Tag Archives: incentives

The Business of Life Chapter 27 – no way back

Some people would say that it was madness, but I found it liberating to know that I had blocked off an escape route and that the only way was forward.  Having withdrawn from the job search process and informed head hunters I was out of the game, I had but one goal and that was to achieve a management buy-in (MBI).  To facilitate this process I had to earn just enough to support the household and preserve my savings for the stake I would need for my share of equity.  As John Major resigned the leadership of the Conservative Party to trigger a leadership election in June 1995, thus burning bridges in the hope of winning party support, I made my own play for future success.  My bid was rather less exalted but it was critical to me and had a similar air of ‘do or die’.No Way Back

A corporate finance partner at Grant Thornton I had met during the due diligence process at Selmar was my initial port of call.  “Why do you want to do this?” he enquired when I had finished laying out my plans.  “Because I can be a whole lot more successful at running businesses than most of the clowns I’ve worked for!”  “Wrong!” he shot back at me, “You stand in front of a venture capitalist and tell him that and you’re finished.”  I felt perplexed and my look must have revealed my confusion.  “You’re doing it for the money, you want to make shedloads of money for yourself and for them.  That’s what they want to hear.”

My first task was to commence my own due diligence on the process of achieving an MBI.  I started this by talking to several contacts, either old or new, who had managed to get VC backing to either buy-out (MBO) or buy-in to business.  Their advice was interesting but the one phrase that struck me as invaluable given my own experience with cash was, “Never buy what you can borrow and never borrow what you can steal!”

An essential element I absolutely had to ensure was in place was a contingent fee arrangement with a firm of accountants and a lawyer firm.  To get a deal to completion meant accounts and lawyers putting a great deal of hours on the clock for both accounting and legal due diligence plus all the work on the finances, deal structure and the sale & purchase agreement.  These costs would run to hundreds of thousands of pounds and without this ‘no win, no fee’ arrangement in place, failure to complete a deal would ruin me.  In the deal-charged environment of the 90’s all of the major accounting and law firms realised that without such an arrangement the deals would simply never happen.  The quid pro quo was an acceptance by VCs that transaction fees would be inflated for success.  It was a feeding frenzy.

The combination of my approaches and CV got me meetings with the corporate finance partners of every major accounting and law firm I approached.  A vast amount of highly practical advice flowed from these meetings, which was adding to my rapidly growing knowledge of the intricacies of the MBI process.  All lost no time in telling me how difficult it was to achieve and how risky it was to buy a company as an outsider, “You just won’t know where the skeletons will fall out of the cupboards!”  Knowing that it was going to be a lengthy and fraught process, the key aspect both parties were assessing was the personal chemistry.  There had to be mutual respect and trust, something that I was well aware of, but something that would also be brought into a stark spotlight in the future.  The result of many meetings was an agreement of backing from KPMG and Pinsent Curtis both in Leeds.

With one vital building block in place I started contacting all of the major VC firms.  Again I succeeded in achieving meetings at director level with every firm I approached.  The choice of equity partner transcended almost every other consideration.  Yes, you would share equity in a deal but management equity was a very subordinate animal to that held by a VC.  I knew that all firms could and would be ruthless in the event of non-performance but there were other considerations that I knew to be critical.  Most of the firms I talked to had a strict policy of exiting from their investments within a set time period, being driven by the way they raised finance.  I had met one management team who had almost been sunk by being forced to refinance as a result when their business was going through an appalling difficult period.

The one exception to this almost cast iron rule was 3i Plc whose policy was that management drove the timing of exit.  With its roots in the Industrial and Commercial Financial Corporation and the Finance Corporation for Industry going back to 1945, 3i had probably more experience and understanding of financing private businesses than any other VC.  I had had a welcome and very useful initial talk with the head of the Leeds office and, following all of my other meetings, I decided that I simply had to get 3i backing.  The head of the Leeds office was Jonathan Russell (who went on to become a main board director) and underlying his smooth and urbane appearance and warm welcome was a very shrewd businessman.  After I had filled him in on my success in getting contingent fee arrangements in place with KPMG & Pinsents, he leaned back in his chair, nodded and enquired, “Anyway, how’s your job search going?”

