By Stuart Morley

Bob was the president of Drill Inc., a North Bay based custom mining drill rig manufacturer. 

He’s inherited the business from his father, Donald, who had started it a long time ago with a vision to bring a new cost-effective drilling rig to the Canadian market.

Donald had hoped Bob would continue the business to support the family for several generations. But the son’s focus was on selling and then investing his wealth so he could travel the world. Donald used to joke that he was a missionary when it came to building Drill Inc. while Bob seemed to act more like a mercenary, treating the business as an ATM to fund his lifestyle.

When Donald retired, he gave the business to Bob, giving him 20% of the shares, while some proceeds of the sale went to his daughters. Donald’s brother, Allan, bought the remaining shares using the “family and friends” fund established by the family office for which he managed investments. 

Over the years, the two brothers would discuss the business when the latter and his family visited Donald in February to go snowmobiling and ice fishing. Both brothers were sports fans and used to compare business with sports. Bob inherited their perspective of seeing business as a game with winners and losers, so he spent a lot of time comparing Drill Inc. with competitors.

He regularly attended lunches and sporting events with suppliers to gain valuable market insights. Bob also attended industry conferences and hired consultants to help undertake market research to anticipate changes when he prepared his three-year strategic plan for Drill Inc. 

That’s how he continued to grow Drill Inc. until revenues reached a peak of about $40 million with operating profits (also called EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization) of about $4 million. Several competitors approached Bob to pitch him their businesses, but he declined. He remained focused on building Drill Inc., one customer at a time. Bob also ignored offers from large competitors because the value they were offering wouldn’t fulfill his retirement goals. 

He achieved business growth by offering custom drill solutions to clients. Allan cautioned Bob that where customization meant higher prices and a better gross margin, it also lowered manufacturing productivity due to all the custom changes and the need to keep a large inventory of unique spare parts. Bob believed the higher prices were more than enough to offset these downsides, but this meant he needed a significant increase in inventory and therefore Drill Inc. needed a $10 million loan from the bank to fund it. At the time, this was easy to arrange because the business was so profitable. 

As the industry was very cyclical, the business was valued at four times EBITDA, which meant it was worth $16 million (4 x $4 million EBITDA = $16 million). Therefore, Bob’s equity was $3.2 million (20% of $16 million), before deducting any business debt. 

However, during the next down cycle the revenues dropped to $10 million. The company could generally survive these big swings because it operated with high margins, making it easy to cut costs But this time, although Bob was able to reduce the costs so the business could break even, he also had to pay back the $10 million loan. 

The bank was not happy when Drill Inc. was breaking even, because it triggered the loan agreement rules, which dictated debt repayment, technically making the company bankrupt. The bank offered to continue to support the business if Bob asked his shareholders to put an additional $1 million of equity into the business. 

When Bob asked Allan to arrange the additional equity, Allan was so upset at this situation that he decided he and his other shareholders would not fund any additional equity the bank demanded to help Drill Inc.

Dean, the bank’s special loans department manager, believed Drill Inc. was worth saving, as it was a significant employer in a rural community. He knew it was a cyclical industry, so the business would become profitable again.

Dean suggested that Bob should invest $1 million into the business. This way, Drill Inc. would have the cashflow to service the loan and cover costs, until the next upward cycle. However, when Bob told Dean he did not have the money, the banker suggested either selling the business or talking to his friend, Paul who worked for an investment firm that financed turnarounds.

Bob did not want to sell the business just yet, so he agreed to talk to Paul. After several meetings, the two signed an interim agreement, making Paul the interface with the bank and business overseer. Low business profitability meant the bank felt Bob’s view as a shareholder was no longer valid. Since Paul’s firm was putting in new equity as shareholder, the bank saw Paul’s firm as the de facto owners and trusted his view of things as Paul’s firm was taking the biggest financial risk.

Paul and his staff studied Drill Inc.’s operations and discovered that the numbers hadn’t been accurately reported to the bank. They streamlined operations and helped Bob find a new chief financial officer. Paul also worked with engineering staff to decrease the drill customizations, reducing the need for a large inventory of unique parts.

Then he convinced Bob to take a pay cut in return for additional equity in future.

Paul also negotiated with the bank to reduce the loan from $10 million down to $2 million on the condition that his firm would put in new equity. The collateral for the bank loan was the $15 million inventory, which would be scrap if the business were liquidated. 

Paul’s firm was getting ready to put up $1 million in new equity when Allan called to say that he and the other shareholders wanted to put up some of the money, rather than take a dilution from 80% of the equity. After several rounds of negotiations, they agreed on a formula to put up $1 million of new equity in the business.

Bob had to stay out of this because his wealth tied up in the business and the luxurious home he owned in North Bay. However, he was able to negotiate an equity increase to 37.5% and the option to buy out other shareholders once the business reached the prior profitability.

When the $1 million was added to the business and the debt had been cut to $2 million, the restructured assets balance sheet was reduced from $16 million to $3 million, which was offset by $2 million in bank debt and equity of $1 million.

It took about three years for the business to reach revenues of $27 million. With higher margins, the EBITDA was back to $4 million. As per the agreement, Drill Inc. was valued at $16 million (4 x $4 million), the same as the equity in the business since there was no debt remaining.

This meant that Bob’s equity was now worth about $6 million ($16 million x 37.5%).

Bob now had to borrow $10 million to buy out the other shareholders. He invited several banks to bid, eventually selecting a different institute than the one that had put Drill Inc. in special loans. 

Paul’s firm negotiated a 20% equity position for putting up that much of the additional $1 million in equity, as well as providing interim management of Drill Inc. and negotiating with the bank. 

Before Drill Inc. got into trouble, the family office shareholders owned 80% of the equity in a business that had $40 million in revenues and was worth about $16 million before deducting $10 million in debt ($16 million – $10 million debt = $6 million x 80%). The equity at that time was worth $4.8 million and now, they owned 42.5% of the equity, worth $6.8 million for a business with revenues of $27 million. 

Paul thought Allan and the family office shareholders would be happy because their shares were valued at $2 million more than the best year before the restructuring. Plus, If Paul’s firm had not done the deal, Drill Inc. would have been sold or wound up with the family office shareholders receiving nothing.

While these other shareholders were happy that Paul’s firm received 20% equity when the deal was done, they were less so inclined three years later, because they thought Paul’s payout was excessive compared to their payout. 

As Allan had lost face with his clients who invested with him in Drill Inc., he persuaded them to take the payout. Bob now owned 100% of Drill Inc. By this time Donald had died and while Allan attended the funeral, he no longer talked to Bob. The Drill Inc. owner’s parting comment to Paul was that his father had perceived him as a mercenary. But in Bob’s eyes, Paul was the mercenary looking to make as much money in a few years, whereas Bob had become the missionary by continuing the business. 

A few years later Paul read an article about how Bob was a great entrepreneur who had built and sold Drill Inc. to a large European company for $50 million and retired.  Bob was quoted as saying the way to success is to focus on building one business to sell!

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