Chapter 54: Proper Valuation

April 23, 1995, Chicago, Illinois

On Sunday morning, Jessica, Kara, Birgit, and I walked to Kenwood Academy where Will attended school. He and a teacher were waiting inside a set of glass doors. They let us in, and Mr. Hannity directed us to the gym. Sensei Jim and several other students were there waiting, and after bowing to Sensei Jim, I went to talk with Felipe, accompanied by Birgit.

“Hi, Mr. Felipe!” Birgit said brightly.

“Hello, «Tesoro»! How are you today?”

“It’s cold outside!”

“I agree! It makes me want to go back to Florida!”

“You’re leaving?” she asked, sounding sad.

“Oh no, «Tesoro»! I just meant I don’t like the cold.”

“I never asked, but do you have family?” I asked.

“All grown,” he said. “It’s just me. I have grandkids, but they’re all in Florida or the Carolinas.”

“Sensei Steve?” Marcia said from just behind me. “Do you have a minute?”

“Excuse me, Felipe,” I said.

He nodded and I turned to Marcia.

“What’s up?”

“My mom asked me about the scoring for the tournament and I had no idea how it worked. Do you know?”

“Sure. I guess you haven’t received your registration packet yet, because it will all be explained in there. You should have it in the next few days, I’m sure. I can explain, if you want.”

“Please. She bugged me about it yesterday and insisted I ask today.”

“Is she pressuring you?” I asked.

“No. She’s just excited!”

I nodded, “OK. Anyway, the kata competition is pretty simple. In your registration packet will be a list of ten kata. When it’s your turn to compete, you’ll be asked to do five of those ten, with a completely random selection from that list. They use a 10-sided die so there’s no favoritism. For each one, you start with a hundred points, and then deductions are made based on mistakes which can be about accuracy or about being too mechanical. That’s why we’ve worked on you being fluid in your movements, as well as being technically correct.

“For sparring, there are 1000 points available. If you win a round, you get the maximum points for that round, with deductions for each point you gave up, and each segment you lose. The maximum points for each round depend on how many rounds there are, with the last round worth more than the first. So your goal is to yield as few points as possible, and win each round 3-0, 3-0.

“Once the sparring competition is completed, they take the points from kata and add them to the sparring points to achieve a final score. The person with the highest score wins the overall championship, UNLESS someone wins both the sparring and kata competitions outright. That’s only happened a few times according to Sensei Ichirou. It almost always comes down to points.”

“So it’s possible to lose the sparring competition and still be overall champ?”

“Possible, but not likely, given sparring is worth twice as much. I suppose you could finish second in sparring and win kata by enough to make up the difference. The overall champions when I judged won the sparring competition and finished in the top three or four in kata.”

“There’s one champion for each age group?”

“Yes. Basically it’s elementary school, High School, College, and adult, but the ages don’t break down exactly. The tournament champion is the highest scoring black belt. It’s possible, for example, for you to outscore them, but if you think about it, a head-to-head sparring competition would be no contest for them.”

Marcia laughed, “TELL me about it!”

“Our goal is for you to win both the sparring and kata competitions outright, making you citywide champion in your age group without worrying about points.”

“The kata that are on the list, do I know all of them?”

“I can’t imagine that you don’t. You know all the kata for your level, plus the four you would need for 3rd Kyu. When you get the list, we’ll know specifically what to practice, but I’m confident. You’re a good student.”

“And you’re a good teacher!”

“Thanks. It looks like they’re almost ready. Let’s go over by Sensei Jim.”

We walked over to where Sensei Jim and Mr. Hannity were standing. Sensei Jim called everyone to order and then the two of them explained what was going to happen. Once they finished, the filming began with Will, Birgit, Felipe and two other students breaking boards, followed by several sparring demonstrations at various belt levels, and finally by me, Martin, Kara, and Marcia demonstrating kata.

“What do you think?” Sensei Jim asked when we finished.

“I think it’s going to look great, especially the contrast between, say, Felipe and Birgit, who are both yellow belts, breaking boards. Will and Jolene sparring is another nice counterpoint, and the same with Marcia and Jessica.”

“Marcia is looking very good, Steve,” Jim said. “Both her sparring and her kata. I think you may have a winner on your hands.”

“I think so, too. She said her mom is hyped.”

“Not pressuring her, I hope.”

