Leveraged buyouts, the acquisition of companies where the purchase price is paid primarily by borrowing, became increasingly common in the 1980s. Very often, existing management teams are invited to participate in a leveraged buyout by the acquirer. Occasionally, it is the management team themselves who initiate the transaction and in this variation the arrangement is a ‘management buyout’. One of the earliest large management buyouts occurred in 1919 and involved Henry Ford’s purchase of the entire outstanding stock of his Ford Motor Company.
Founding the Ford Motor Co.
Henry Ford was born in 1863, just ten miles west of the center of Detroit, Michigan. Prior to his automotive entrepreneurship, he established a small sawmill on his family’s farm and later worked as a machinist for the Edison Illuminating Company. In the 1890s, still in the early days of the automobile, he built two cars for himself and received encouragement from his employer’s founder, the inventor Thomas Edison. The Ford Motor Company would not be his first foray into business though. Ford had founded two earlier automobile companies, the Detroit Automobile Company and the Henry Ford Company and both ended in failure.
The first of these ventures, the Detroit Automobile Company, was formed in 1899. It would seem as though the company got off to a solid start; its early shareholders and lenders included the president of the Edison Illuminating Company, the mayor of Detroit William Maybury, a U.S. Senator, and other prominent businesspeople. However, these investors did not come to see eye to eye with Ford. The shareholders demanded the company focus on production while Ford was busy working on designs; Ford also resisted close board supervision. Finding their different perspectives irreconcilable, the company was dissolved in 1901.
Some of Ford’s backers were willing to give him a second chance. These investors in the Detroit Automobile Company stuck with Ford and funded his second attempt at building a car manufacturer, the Henry Ford Company. Nonetheless, this group of more patient backers still wanted Ford to proceed more quickly than he was prepared to. This company lasted just a few months when Ford again resisted board supervision and his investors’ hurriedness. In time, he would come to see the position of minority shareholder in his own firm as unacceptable. For his third try, he would strive to gain majority control of the company.
The Ford Motor Company was founded in 1903. For now, Henry Ford had accepted that he was better suited for design work than building cars at scale and choose to outsource the production of the first Ford cars to two Michigan brothers, Horace and John Dodge. They received the contract to build the first 650 vehicles for Ford. They also became shareholders in the company after Ford was late in making payments under their contract and could not pay the brothers in cash. They each held 5% of the company’s stock by 1908.
Dodge v. Ford
Despite giving up some ownership to the Dodge brothers, Ford became the company’s controlling shareholder, owning 585 of its 1000 shares then outstanding. This was partially the result of his buyouts of another early shareholder’s position, that of his early backer Alexander Young Malcomson. So, it would seem Ford was in firm control of his company. However, Ford was still legally required to protect all of his shareholders’ interests and so their minority positions in the company were relevant to the way he needed to manage it. This became especially pertinent after his relations with the Dodges worsened significantly in the 1910s.
In September 1916, Henry Ford received a letter from the Dodge brothers in which they threatened to sue him. Surely investors would be happy with the company’s performance. After all, production of the company’s Model T automobile had grown to a half a million cars that year and sales reached $200 million. The Dodge brothers’ minority ownership in Ford had returned more than $35 million since they obtained the shares shortly after the company was founded. They demanded more though. In their letter, the disgruntled shareholders demanded the company increase its dividend, arguing that the firm’s profits and cash position were not being adequately shared with its owners. They also accused Henry Ford of essentially ignoring his minority shareholders.
A lawsuit was launched by the brothers against Ford, demanding that the firm abandon plans to build a new factory at River Rouge, Michigan and return cash to its supposedly neglected shareholders. The brothers were not ordinary passive shareholders though. They had already lost the exclusive right to manufacture Fords after the company brought production in-house. As a result, they were in the process of marketing their own cars under a new firm created in 1913. The Dodges, though beneficiaries of Ford’s success were now threatened by it, giving them plenty of incentive to put up roadblocks in the way of Henry Ford’s plans.
The trial began in May 1917 and it seemed like an uphill fight for the Dodges. Courts weren’t keen on closely scrutinizing and intervening in business decisions where the dispute was so technical yet subjective in nature; judges accepted that they weren’t business executives. As long as the court believed that Ford’s decisions would at least plausibly maximize shareholder value, and would thus benefit the investors, there was nothing more Ford needed to prove. That said, there was a reason for his tense relations with so many past backers; Ford was not exactly on board with the principle of maximizing shareholder value.
During the court proceedings, Henry Ford described making money as merely incidental to the company’s mission and not the mission itself. Ford’s answers to the Dodges’ attorneys’ questions perhaps did more to help their cause than any hard evidence they could provide. Statements like that just mentioned led the trial court to rule in favor of the Dodge brothers in December that year. The Ford Motor Company was prohibiting from moving forward with its new River Rouge factory and the court ordered the payment of a special dividend of $19 million.
Buyout
The Michigan Supreme Court would later partially reverse the lower court’s decision in Dodge v. Ford Motor Co., but this did not come until 18 months later. In the end, Ford was allowed to build his River Rouge factory, which is still in operation today. Nonetheless, the litigation convinced him to gain full control of the company. Even minority shareholders were too problematic for Henry Ford and he also no longer needed their money as the company was by now very profitable. By the time of the Michigan Supreme Court decision, Ford was already working on buying out the company.