This wasn’t a trap I was ever in danger of falling into and took delight in firing back, “I don’t have a job hunt.  I’ve closed all the corporate doors and I’m going to succeed in achieving an MBI with you.  That is my future.”  I was then vetted by Patrick Dunne (who ran their MBO / MBI programme) in London and was then able to benefit from the vast knowledge 3i had gained in this sector.  From their research I was able to ascertain just how many MBI candidates there were in the country attempting to achieve the same goal as me.  Comparing this number (over 2,000 from memory) with the number of deals actually completed each year (210 in 1994) was, at face value, disheartening.  Of these only 28 were MBI transactions that had been completed!  When I considered the reasoning behind Jonathan’s question about my job search and added this to the knowledge I had gained so far I realised that the odds were better than the apparent 1.4%.  Clearly some of the c2000 executives seeking a deal would give up on their buy-in plans as soon as a decent job offer came along.  I also knew from my research so far that the majority of people who claimed they had a goal of an MBI merely waited for the deal community to throw up an introduction to a potential transaction.  I had already decided that I wasn’t going to sit around waiting for a deal to show up, I was going to make it happen.  When I added this self-sufficiency to my competitiveness and determination, I decided the odds were rather better at around 8~10% pa.  Good enough for me.

I started work on a methodology for searching for suitable targets.  The advice I had been given so far was to buy a dog.  What was meant by this was buying a failing business and turning it around would yield fantastic returns.  The problem I envisaged with this approach was that the margin for error narrowed to almost zero.  Problems come from all angles even in a good business that one knows well but buying into a failing business raised the stakes dramatically.  No, I decided, I would buy a profitable business even if the price was higher but it wouldn’t be balanced on a knife edge from day one.  The obvious approach would be to attempt to buy a business in a sector where I was experienced, so the lighting industry had to be on my target list and I started making approaches to all my contacts in this sector.

I had drawn up a list of ideal criteria for a target company and this included:

  • Privately owned
  • No more than 3 shareholders and ideally same as directors
  • In business for between 15~30 years (potential retirement sale)
  • Turnover between £3m~£25m
  • Profitable and cash generative
  • Engineering, industrial manufacturing or distribution
  • Were differentiated in some way (or could be)
  • Had growth potential.

Obviously businesses in declining sectors were out and I also decided that I would have nothing to do with those selling consumer products into high street retailers.  I new that Companies House had all the information required to ascertain if the first 6 criteria could be fulfilled for a small fee.  However, there is no way one can carry out a criteria based search from this source (needles and haystacks).  However, I knew that there were many credit agencies and other research companies who bought the entire information from Companies House and compiled databases that could be searched by criteria.  Their fees were beyond me though.

Leeds business library proved to be an excellent halfway house for the information I required.  It had research reports on a vast number of UK business sectors and it had searchable databases that would give me a snapshot of likely companies.  In addition, the cost of information was only £0.10 for a printed page.  I would blitz a business and geographic sector and come away with a single page on each of around 200 companies.  Returning to my office at home I would wade through this information refining it down into a short list of 20 to 30.  I would then arrange a meeting with Phil, the corporate finance partner at KPMG and we would then discuss each one and agree a final list of 10 to15.  Phil would then get one of his team to run off a complete financial history for the last 5~10 years in great detail for each one.

Back in my office I would then input all of the resulting data into a large spreadsheet model I had developed that would produce key ratios, further analysis and graphs.  The resulting report I produced for each company showed at a glance a clear picture of the health of each business plus all of the relevant trends.  I would put together any further information I could gather as desk research and then get together with Phil to review the results.  These reports together with our discussions enabled us to whittle the list down to 5 to 8 key targets.  Having discussed the various ways of approaching these targets Phil counselled that we would get a better response if he approached each company saying that he had a client with funding in place who was interested in a purchase.

