The failure rate of new businesses is high with around one third disappearing within their first three years. But once through this initial period the rate of attrition falls and many businesses survive to have a long life, weathering even the odd recession (I knew the current generation of the same family that had started their firm in 1783). But there is one circumstance where a business is put under great strain and that is when it changes hands. Research has shown that the majority of acquisitions work to the benefit of the vendor’s shareholders. There are many reasons for this phenomenon but I’d like to share with you what happened when the perfect storm hit a business that I had acquired.
Back in the investment cash fuelled 90’s, management buy-ins (MBIs) were less common than management buy-outs (MBOs) but a large number were completed under a venture capital strategy that can be summed up in layman’s terms as “If you throw enough hot cr*p at a blanket some of it is bound to stick”. A refugee from corporate life, I had been pursuing MBI opportunities for a year and a half. Strangely enough the pursuit of money was not my main driving force; having formed a low opinion of senior corporate management from my years in the boardroom running businesses for parent companies, I really wanted to do my own thing. So, I had been working with a major UK VC and had investigated with them a large number of targets loosing out in the final bidding for three deals already (after many months of work in each case). When my phone rang one day a memorable call set some very memorable events in train.
“Would you like to have a look at a business for us?” was the question posed by the VC executive I had got to know well. This was a real break-through for me. Up until this point I had been carrying out all of my own research and only involving the VC when I had an opportunity on the hook and a draft business plan. It transpired that they had been brought a prospective deal by a three man team but had decided that one individual (earmarked as the chairman) didn’t meet their selection criteria. I met the remaining two team members and reviewed their business plan with them in a long meeting. The impression I came away with was that the team leader (we’ll call him Richard) was a great guy; originally a chartered accountant from one of the major firms and well experienced in business, Richard was charming & urbane and we hit it off at once. The plans for improving the business seemed realistic and achievable. The other team member, Tim, struck me as a solid and dependable man who would make a great operations director for the business. There was the added advantage they had both worked together previously.
The target company (we’ll call it Bridgestream) was, at the time, a privately-owned service based business with a large distribution arm for the products it used. I reserved judgement until I could carry out my own due diligence. The following week I visited, met the owner and had a chance to look over the main premises. Being after office hours I wasn’t able to meet any of the staff or get a feel for the atmosphere of the business while it was operating (confidentially concerns on the part of the owner had precluded a visit during normal hours). I came away thinking, the premises are old, they had a neglected feel and I didn’t take to the owner.
However, when I reported back to my VC contact it seemed we shared the same view. The business was not a particularly exciting one as it stood but the business plan the team had tabled seemed realistic and we both shared a very favourable opinion of Richard; furthermore, it seemed that he came with a tremendous recommendation from the references that had been taken. We agreed it would be a goer given a ceiling on the purchase price, a satisfactory funding package plus my role as chairman in the team.
Richard, Tim and I worked on a detailed reworking of the business plan whilst we awaited the financial due diligence to be completed. A series of meetings with banks and factoring companies resulted in finalisation of the funding package and my individual equity investment was settled. I was surprised to learn just how large a cash stake Richard and Tim were putting up. They had originally planned to complete the transaction without external equity participation but suffered when, being unable to finance the deal on that basis, had revealed to the VC just how much they could scrape together (and that was then set in concrete).
The final element of the funding package was an element of vendor finance in the form of a deferred element of the total consideration. The vendor haggled but finally conceded. Shortly before completion, we met to receive the financial due diligence report. There was good and bad news. Whilst the overall level of company performance was confirmed, it seemed that the financial systems were not particularly robust. There were two associated companies, only one of which we were purchasing (the distribution arm), the vendor retaining the service business. The concern was that the accounting systems couldn’t be relied upon to always delineate between the two companies. Richard undertook to work with the vendor to review the systems and finalise a working capital level for completion which would be guaranteed.
Negotiations over the sale and purchase agreement dragged on but we finally completed the transaction with everyone happy. We were the new owners of Bridgestream (along with our VC equity partners) of a distribution business with eight branches around the UKand two separate operating arms. For me I had made my first private equity investment (soon to be followed by others). However, even as we sipped our champagne and accepted the congratulations of our advisers, the storm clouds were gathering.
In part 2 you’ll be able to read of the depth and breadth of the problems that were heading our way.
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