At very least, Ford would need to purchase the Dodges’ shares for $25 million, or $12,500 each for 2,000 shares, so to remove them from the company’s ownership. To accomplish this, he formed two new entities, Henry Ford & Son, Inc. in New York and the Eastern Holding Company in Delaware. Into these firms, Ford contributed his personal stock. Eastern Holding Company then changed its name to Ford Motor Company and made arrangements to buy out the remaining shares of the old Ford Motor Company in Michigan.
Financing
Between his offer to the Dodges and the other minority shareholders, Ford needed $75 million to purchase a total of 6,100 shares at the $12,500 price. This was also assuming he left the stock of one of the more trustworthy associates unpurchased, that of the then-mayor of Detroit, James Couzens. To finance the buyout of his minority shareholders, Eastern Holding Company obtained funds from a syndicate of banks led by Chase Securities Corporation. The syndicate also included Old Colony Trust of Boston, a bank since absorbed by Bank of America, and Bond and Goodwin of New York.
Ford had never borrowed in capital markets before; indeed, there is no record that Henry Ford had ever before taken out any loan at all. Even in the management of his personal finances, he avoided debt; never even taking on a home mortgage. The company built its now numerous factories by retaining its earnings and paying out less in dividends than it could afford to pay, the very business practice the Dodges aimed to stop.
Some $70 million in notes were issued in July 1919 to fund Ford’s buyout. This was essentially bridge financing, with Ford agreeing to redeem the entire issue within one year; the first $10 million was to be returned to investors in just three months. Technically, the entire issue took the form of a three-month note with up to three renewals. The banks also agreed to fund an extra $5 million upon Ford’s request subject to 15 days prior notice, bringing the entire transaction size to $75 million. The notes were issued at a discount of 5.5% annualized and the bankers received a fee of $750,000 or 1% of the face amount of the transaction.
In the end, Ford also ended up purchasing the shares of his friend, James Couzens. So, 8,300 shares were acquired in all, at a cumulative price of just over $105 million. This massive deal gave Henry Ford and his son Edsel 100% ownership of the company. However, as with all great buyouts, it is the aftermath of the share acquisition that matters most. The company was now more heavily indebted and business conditions were evolving quickly in the aftermath of the peace that ended the First World War. Shown below is the Ford Motor Company’s balance sheet after its debt issuance but before it had paid for all of the stock it acquired.
By 1920, American economic health was worsening amidst a post-war economic recession. The newly constituted Ford Motor Company had to cut prices, including a 31% price drop on the Model T. There was a lull in demand and inventories of unsold cars grew. It all came at the worst possible time. Rumors of financial trouble at the company abounded and bankers proposed extending new financing to the firm but Henry Ford was still keen on repaying its bridge financing in full with cash it could raise organically. To raise the mountain of cash needed to redeem the debt and in response to the economic contraction, Ford cut costs by reducing employee count and even selling some equipment. However, there was no chance this alone would be sufficient.
In the end, the firm also benefited from less obvious solutions to its pains. The company pushed much of its unsold inventory onto its dealers, essentially exporting their financing puzzle to their sales partners. The dealers had to take on loans to finance the unordered shipments which they were contractually obligated to buy from their manufacturer whether they wanted to or not. This maneuver alone raised $24.7 million for the company.
Further assistance came from the economic recession itself. The cooldown in business conditions, along with the end of the war, had taken strain off the country’s railway network which the company relied on to ship its cars to dealers. The reduction in vehicle shipping times from the cleared railway backlog also improved Ford’s balance sheet by converting more inventory in transit into cash. The effect of this amounted to an increase of $28 million in the company’s cash position. By the spring of 1921, conditions were once again improving and Ford was in sound health with cash on hand alone exceeding all of its debts.
Lesson
Leveraged buyouts, whether launched by a private equity firm, a large existing shareholder, or a management team, all involve the purchase of a target company’s stock using primarily debt financing. The profits of the acquired company provide the means to then repay the massive debts incurred in effecting the buyout. This is usually where events tend to deviate from the plan. Competitive pressure, economic deterioration, or other unforeseen events that can be withstood by a healthy firm can sink a heavily indebted one. Ford was afflicted by problems just after its management buyout, but it did manage to survive and without the injection of new outside capital either. In any case, the true final resolution of a leveraged buyout does not come until the debt is finally repaid or at least brought back to normal levels.
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Further Reading
1. Brinkley, Douglas. Wheels for the World: Henry Ford, His Company, and a Century of Progress, 1903-2003. Penguin Books, 2004.
2. “Ford Moto Co.” Moody’s Manual of Railroads and Corporation Securities, Poor’s Publishing Company, 1920, pp. 614–614.
3. “Ford Secures Full Control of Auto Plant.” New York Tribune, 12 July 1919, pp. 1–3.
4. Henderson, M. Todd. “Everything Old Is New Again: Lessons from Dodge v. Ford Motor Company.” SSRN Electronic Journal, 2007.
5. Report on Moto Vehicle Industry, Government Printing Office, 1939, pp. 622–643.