“Marcia said that wasn’t the case. I think her mom is just super-excited by how confident Marcia is.”

“Good. We want parents to encourage, not pressure.”

“I think we’re OK. Marcia’s always been straight with me and I asked her directly.”

“I have some other news for you.”

“Oh?”

“Jacquelyn called me last night. She passed her black belt test.”

“That’s awesome!”

“She said she tried to call you, but nobody picked up and she didn’t leave a message. She said she’s doing really well at Yale Law School.”

“I have no doubt about that.”

“Remember we’ll be filming during class this week.”

“When will the final video be available?”

“About a month. Mr. Hannity will give us a videotape master plus something he called ‘QuickTime’.”

I nodded, “That’s going to be a computer file that can be played by the ‘QuickTime’ player on a Mac or PC. We can put those on CD-ROM and distribute them to people who have a reader device on their computer. For everyone else, we need to duplicate the videotapes. The video store where I rent movies occasionally, offers duplication services.”

“Mr. Hannity said he has a friend who does it right here in Hyde Park. I wonder if it’s the same guy.”

“I’d go with whoever Mr. Hannity is recommending,” I said.

“That’s what I was thinking as well. See you tomorrow?”

I nodded, bowed, and then collected my family and headed home. When I arrived I found a message from Bo and Gina saying that they’d had a baby boy who they had named ‘Robert Peter’. I made a note to have flowers sent to her, shared the news with my wives, then headed upstairs to change into comfortable clothes.

April 26, 1995, Chicago, Illinois

“I guess we shouldn’t have said anything the other day,” Jon said at breakfast on Tuesday.

“The bomb explosion in California?”

“Yeah. The radio this morning said it was probably the Unabomber.”

“That’s what the Tribune said, too.”

“Do you think the two guys they arrested bombed that building in Oklahoma?”

“I talked to Pete, and while the Marshals service isn’t directly involved, he’s pretty sure the FBI got the right guys. I get the idea they’re looking for others, in addition to Timothy McVeigh and Terry Nichols.”

“Your hatred for government runs pretty deep, but you have to admit their response was horribly wrong.”

“I’m for limited government,” I said. “Blowing up federal buildings is going to get you exactly the OPPOSITE!”

“Speaking of the government, did you get your gun back?”

“No. It’s only been about ten days. I expected two weeks, at least. If they test-fired the gun already, and if it had matched, I wouldn’t be sitting here.”

“How could you get another gun so quickly? The same day?”

“I have all the necessary permits. I simply need to go to a licensed firearms dealer and I can get one the same day. Technically, I could do a private transfer with another citizen without any kind of check, but I wanted to make sure it was all kosher, lest I give the police any OTHER ideas.”

Jon shook his head, “Madness. Do you mind if I borrow Jessica’s car again today? It’s bloody cold out!”

I chuckled, “Whinging poms!”

“You have an Aussie working for you?”

“No, but I heard that when I was Down Under. I know some other ones, too! I think the Germans had the best one - Inselaffe!”

“Bloody Jerrys!” Jon laughed.

“What? ‘Island ape’ doesn’t suit you? How about rosbif or les goddams?”

“You Seppos are the worst!” Jon laughed.

“And on that note, this Yank needs to get to work! The keys are on the rack in the hallway next to your room where they usually are. And with the ‘ER Doc’ tag, you can park right next to the door, so your dainty self isn’t harmed by the Chicago winter.”

“It’s bloody Spring!”

“Only according to the position of the sun!”

I left the kitchen and went to find Jessica, Elyse, and Michelle for our drive to work. We dropped Jessica at the hospital, and then dropped Michelle and Elyse at the NIKA offices. I didn’t go in, instead heading to the Spurgeon Capital offices to meet with my sister to go over her findings. She was waiting in her office, with its tremendous view of Lake Michigan.

“Your office at NIKA won’t be anything like this,” I said as we hugged and went to sit on her couch.

“I think I’ll manage,” she laughed. “I won’t make as much money, either, but your nephew won’t starve on my salary at NIKA!”

“So what did you find?”

“Hang on a sec. Do you want coffee or tea?”

“Tea, please. Earl Grey or English Breakfast would be fine.”

Stephanie leaned forward and pressed a button on the phone, “Ernie, a pot of Earl Grey, please.”