Whilst carrying out this research I had been working my way through all of the potential businesses I knew in the lighting industry that were worth an approach.  I had meetings with a number of potential targets but despite serious interest from the owners there was really nothing worth pursuing.  I was waiting to hear of the results from the initial batch of letters Phil had sent out when he gave me a call and suggested we meet.  He explained he had information on a paper processing business that was for sale and he could introduce me if I was interested?

Was I interested!  After months of work I was off running with a lead on a business that was for sale.  Would it shape up?  Could I pull off a deal?

 Image courtesy of http://www.virtualdjradio

The Business of Life Chapter 23 – Keeping Enemies Close

An early, hazy summer sun was shining the morning my flight approached Geneva and I could see the Jura, the city and Lac Leman spread out below.  I had spent ten years flying into Geneva on a fairly regular basis but this morning was different.  I was coming here to live and to work and although visually everything was familiar it felt very strange indeed.  A few years earlier our European head office had moved from tiny, cramped offices next to the lake into a new block adjacent to the airport.  Although it was now just a short walk from the terminal to our offices, the heat of a sunny day together with the humidity that came from Geneva’s position, ringed by mountains and built by the lake, meant I arrived drenched in perspiration. 

Sitting for a few minutes in the office I had inherited from Louis, my predecessor, I gathered my thoughts.  It was compact and somewhat clinical but did offer an astounding view.  Sitting at my desk I could see, over in the distance across the city and Lac Leman, Mont Blanc, just visible above the haze.  After a welcome cup of coffee delivered in beautiful white china by Germaine my new secretary, “Louis would never accept his coffee in anything else!”, I went in search of Don.  Sitting in his palatial office he proceeded to light a Marlborough.  The offices had previously been declared a no smoking zone but Don had imperiously decreed that the rule didn’t apply to his own office.

The briefing I received was perfunctory.  Don announced that stock levels across Europe were far too high and he wanted me to make a significant improvement.  I was perplexed as the company had spent a vast amount of money previously on a Distribution Resource Planning (DRP) software programme.  This programme (identified and implemented by Peter, a Cambridge PhD, who had been recruited to head up pan-European logistics) was designed to analyse sales history and trends and make more accurate forecasts than the capabilities of mere mortals would permit.  I politely reminded Don of this but was greeted with the response that my marketing team should be close enough to the market to be able to predict sales far more accurately.  He would hear no counter argument and made clear the meeting was concluded but not before emphasising that this was to be my absolute priority.  I said I would investigate and see what needed to be done.  This issue was destined to become my Nemesis.

The rest of the day was spent gaining the views of my new team.  They were a real multinational group including Swiss, German, French, Belgium & Romanian members most of whom I already knew extremely well.  The marketing department numbered 13 out of a total headquarters staff of 70.  In addition I also had what is referred to in management speak as ‘dotted line responsibility’ for the sales and marketing functions in all of the 16 European countries where we had subsidiaries.  At the end of that first day I was sitting quietly in my office writing notes on the day’s meetings when Rien Swaanen (VP Manufacturing) burst in.  Without pausing first for pleasantries or even common courtesies, he immediately launched into a vitriolic attack on me, my function and the whole of my new department.  I was totally mystified because the attack was laughable and demonstrated a gross lack of understanding of the issue he was complaining about.

A few years previously after Jean’s death,  I had heard from a colleague that Swaanen’s wife was suffering from the same cruel disease.  I felt spontaneously driven to write to him and let him know of my concern for them both and offered an understanding ear if he ever felt the need to talk.  Very shortly afterwards, I got a call from Swaanen’s secretary to fix a date for us to have dinner on his forthcoming visit to the UK.  We talked late into the night and he poured out his soul to me and thanked me profusely for my concern for them both.  It wasn’t long after that I heard the sad news that his wife had finally passed away.  I wrote again but it was some time before we met as I was still running the UK while he was based in Geneva.

A year or so later, I again received a call from Swaanen inviting me for dinner on his next visit.  Business concluded I drove him to his hotel.  As the sun was shining brightly on that fine summer evening, we decided to take a walk along the river that ran by the country hotel I had chosen.  Once more Swaanen talked at great length, of the pain of his wife’s suffering and death, of the slow repair of his inner self and of a returning belief in the joys of living.  And then he shared with me his love for a new woman in his life, how they had met, what she meant to him and how they would spend their life together.  I had been pleased for him but now, for some inexplicable reason, he was acting as if I was an enemy appearing in his back yard.  I retired to the hotel that shared our building.

