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Tale of two earnouts Featured

10:32am EDT July 21, 2004
Joe Hieronimus and a partner started Robbins Communications, a telecommunications networking business, in 1978 in a basement with virtually no start-up capital.

During the 1980s, Robbins Communications opened branches in five additional cities and made the Inc 500 three years running.

A low-cost start-up in a rapidly growing industry looks, at first blush, like a venture bound for glowing success. But as Robbins Communications sustained growth at 50 percent a year and more during the 1980s, by 1988, its partners found they had a funding crunch.

"One of the things we ran across, because we were growing quickly, was the realization that at some point in the game we were going to run out of the ability to finance our growth," says Hieronimus, who is now vice president of ISR Solutions Inc., a Chantilly, Va.-based business that, in March, acquired the COMM Group, a systems and network integration company formed by Hieronimus in 1997, several years after the sale of Robbins Communications.

"Because we were a growth-oriented business, every year we were compromising some of our earnings because we were making investments that would pay dividends next year or the year after or in future years," says Hieronimus.

Robbins Communications looked at several options to raise capital to fund its growth, including venture capital, an IPO and a leveraged ESOP, but all had substantial drawbacks. Ultimately, they decided to seek out an acquisition partner that would allow them to realize the value of the business they had built while bringing in needed capital for growth.

A New York City-based public company in the construction business, JWP Inc., wanted to build a national communications network company. JWP made an offer that included restricted stock, a short-term note, an increased compensation package and employment agreement for the partners and a multiyear earnout agreement that Hieronimus says helped to seal the deal.

The earnout was structured to reward Hieronimus and his partners with a payment each year when the company's performance exceeded a predetermined level. It looked like a good deal, but they found that their new owner had little incentive to provide assistance that would allow the company to reach those financial goals. To make matters worse, Hieronimus found that the annual renegotiation of the earnout agreement usually ended up in litigation.

JWP ultimately fell into bankruptcy, while the company that started as Robbins Communications grew to 17 branches and $70 million in annual revenue. It was bought and sold several times until it was acquired by Black Box Corp.

When Hieronimus and his partners decided that it was time to sell their next venture, the COMM Group, they found a wide gap between what they thought the company was worth and the valuation by ISR, the buyer.. They closed the difference with an earnout agreement, but with a much shorter term than they had agreed to with JWP. COMM Group's partners also received equity in ISR, giving them an opportunity to recover some of the potential value of the COMM Group that wasn't realized with the sale. And, ISR has brought several national projects to the former COMM Group, with clients that include the Federal Reserve and Ernst & Young.

As Hieronimus learned in the Robbins Communications deal, earnouts can help close deals in which the buyer and seller have different views of a company's valuation, but they can pose problems if they aren't carefully structured.

Says Hieronimus: "Although it was the key enabler to get the deal done (and) it was a significant component of the transaction, one of the first things we learned was they can be very divisive instruments." How to reach: The COMM Group Inc., www.comm-grp.com