“Coming right up, Mrs. Krajick!” came a very formal response.

“Give me a fucking break, Squirt!” I laughed when she released the intercom button. “NOBODY, and I mean NOBODY, uses formal addresses like that anyplace I’m in charge.”

“Samantha’s dad instituted that, and Samantha thinks it’s important because she and I are both really young.”

“So were all of us when we started NIKA!”

“It’s very different in an entrepreneurial environment. You’ve seen how things are here. Everyone wears formal business clothes - suits, skirt or pantsuits, or dresses.”

“I suppose, but I trust Bo because he’s smart, not because he wears a suit while he’s driving his spreadsheet!”

“When’s the last time you saw someone dressed casually in a bank? And I don’t mean customers. It’s about public perception. You should know that, big brother.”

“Sure, a public face. But in the office? Ernie wears a suit! Can you imagine me requiring Lucas to wear a suit? Or even a tie?”

“I’d pay money to see John Reynolds in a suit and tie!”

“I think he’d quit first, though he has started wearing more typical clothing. It kind of wears off on you. You remember Greg, right?”

“Sure. But your sales team wears suits and ties.”

“Public facing,” I said.

Ernie came in with a pot of tea, and I took note of his well-tailored suit. I knew Samantha paid him far more than her father had, so I suspected he could actually afford those suits.

“What do you think of the valuation?”

“It’s far too high,” I said. “But I bet they knew that.”

Stephanie nodded, “I’m sure they did. I didn’t find anything you would call a smoking gun. The main difference between NIKA and Lone Star is they pay out nearly all of their profits as dividends, rather than keeping a large cash reserve. They manage by using their credit line which slightly reduces their overall profitability, but isn’t anything out of the ordinary.

“Their bonus structure and commission structure aren’t as generous as yours, which allows the VC firm and the other shareholders to receive larger dividends. Their salary structure is, well, unstructured. There is no rhyme nor reason for who is paid what, and as best I can tell, it’s based on paying what it took to hire the person. And there’s a potential liability for you there.”

“Let me guess, the females on staff are paid less than the males.”

“Significantly so. Most of the programmers are male, but a very senior female programmer makes less than all of the mid-level male programmers. If she were to find out, she’d probably win her lawsuit. And if you buy the firm outright, you inherit that liability.”

“Wonderful. Any other nasty things like that?”

“They’ve settled several lawsuits with customers over the past five years. I don’t have any details, but you’ll want to review those settlements during due diligence. In addition, Brad Giesma and the two remaining founders have golden parachutes of six months’ salary. Finally, and of more concern is a lawsuit filed by one of the original founders who disagreed with the sale of a majority stake to the VC firm. That was settled as well.”

“Why is that a concern?”

“His shares were bought by the VC during the settlement, then used to make other stock grants, including to Brad Giesma. I don’t know enough to know if he could challenge the settlement based on our valuation. It’s something to discuss with Jamie and one of our attorneys who specializes in venture capital deals.”

“Do you know why they brought in the VC firm?”

“The two main founders wanted to cash out, as well as raise money to expand to Reno and the Raleigh-Durham area. The third one wanted the deal, but felt the original founders should keep control of the company.”

“Was it a good deal?” I asked.

“From everything I can see, it was. They expanded without taking on new debt, or running up their line of credit beyond their normal operating fluctuations. They turned a profit for that year, even discounting the cash infusion.”

“Any other red flags?”

“No. Their taxes are paid on time, their withholding deposits are made on time, and they’ve never been audited by the IRS. Everything checks out.”

“No issues with vendors or clients?”

“Not from the financial side. You’ll have to discover any other issues in due diligence.”

“What’s your bottom line?”

“It’s a solid firm and worth purchasing. The asking price is high, but we’ll get Bo to give us a realistic valuation based on sales trends, contract renewals, future profits, and the industry in general. That said, because you’re going to shed most of the expenses, you could afford to pay more and still come out way ahead.”

“What about the leases in Nevada and North Carolina?”

“Both expire at the end of this year, with five-year options.”

“Did you talk to anyone there beyond what you needed to for your audit?”

“Arthur Andersen always forbids any kind of socializing, so I didn’t do that out of habit. I did some shopping, had some very nice dinners on your tab, and otherwise just relaxed.”