The following morning I was met by Walter the office manager, a genial Swiss German who proved an invaluable part of the process of integrating me into Swiss life.  Our first stop was the ministry responsible for registering foreign workers and I was guided carefully through the process of obtaining my visa.  We then set out to inspect the half a dozen apartments Walter had lined up for me to view. In the end the last viewing of the day proved to be the one.  It was a pleasant and large apartment in an old block, close to the lake with on street parking and local cafes and bars, close enough to walk into the old town and it gave me a good feeling.  Critically, it was on the same side of the lake and only 3 kilometres from our office.

Louis had promised to meet me for a full briefing on my role but this never materialised.  Instead, I received in the post a few notes he had jotted down, which included the suggestion that I read through the files he had left.  One of the priorities was to continue working closely to bring a project with The Boston Consulting Group (BCG) to a successful conclusion.  It seemed that Don had initiated a number of major projects when our parent board had put the business up for sale, of which this was one.  The scope of the project was an outwards one to look at the European market and assess what could be done to improve our position.  I also discovered that another major project had been to look at the performance of our manufacturing operations across Europe but this had been put on hold (it was never instigated and I suspected Swaanen’s dead hand).

When I met with the BCG management a short time later I learnt that on finding that no product line profit and loss statements existed on a pan-European basis they had managed to create these.  I was staggered to find that our company, a major global player, had never attempted to create this basic information.  I had been carrying out this process in the UK for some time and found the information simply invaluable.  What the BCG exercise revealed was staggering.  Working from the factory cost price through to the ultimate selling price at market level less all costs showed that our entire incandescent product range was making large losses.  Furthermore, France which had for years been paraded as the premier example for their marketing excellence in this product area, was making the greatest losses.  The situation should have been recognised and addressed years previously.  However, in the current circumstances the required solution (closing obsolete factories and investing in new production facilities) was out of the question.  My previous UK profits for this product group were amongst a minority and vindicated my strategy in this area.  My cynicism started to mount.

The routine side of my new role involved monitoring progress on planned new product development projects, touring subsidiaries to review and promote good marketing and sales practice, sitting through Don’s meetings, which never seemed to address core issues and taking part in the travelling circus that was the individual country operations reviews.  New product development was driven by technical developments that manufacturing felt would enhance product performance rather than any attempt to establish what markets required.  It became crystal clear that my previous suspicions were well founded.  The central marketing function was largely reactive and existed without a clear role in overall company strategy.  In fact there was absolutely zero talk of strategy to improve the long term viability of the company and if such a strategy did exist it must have been securely locked away in a Credit Suisse bank vault.

The hectic schedule of meetings I was required to attend (both in Geneva and elsewhere in Europe) gave me the feeling I was on a treadmill that custom and practice had determined but which rarely achieved anything of value.  However, during this time I had been working away on the objective I had been given by Don and had started to see some startling results.  Swaanen had an entire department (headed up by Peter the director of logistics) solely to run the DRP system and manage the logistics of our business.  I had always kept close to Peter and had been a fervent supporter of the DRP system.  I had encouraged him to work with me in widening the scope of the relationship I had built with some of the largest UK distributors and this had borne fruit.  When I arrived in Geneva I found that this whole department with its huge potential was largely ignored by Swaanen.  With the added benefit of the relationship I built with Peter’s team, I soon had them working enthusiastically with me.

The DRP system complimented Manufacturing Resource Planning (MRP) that ensured materials for production in our factories were available when required.  The purpose of DRP was to ensure that our subsidiaries around Europe had exactly the correct stock levels of all finished stock at any time.  The system was participative with the subsidiaries in that it required that each and every one to define stockholding parameters, share key demand factors (e.g. large contracts producing sales spikes) and merely to review the sales forecasts generated by DRP each month for individual products lines.  In this system the subsidiaries never had to place an order as once up and running and reviewed regularly it replenished stock automatically.  This system was predicated on the finding that the best place for non-differentiated stock was in the centre (the factories) with rapid replenishment of subsidiary stocks.  The problem was that it seemed that the system was not working, giving rise to Don’s complaint of high stocks.  There were profound systemic problems.

