Having successfully acquired the Metal Spinners group of companies I was elated. But the glow of post-deal euphoria was destined to be short-lived. As I started the process of taking control of the businesses with Roger and Mark problems in the other companies were bubbling to the surface. I shall be returning to the MSG experiences in due course but, meanwhile, there are other tales to tell.
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. Business risk is omnipresent but there is one circumstance where the greatest risk arises and that is when a new owner takes control. Research has shown that the majority of acquisitions work to the benefit of the vendor’s shareholders. There are many reasons for this phenomenon, including inappropriate strategy and culture being introduced and sometimes sheer incompetence on the part of the new management. But the greatest problem for even the best new incoming owners, despite the most exhaustive due diligence, is that they simply don’t know where the bodies are buried.
Introduced by 3i to become investing chairman for the acquisition of the Bridgestream business (not its real name), I had become the third member of the buy-in team. The impression I came away with my initial meetings 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 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 that they had both worked together previously on another 3i investment.
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 (I’ll call him Offhand).
However, when I reported back to Mark T at 3i it seemed we shared the same view. The business was not a particularly exciting one but the 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 and the experience I could bring to the team.
Richard, Tim and I worked on a detailed reworking of the business plan whilst we awaited the financial due diligence from KPMG. 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, they had revealed to 3i 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 then 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 3i) of a distribution business with eight branches around the UK and two separate operating divisions. For myself, I had made my first private equity investment. However, even as we sipped our champagne and accepted the congratulations of our advisers, the storm clouds were gathering.
With the glow of success (or it might have been champagne) still infusing our faces the following morning, we took control of the business and set about reviewing our new company. Bridgestream traded from eight warehouses across the Midlands and Southern England, supplying a wide range of chemical and consumable products into two discrete industrial markets. The business was trading profitably (albeit on narrow margins) but had high overheads in terms of both premises and staff. Our business plan included achieving major savings by consolidating down onto a single site; this would also have the advantage of operating with reduced inventory whilst improving customer service. During the remainder of the first week, I visited most of the sites, which served to confirm the urgency of the plan.
The first bombshell came with my return to the office to find an extremely concerned looking Richard in his office with the management accountant. “ We’ve been screwed.” Richard announced to me. In contravention of the terms of the sale and purchase agreement the vendor had cancelled all of the previous month’s payments to creditors. The effect of this was to deprive Bridgestream of the major portion of the working capital we had relied upon. I agreed with Richard that an overhaul of the accounting systems was vital if we were to have accurate information.
The situation was compounded when we also discovered a few days later that in settling an intercompany debt pre-completion between Bridgestream and its sister company (remaining with Offhand), a large over-payment had been made. The net effect was now a hole in our working capital of well over half a million pounds. This was a situation that moved us from being seriously injured to virtually crippled. Richard quickly spoke to Offhand who made soothing noises over the matter and promised to look into the situation. We hastily re-ran our cashflow projections and calculated that, with changes to our payment terms and some savings we could make we might survive; but we needed that cash. Now. The next call was to our lawyers.
Despite many calls to Offhand, no payment was forthcoming, so on our lawyers’ advice, we instituted proceedings against him for breach of contract. Offhand’s reaction was to issue a counterclaim claiming repayment of the deferred consideration. As the months dragged on I attempted to engage Offhand in an Alternative Dispute Resolution (ADR) process but despite agreeing he never showed up for a meeting. One of our managers still in contact with Offhand reported that he had no intention of paying as he believed we couldn’t afford the legal costs to win our action. The legal processes rolled on and our costs duly rose.
Meanwhile, the cash situation was not improving. We were surviving but barely and the prospects of a new loan to compensate were zero. Towards the end of that first year, the directors all agreed to reduced salaries. Richard had previously agreed to replace the management accountant (we had acquired with the business) as he was, in Richard’s own opinion, simply not up to the job. The months dragged on but no change took place, Richard always having one excuse after another to delay making a change. It also became apparent that our invoice financing company were reducing their advances to us, having the effect of stressing our finances still further. A meeting with their management revealed their concerns over the credit worthiness of many of our customers. Richard promised a major drive to improve debt collection.
Richard had started giving me growing cause for concern over this period. He was increasingly absent from the office, ostensibly improving sales but instead he frequently met with one ‘snake oil salesman’ after another and came back full of his latest ideas for additional (and wholly inappropriate) new product lines. The monthly accounts were increasingly late for our board meetings and appeared to be showing profits whilst we were bleeding cash. After another board meeting when we were again without full accounts, I called off the meeting and met alone with Richard. What followed were, hopefully, the most difficult couple of hours of his life. I covered all of his shortcomings, his continued failings to take corrective action despite commitments, inappropriate sense of priorities and his duties as a director and informed him I required a programme of specific actions over the next month (through to our first year end).
Over the next couple of months we set about the site consolidation process. We finally found suitable premises, close to the centre of the country and the motorway network and, after careful planning on Tim’s part, we made the move over one hectic, weekend. The long awaited reduction in stock levels finally started showing benefits and along with the staffing reductions our overheads would come down (after the effects of the redundancy payments had fed through).
Yet another turn of the screw came when the financing company rewarded our stock reduction programme with a corresponding reduction in their advance. The promised sales improvement failed to materialise and combined with our reduction in stock financing we were seeing no improvement in cashflow. Richard was pleading the need to concentrate on finalising our year end accounts (which we were under pressure to produce) and had still not replaced the management accountant (saying now that he had great loyalty). I was forced to give him additional time to achieve the commitments he had made to me. Richard shortly afterwards produced management accounts showing a break-even position at the year end. He also promised that the cash situation would quickly improve and that, now the move was complete, we would see real benefits.
Some weeks later my mobile rang with a devastating call from our major supplier. I learnt in a very difficult conversation that Richard had reneged on a previously agreed payment schedule and was now avoiding calls. He informed me that all confidence in Richard was exhausted and was going to close the account. I promised immediate attention to the issue and asked, on my personal surety, for additional time to resolve matters. By this time I had also gone many months without payment of salary and other business expenses I had incurred. The following day I was due to meet with Richard and Tim at KPMG’s offices for the audit meeting, so I decided to delay any conversation until we could meet face to face.
The information from our audit partner was worse than I could have imagined. The year-end break-even result Richard had reported (critical to the continued support of our financing company) was in fact a very large loss. Furthermore, we were informed that the firm had never seen an accounting system in such a mess. Richard bumbled on making a series of ludicrous excuses whilst I sat and tried to configure a plan. The first step had to be to remove Richard; not only was he past the point at which he could recover any credibility, it was clear that he was utterly incompetent. I made suitable excuses and left to start moving things forward.
My first action was to meet with our VC partner to bring him up to speed and gain his agreement to the action I was proposing. I then had a meeting with our lawyers to review the terms of Richard’s contract. They agreed that the situation constituted a serious enough breech of his duties to warrant dismissal without compensation. That left the issue of Richard’s equity, which was literally under water and without value. Under the terms of his contract if he left the company he was required to sell the equity back to the company at an agreed valuation. In an act of generosity I set a valuation at a nominal sum. I called Richard and set up an extraordinary board meeting for a couple of day’s time.
What followed was the hardest task I have ever had to undertake in business. It had fallen to me to fire more than a few people in my time but to take away someone’s dreams and their life’s savings at the same time was not something to relish. In the event a usually verbose Richard was stunned into silence save for a few monosyllabic replies. I escorted him whilst he cleared his office and saw him off the premises. Later that night he returned blind drunk and hurled two pallets through the front office windows. The exercise of power can be a sobering experience.
Could we save the business?
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