Case Study #1: Carve-Outsourcing™ the Internal Research Group of ”LeafDataCo.”
Founded in 1990 in response to the booming market for lawn and garden products in general and leaf blowers specifically, LeafDataCo is a publicly held provider of market research data and analysis for the leaf blower market.
The firm is named, of course, for its founder, Phillip Leafdata, who retired in 2003 following the IPO of the firm on a national exchange. Contrary to popular opinion, Jessica Dataco, the firm’s new President, is not related to the founder in any way, nor does she hold a significant equity interest in the firm.
The firm is located in a small town environment and is a major employer in the region. The ebb and flow of the economic tides have a direct impact on the local perception of LeafDataCo as an employer and good corporate citizen.
The leaf blower market is a broad and fragmented field composed of a variety of consumers of market research data ranging from highly specific and customized reports to more general and static market indices. Five major providers of leaf blower market research compete with LeafDataCo.
Concerned by the high internal costs of producing custom market research and the difficulty in creating recurring revenue streams from such products, LeafDataCo elects in 2005 to shift its strategy to focus on the more commoditized and lower production cost, general market indices segment of the business. Now a public company, the overall margins of the firm, driven primarily by the general market research business, are being dragged down by the custom market research unit’s higher costs and putting pressure on LeafDataCo’s stock price. This necessarily entails disposing of the firm’s custom leaf blower market research arm, a unit composed of some 250 employees, some with decade long histories with the firm.
The unit itself, primarily run as an internal resource for LeafDataCo, has never been extensively marketed to customers, lacks the consummate organic marketing expertise, is not a stand-alone unit, and has never been run on anything other than a ”break even” structure internally. LeafDataCo, now focused on the much more lucrative commodity research business, does not, therefore, have the time or internal resources to develop marketing expertise and strategy for the unit.
Any consideration of a sale of the custom research unit is torpedoed by concerns from the Board of Directors of LeafDataCo that the highly proprietary nature of the custom research unit’s products make tendering it to a third party or permitting one of the firm’s competitors to acquire the unit a non-starter. Accordingly, the Board begins discussions with respect to closing the unit entirely. Key in this decision is the concern by the Board that the auction process alone would risk the leakage of critical business data to competitors.
Several directors point out that, given the strict non-compete clauses in key employee agreements precluding employees of the custom market research unit from seeking work in the industry if they are laid off, downsizing will be political dynamite for the firm. Waiving these clauses, however, raises the same risk of data leakage as a sale. Even in the face of these concerns, however, LeafDataCo’s bankers point out that the economic costs of closing are far outweighed by the benefits increased margins will have on the firm’s stock price.
Having worked before with Catalyst, however, one of LeafDataCo’s outside counsels suggests that a discussion with Catalyst might be beneficial in exploring non-conventional options. Jessica Dataco is dispatched to meet with Catalyst and report back to the Board on her findings.
Faced with the situation, Catalyst suggests several alternatives during the initial meeting with Ms. Dataco, the most attractive of which entails the sale of the custom research unit to Catalyst with a multi-year service agreement back to LeafDataCo providing continued access to high-quality custom market research.
Because Catalyst is beholden to no traditional Limited Partner or Investment Committee things progress quickly. Catalyst calls an emergency partnership meeting the same day as the meeting with Ms. Dataco and within 48 hours, Catalyst has obtained internal authorization for the investment and develops a general structure authorized by the partnership that permits the existing custom research employees to maintain their current benefits package with minimal changes, participate in a new equity sharing plan in the new entity, and align employee and new management incentives with the new unit.
Catalyst also develops a marketing plan to grow sales and marketing resources internally in the new entity and put it on self-sustainable footing quickly. This is coupled with a concrete investment plan to develop back office and support functions to permit the firm to quickly evolve into a stand-alone entity.
Certain accounting treatments (namely FIN 46) which might have required consolidated reporting if the new spin-off looked like a ”special purpose entity” are addressed in this fashion.
Initial personnel due diligence into the customer market research group reveals both that minimal layoffs would be required and that a number of individuals possess management potential, but that a significant internal development effort will be required to realize these potentials.
During the early due diligence process, Catalyst spends significant time with the employees eliciting their hopes and desires as well as providing a window into what life as an independent Catalyst subsidiary is like. Catalyst takes pains to convey the importance of employee satisfaction and empowerment within the Catalyst portfolio. Employees are reminded that while they were once just a small unit of a public company, under a Catalyst umbrella they will suddenly be ”the center of the world” again. The proposed equity and/or profit sharing plans, linked to firm performance, help improve morale and internal support for the transaction. Before long, the vicious rumors about a ”sale” and ”layoffs” are mostly under control.
Finally, Catalyst prepares a rapid transaction schedule, anticipating an 11 week closing timetable and the appointment of Catalyst Operating Executives as the interim senior management team for the new entity.
This solution presents LeafDataCo with several distinct advantages over the other alternatives originally considered by the Board:
1. The cost center of the custom research group is removed from the books of LeafDataCo entirely and cleanly.
2. Access to the core product set, a popular offering despite its low margins, is maintained for LeafDataCo, preventing customer alienation or the loss of ”one stop shop” market research status for LeafDataCo.
3. A quick disposition, allowing the next or following quarterly report to carry the sale announcement thereby avoiding a protracted ”limbo” period and all the attendant distractions such a period creates.
4. LeafDataCo will not have to endure the reputational blow of laying off loyal employees, who will instead be able to take direct part in developing their efforts into a new product line under Catalyst’s guidance. A press release announcing the much more positively received ”zero-layoff” sale and continued partnership of the two firms is prepared.
5. LeafDataCo will book the transaction as a sale and realize a variety of monetary gains.
Catalyst is given the go-ahead and within 9 weeks (2 weeks ahead of schedule) the transaction is consummated.
As with all transactions we contemplate, the three key features of Catalyst sponsored transactions provide the seller with distinct benefits in this case:
Speed: In this case Catalyst was able to develop a structure, perform due diligence and close a transaction in a quick 9 weeks. The result was a rapid disposition for the unit and significant benefits for the seller.
Certainty: Both the seller and the unit employees were able to move quickly and decisively to commit to a course of action owing to the direct and consistent plan developed by the Catalyst team.
Integrity: Because Catalyst concentrates on the interests of the many stakeholders in a transaction, and because we ”say what we mean and do what we say,” both the seller and the unit employees were able to proceed with confidence in completing a transaction where Catalyst was able to act as a ”white knight.”