Every employee at management grade and above (worldwide) participated in a Management by Objectives (MBO) system. Each individual had as many as eight or more quantitative objectives they had agreed to each year and bonuses were awarded on the basis of performance against each component.  At senior management level these objectives were spread across set areas and could be very prescriptive. For country and factory managers and above there was a specific target given each year for stock levels.  Given that stock levels were contributing to bonuses, subsidiary managers in each country felt inclined to attempt to manipulate these by adjusting the sales forecasts produced by DRP.

The factory managers also had an incentive to manipulate stock levels as they too had targets to minimise stock at factory level.  At one meeting shortly after a year end Swaanen had actually boasted that only the action of his factory managers in overriding sales forecasts agreed by subsidiaries prevented sales targets in subsidiaries from being missed.  The factories had an additional incentive to ship more stock than required because of the ever increasing drive to increase line speed to reduce costs.  Driven by a misguided bonus system both sides were playing the same game and I suspected this was the cause of excess stock.  The problem was that I had lacked the means to prove this.

Working with Peter and his department we solved the issue.  I asked if the DRP system could recover the individual product line sales forecasts it had generated for each subsidiary for the previous 12 months.  “Of course”, came the immediate response.  I then asked if these could be plotted against actual sales achieved over the same period and the revised sales forecasts the subsidiaries had made.  “Of course”, again!  Within hours I had a complete picture.  With the exception of a few low volume lines that had a very lumpy and unpredictable sales pattern, every major product line, in every country, monthly sales forecast by DRP had been far more accurate than the ones adjusted by the subsidiaries.  If the subsidiaries had done nothing more than merely tick the original DRP forecasts without making any adjustments and the factories had shipped against these, the calculation showed we would have ended the year with $10m lower stocks!  I had the answer and the proof.  We had to change the bonus system and stop the counter productive double guessing that was driving stocks higher.

Could I convince Don that I had found the root cause of the stock problem?  And would he agree to make the necessary changes?  Before I could take this issue further it was announced that a sale of the business finally had been agreed in principle and the potential new owners were to visit us the following week.

Image courtesy of Europeupclose.com

The business of life (chapter 7 – on gaining a broader insight on life)

Business was not without its occasional pleasures.  From time to time various dealer conferences were attended in venues a littler warmer than off-season Eastbourne (my wife joining me for one welcome trip toMalta).  Another memorable trip for a number of reasons was a visit David organised for 3 of us target busters to a number of our fellow European distributors.  The great surprise upon gathering at Heathrow was being ushered like royalty through departures and out onto the tarmac where the company jet was waiting to fly us off to Copenhagen. 

Our first evening passed fairly quietly and an early flight the following morning took us to Odense. After a very short meeting at our distributor’s office we were taken to a delightful restaurant where beer and schnapps commenced at around 11.30 and flowed until some time after 5.00pm.  A very long evening and night followed and saw me the next morning (following about one hour’s sleep) suffering from a monumental hangover.  Somehow I managed to survive the drive to the ferry and was dragged into the bar where I promptly announced I wanted to die.  The barman took one look at me, poured a glass of dark brown liquid and instructed me to drink it down in one; I did and it had the most incredible effect.  Instantly a deep calm settled upon my very fragile stomach and within another 5 minutes my head cleared.  I had discovered Gammel Dansk.

The Beatles may have long departed but Hamburg was still memorable.  Deciding to wash the travel dust from my bones and sweat out the remnants of the previous day’s alcohol, I joined one of my colleagues for a visit to the sauna in the Intercontinental where we were staying.  Not realising it was for mixed sex we marched in as naked as nature intended to be greeted by a very Germanic blond (in similar state of nudity and using her towel simply to sit upon) with, “Hello English”.  Given we had not uttered a word I am still trying to work out what it was that gave us away.

