.

To begin with, we realized that we would not be able to do a leveraged buyout. Buying a business through an LBO is like buying a house: You come up with a down payment and borrow the rest. As you pay down the debt, using the company's cash flow, the value of your equity increases, often dramatically. That's how a lot of people got rich in the 1980s. But it's all contingent upon your ability to borrow the money in the first place. In this case, Koten estimated that the magazine would go for about $30 million. Inc. simply didn't have enough physical assets or cash flow to support the amount of debt that an LBO would require. At the time, its EBITDA (earnings before interest, taxes, depreciation, and amortization) was negative if you included G+J USA's corporate allocations and $3.4 million if you didn't.

So if management intended to bid, it would have to ally itself with an individual or a private equity firm willing to put up the capital, which was a different ball game. For one thing, the managers' stake in the outcome would be small—perhaps as little as 10% of the company's eventual market value, and much less if they weren't able to build the business fast enough to meet the investor's minimum requirements for return on investment. Even if they did pull it off, they would simply be postponing the sale of the magazine, since the investor would likely want to cash out in a few years. Most investors want to make money, after all, not run magazines.

Brodsky and Kaplan took all this in and recognized that Koten might have better options. They encouraged him to consider all the proposals that came his way. He was in a strong position, they noted, because Inc. was stable and profitable on an operating basis. Accordingly, most potential buyers would want him to stay. Brodsky urged him to keep an open mind. "That was a very important message," Koten said a few weeks later. "I realized that you couldn't predict how things would go, so you shouldn't make a rigid commitment to one particular idea about how things ought to work out. You can't control a process like this, but you can be a part of it."

Running the Numbers

In fact, there were other reasons a management buyout was unlikely, as became evident that evening when four senior managers got together to discuss the possibility. The participants were Koten, Byrne, Denson, and Inc. publisher Lee Jones. As they sat at Harry's Bar in the New York Helmsley Hotel on 42nd Street, Denson expressed skepticism that a buyout could be put together on such short notice. Even if management could do it, he wasn't sure it would be worth the effort. He said he knew the kind of return private equity firms would be looking for—about 30% annually over five years. If a firm bought the magazines for $30 million, it would want to sell them for $110 million in 2010, which meant they would have to be generating about $10 million in EBITDA by then. That would be possible only if the management and staff focused single-mindedly on maximizing profit. No longer, for example, could a management-owned company continue to cover Fast Company's losses. Byrne and the magazine's publisher, Matt Barba, would have to come up with a radical plan—or preside over the magazine's closing. Byrne didn't say much, but the pained expression on his face spoke volumes.

Meanwhile, Jones was running some numbers in his head, and they weren't adding up. If the equity guys wanted a 30% annual return, what would be left for management? Would it even work to do a buyout with so many people—these four plus, presumably, Barba and Ed Sussman, who runs the Web operations? Jones had his doubts. Koten shared them, but he'd come away from the meeting in Brooklyn convinced that they should try anyway. After all, nobody knew what the ultimate sale price would be. There was always a possibility that G+J wouldn't be able to pull off the sale in the agreed-upon time, in which case Meredith would wind up with the magazines, wanting only to get back what it had paid for them. "Look," Koten said, "we've got an opportunity that's landed in our laps. We may have a slim chance of succeeding, but if we don't give it a shot, we're going to kick ourselves a month or two from now when somebody buys this thing for a price we probably could have gotten to."

"That's absolutely right," said Denson.

But attempting a management buyout also raised ethical and legal issues, since all of the participants in the meeting believed they had a contractual responsibility to see that the fiduciary interests of the G+J parent company and its shareholders were met. So the managers came up with some guidelines for themselves. They agreed they could do anything that would have the effect of encouraging more and higher bids. They couldn't discourage anyone, nor could they provide inaccurate information that would make it harder for G+J to achieve the best possible price.

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Bo Burlingham

Burlingham joined Inc. in 1983. An editor at large, he is the author of Small Giants: Companies That Choose to Be Great Instead of Big. The book was a finalist for the Financial Times/Goldman Sachs Business Book of the Year Award in 2006. Burlingham is also the co-author with Norm Brodsky of The Knack; and the co-author with Jack Stack of The Great Game of Business and A Stake in the Outcome.

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