“OK. Go ahead and speak to Bo and ask him to work up a valuation number. We need to make an offer by a week from Friday. I’ll need to present it to the board before then.”

“I can’t imagine it’ll take more than a couple of days.”

“Cool. I need to figure out how to defuse the possible lawsuit from the female programmer. If she’s any good, I could hire her, and her salary would be adjusted. And I’d do that before the deal closed, with permission from their board, and an agreement where she waived any claims against Lone Star.”

“Run that by Jamie and your employment expert. Some claims can’t be waived.”

“You’re full of good news, Squirt.”

I drained the last of the tea in my mug and stood up. We exchanged a hug and I headed back to the NIKA offices. I let Elyse know things were moving forward, but didn’t share any additional information, which I preferred to come in Stephanie’s official analysis, which I’d have by the end of the week.

Stephanie called me just after lunch to let me know Bo would have a valuation done by Friday afternoon and I asked Kimmy to schedule a Board of Directors meeting for Monday.

April 28, 1995, Chicago, Illinois

Late on Friday afternoon, I went to Spurgeon Capital to meet with Stephanie and Bo.

“This number is far more reasonable,” I said.

“Samantha said she has no issue with going ten percent over our valuation,” Stephanie said. “Beyond that, we’d all have to sit down and discuss it.”

“That makes sense. I think we’ll use ninety percent of Bo’s number as the offer target. And that’s total, including the side deal for the software. That lets me use as much as ten percent as an apparent sweetener for the software deal, and still gives me some room to move the bid up without going over Samantha’s funding limit.”

“I’d say that makes sense,” Bo said. “If push comes to shove, I’d support going over that ten percent limit which Samantha gave based on potential revenues and your ability to quickly cut costs. But you’d have to move quickly on that issue.”

I nodded, “I plan to. Squirt, what do you think about a thirty-day due diligence period?”

“It really depends on how much time you need to evaluate their operations and the software. Financially, I’m happy.”

“How will they distribute the proceeds of the sale?”

“That’s a good question. Everything will depend on the agreement the founders made with the VC. I didn’t see those contracts, but they aren’t particularly relevant to you. It’s very important that you write into your offer that they can’t access their line of credit nor can they incur any debt without your authorization. Probably set some limit so they can order office supplies, and that kind of thing with a purchase order, but not anything substantial.”

“What do you think? Make it $5000?”

“I’d say any expenditure except salaries, rents, and existing contractual payments which is over $5000,” Bo said. “You don’t want them playing any games. You also need to require the VC firm to indemnify you against any claims that arise for any actions on their part as of the first conversation you had with their President. And that’s the VC firm, not Lone Star. That way, if anyone plays any games or tries to pull a fast one, you have a claim against the VC firm.”

“Samantha said they’re reputable and straight-shooters.”

“They are, but you never know what one of the founders might do.”

“That’s how I’m going to handle the issue of the discriminatory pay,” I said. “We’ll sign a side agreement in which they indemnify NIKA against any claims for sex discrimination. If the female programmer is good, we’ll hire her and pay her a bonus in exchange for holding NIKA harmless for any actions by Lone Star. We’ll do that with anyone else we want to hire, and those contracts would be signed immediately before we close on the deal.”

“Did Elyse run a financial analysis?” Stephanie asked.

“A preliminary one based on keeping the support staff until the end of the year. We’d be running that part of the business in the red until the annual license agreements come due in November. That’s more or less what happened with BLS because of the way we all bill for support contracts. They didn’t have a unified due date the way we do, so we’ll get some income for the pro-rated contacts to sync them to our standard January to December contracts.”

“There will be some income for six months,” Stephanie observed.

“Yes, and based on your analysis, their first and second quarters are when the bulk of their contracts are paid. I’m not sure when they’re due, obviously.”

“What do you figure you’ll lose in terms of customers?”

“I think we’ll retain about eighty percent,” I said. “Assuming things go the way I expect. If they don’t, we’ll bail on the deal and I’ll turn Cindi and her team loose on the weakened competitor.”

“I’d bet the VC agrees to whatever terms you specify, and I suspect they’ll take somewhere around our valuation based on their initial investment. They’ll make a very nice return, in addition to the dividends that were already paid.”

“OK. I’m going to talk to the Board on Monday afternoon. I’d like you two to join us. Kimmy will get you the information to dial in.”