Dinner that evening was in a very upmarket restaurant in a converted wharf building.  The conversion had been carried out in such a way that there were a number of tiered levels permitting a panoramic view across the docks through full height windows.  The evening was relaxed with wonderful food, lubricated with David’s usual expensive selection of wine.  The clientele was decidedly cosmopolitan, expensively dressed and generally decorously behaved; with one exception.  Taking in my surroundings and glancing around the upper tiers of seating (which was in the main affording an expansive view of a sea of knees and the underside of tables) I couldn’t believe my eyes at a scene playing out one tier up.  A couple, clearly the worse for wear were, not to put too fine a point upon it, pleasuring each other (probably in the mistaken belief that what they were doing could not be seen under cover of the table).  This little demonstration of libidinous incontinence played itself out even whilst they were being served by staff, who effected not to notice what was going on right under their noses.

Richard, one of my colleagues, was strictly teetotal and had swept through the trip so far without even a sip of alcohol.  Having missed our flight from Hamburg, we arrived very late inAmsterdam and rushed through check-in at our hotel to get to the bar, which we found was just closing.  The barman said not to worry as he would rustle us up something to keep us going.  True to his word, he reappeared a few minutes later bearing a large grin and an ice bucket filled to the brim with an orange fluid declaring “Screwdrivers!”  “What are screwdrivers?” enquired Richard with a worried look.  “Oh, it’s just a Dutch version of orange juice.” David assured Richard, who rapidly downed a large glass. He declared it very acceptable and said he would have another.  And another and so on, finally becoming very animated when the bucket was drained, demanding more.   The following lunchtime Richard announced he had by then realised the terrible trick that had been played on him….but would try a beer.   He continued drinking through the rest of the day and most of the night.  He never returned to his former self.

Walking back to our hotel that night my colleagues decided they wanted to see the red light district, so a detour to De Wallen was duly made.  Our short (I promise) walking tour left me with two lasting impressions, one hilarious and the other deeply disturbing.  We had wandered along one side of a canal looking at the wares on offer in the various little windows when a commotion started further along the canal.  We elbowed our way to the front of what was a very jocular and large crowd to find a group of a dozen or more Scotsmen.  Clad to a man in their national dress and very much the worse for wear, they were noisily negotiating terms with one of the ‘angels of the night’ through her open window.  Finally a suitable financial arrangement was agreed, the door was opened and they ALL trooped in at once to a vast cheer from the assembled throng.  The curtain was pulled and we drifted away with the crowd.  The room couldn’t have been much larger than the bed it contained.

Further along the canal there were various small theatres offering ‘live sex shows’, which none of us had an appetite for.  As we were making our way back to the hotel, a smartly dressed trio came into view.  Probably husband and wife in their late thirties, the couple were hand in hand with an angelic looking little girl of not quite teenage years.  They paused to look at the offerings of several theatres before all nodding agreement and walking into one that promised the most outrageous show.  No objection was raised by the doorman and they disappeared inside leaving me feeling decidedly sickened, a sensation that has never left me and that returns whenever I recall the incident.

Quite what business lessons we learnt from this European study tour (despite the meetings we held with our various European distributor colleagues) I am not sure but certainly they have not stood the test of time.  Suffice to say that I gained a much wider appreciation of the social customs of our near neighbours and that it was now crystal clear that my strict religious upbringing had done little to prepare me for some of the more mentally (and physically) challenging aspects of international travel.

Over the next few months I received a morale boost with a move to take over the Central London region covering the majority of our major accounts.  My earnings continued to improve and I ended the year taking home more than three times that which I had in my role with my previous company.  This was fine from a financial perspective but it was far from sufficient in terms of either job satisfaction or self-fulfilment.  I continued to push both David and Peter at any and every opportunity for advancement; I must have been a complete pain in the a*$!  Then, the situation began to look much more hopeful with the news that David was leaving.   I liked David immensely, had enjoyed long ‘business’ lunches with him whenever we could fit them in and learnt a great deal from him, but I was aching for the chance to move on and up.  I began to visualise myself in David’s role and was mentally planning changes I would make.

