Canadian-based Cumberland Entertainment (a pseudonym for a real venture) had done very well for itself by finding and exploiting a niche market in North American music distribution. But major US clients had started producing their own titles, and were now direct competitors. What was worse, distributors had also started focussing on lower-end products from other suppliers. Cumberland's modus operandi was suddenly unsustainable.
CEO Tom Smith felt the only sensible course of action was for Cumberland to take over the distribution of its own products, both in order to defend its market position and to ensure higher margins. But this was a risky manoeuvre, and would demand substantial capital. The company had three choices: private equity, bank financing, or organic growth.
Rudolph and Valeria Maag Fellow of Entrepreneurship Christoph Zott recounts the challenge Cumberland faced in ultimately making its decision. Even after lengthy negotiations, however, the initial agreement between management and investors proved quite unsatisfactory. The shareholder agreement failed to consider what should have been at the front of everyone's minds in an expansion stage equity deal - to wit, what might happen if any planned expansion did not materialise for whatever reasons?
With its acquisition strategy a failure, Cumberland found itself with more capital than it knew what to do with. After paying off its sizable debts, shareholders considered their options. Should the surplus simply be kept in the company, or would it be better to work out a new recapitalisation scheme and distribute it as dividends? (Cumberland's managers also pondered how best to serve their personal interests.)
Zott offers the reader a compelling case of how entrepreneur/venture capitalist/shareholder relationships can take on unexpected dynamics over time, especially when dealing with such a complex series of transactions. All players were naturally eager to come up with win-win scenarios, but clearly had their own, often competing objectives. The case also illustrates the challenges encountered in seeking out the right venture capital firm, in the light of certain not inconsiderable setbacks.
What would be the best course of action for all concerned? Should the investors exit the deal, and if so, how?