Almost immediately matters took a turn for the worse when Peter informed me that I was not being given the chance to replace David and lead the team; David’s role was going to Keith one of my team mates, another old hand from the photographic trade.  My heart sank.  A nice enough guy and great company socially but it was clear to me that I could learn nothing from Keith.  Arrogance on my part?  Maybe, but I had studied my team mates carefully for the last year or so and knew that they were now trailing me both in sales performance and the knowledge of how to innovate. A series of meetings with Peter & Keith culminated with a deal being struck; I would support Keith, he would keep out of my hair and the company would support me to fund a study programme to equip me for a bigger role.  Courses at the Institute ofMarketing followed and I started evening classes once more.

One evening some months later I received a call from Peter.  Could I cancel whatever I had arranged for the next day and come into the office to meet him and Angus?  An urgent situation had arisen that he wouldn’t discuss on the phone.  Had I screwed up somehow? Or, was this the chance I had been waiting for?

Images:  Gammeldansk.com / Youropi.com


Love your lawyer

Pre-Nuptials have been making the news again in recent times causing lurid reading for the more voyeuristic amongst us (and some sleepless nights for those without this protection who are planning or fearing a divorce).   I’ll leave it to you good readers to make your own minds up on which sides to take on this 21st Century issue.  However, if you are planning to start a business or have a business with one or more shareholders or partners there is a vital piece of advice you should heed; make sure you have a clear and comprehensive shareholder or partnership agreement in place – one day you willneed it!  Yes, it can be a pain doing it, it costs lawyers’ fees and you spend valuable time drafting an agreement to cover eventualities you are convinced that you’re never going to meet.

Image courtesy of Good4girls.com

However, I have seen many situations where things went wrong and the lack of a properly drafted shareholder agreement made matters far worse.  So, while it’s common in some circles to talk in less than flattering terms about lawyers (perhaps less now bankers have earned their place in the publics’ mind) but, trust me, engage a good one to help draft your shareholder agreement because one day you are going to rely on it.

 Shortly after I joined the board of one company as non-executive director, it became apparent that the two major shareholders were falling out due to the non-performance of one of them.  I arrived one morning to find that one shareholder had fired the other an hour or so before.  Reading the shareholder agreement (over a much needed cup of coffee) I found that there was no provision requiring a departing shareholder to sell his equity.  Now, at the time, the business was a long way from a possible exit but the thought of coordinating a future sale with a long-fired, absent shareholder who had no obligation to sell was too horrendous to contemplate.  After a long and extremely delicate negotiation, I managed to achieve a buy-back of his shares.

 A senior executive of a VC I worked with lamented with me over a situation where they had a long-standing minor equity stake in a family business.  Now here they had a shareholder agreement but one that could fit on the back of an envelope.  My colleague had the right to attend board meetings but had to suffer the strictures of an imperious chairman who instructed him to ‘sit quietly, laddy and don’t interrupt’!  There was no way the family shareholders would agree to either sell the company or to buy the VC out.  The family shareholders simply enjoyed healthy dividends as a result of the separate class of share they held and all my colleague could do was sit and fume at board meetings with an equity stake that was generating no return.

Consider the following scenario; three shareholders have long had an unwritten understanding that they would take healthy dividends and modest salaries (being more tax efficient).  Times get a little tough and two directors decide to make the third redundant.  The third, upset as he is at being ousted from the company he helped created, is consoled with a verbal assurance from the remaining two that, although no longer a director or employee, he will retain his equity and will continue to participate in dividends.  The two remaining shareholder directors instead cease paying dividends and hike their salaries leaving the redundant third without any income.

 Another problem that can bite an unwary business owner in the rear quarters is the lack of a ‘tag along’ clause.  This refreshingly named clause does exactly what says and provides for a shareholder to be able to sell his equity for exactly the same price as that which other shareholders have negotiated with a prospective purchaser.   Without this ‘one out, all out’ protection a major shareholder (or majority shareholders) could negotiate the sale of their equity leaving behind a shareholder who otherwise would have wanted to leave.  Looking ahead, and unless he could negotiate a new shareholder agreement with his new partners (and why would they), he could find himself in the same situation all over again at some future point.

 Of equal importance is the value of a ‘drag along’ clause.  Imagine a situation where three shareholders (with equal equity) have started a company that has done particularly well and is earning good profits.  As their success grows, a competitor makes an extremely attractive offer for all of the equity.  Negotiations proceed smoothly but just before completion, one shareholder decides that he doesn’t wish to sell out from the company he helped create (he is the youngest and, apart from his attachment to the business, and decides that he can earn more from the business if they reject the offer and expand the business instead).  Without any requirement in the shareholders’ agreement to require him to sell his equity, the sale falls through, resentment grows between the three shareholders and the business then suffers.

 Going into business with a partner or partners is exciting (and rightly so).   You’re in love with your business plan and what you are going to create together.  You are great friends perhaps and all trust each other implicitly.   But in just the same way as we humans fall in and out of love with the opposite sex, business partners have their equivalent behaviour.  Forget your shareholder (or partnership) agreement or get this one wrong and it can break your wealth (and your sanity).

 So, before you get into similar problems, get together with your business partners, engage the services of a good lawyer and let them help you put together a shareholders’ agreement that can plot a course through these and many other situations you never want to imagine.  It could be the best money you ever spend.

 Have you had an unhappy business partnership or do you know anyone who has?

Most bonuses are a waste of time…

…and they may even work against you.  There is a received wisdom amongst the great and the good in business that everyone is ‘coin operated’ (usually because they themselves are particularly avaricious).  The majority of people at work simply want to do a good job, have good work mates in a company that is good to work for and offers advancement opportunities.  They are more concerned that they are not underpaid relative to others at their grade or level than being motivated to respond to ‘incentives’.

Image courtesy of Sunseeker

There are roles that perhaps should be remunerated by commission or bonus, invariably sales roles, but high rewards should only be offered where the ‘prominence’ of the sale role is higher than anything else in your marketing mix.  Paying high commissions or bonuses where the real demand comes from long built up brand reputation and advertising is simply inappropriate.

Paying lower than average basic, with high commissions or bonuses, simply because it lowers your breakeven point is not a sound enough reason in isolation; if the role doesn’t require it, don’t do it because it may work against you (and it won’t be your employees’ fault you’re in a recession).  If you do require this flexibility, then at least be honest about it and ensure that everyone shares in the upside when you have a good year, not just the board.  An end-of-year reward can be much more effective for morale than a bonus scheme that the average employee feels too remote from to influence.

There are however no rules.  Despite all the textbooks and articles and research and received wisdom, when you run your own business you can do what you want, providing it is legal and you can get your team to fall in line; it may work and it may not.  I have seen people who slavishly followed ‘best practice’ and failed miserably.  I have also seen business owners put into practice systems that were so far from accepted wisdom that I would have bet hard-earned money that they would fail – but they didn’t (at least not for a long time).  How can this be? My view is that it’s about the harmony that comes from all elements in a system being aligned and having the leadership that works.  Thus you can even have the most (seemingly) malign culture and systems but they can still produce results.

Whatever you are going to do in your business, whether incentives or no incentives, make sure that you have all of your systems, processes and policies all pulling in the same direction.  In one multinational I worked in, key elements of their remuneration and financial systems were actually mutually counter-productive and costing the business millions in excess working capital. When I graphically demonstrated this, they still wouldn’t change.  Why? In this instance, there were conflicting functional pressures that no-one wanted to acknowledge let alone address.

What I used to simply call the law of unintended consequences has now been dubbed ‘choice architecture’.  As the Israeli nursery (described in Nudge) discovered when they introduced a penalty for parents who turned up late to collect their kids, the lateness actually increased (the parents viewing what was a social problem as a financial one)!  And as the war on drugs has just been graphically demonstrated to show, your ‘programme’ may not actually work and, instead, you get vast collateral damage.

So, is it right that board directors keep increasing their own remuneration to ever greater multiples of the lowest paid?  Whatever you do with remuneration, make sure it really is for the right reasons (in a holistic sense), not just because you have it in your power to do so.