If it’s done correctly, a partial exit can advance your company by introducing new people with different skills and experiences, all the while allowing you to enjoy some of the wealth you have generated.
The danger of taking such a step is that, if executed poorly, releasing equity could suggest your commitment to the company is on the wane.
Mark Duffin, a director at global business service provider Rentokil Initial, has undertaken three full exits and one flotation. He says: “If your message is not articulated in the right manner about why you are exiting, then people – who are naturally suspicious in the business fraternity – will look at it and think: ‘What is the ulterior motive?’
“They will wonder if there is a hidden agenda. If someone exits with 60% of his or her stake, doubts will be raised about whether that person is still going to be hungry enough to continue in the role.”
If you’re concerned about broadcasting reassuring messages to interested parties, you need to retain a respectable shareholding. Nevertheless, there’s no mistaking the fact that you will be, in one sense or another, diluting your own power.
David Moss, head of corporate services at solicitor Kingsley Napley, observes: “For as long as you’re in business, you’re at risk. A partial exit is really the process by which an individual ‘de-risks’ his or her involvement in a company.”
Not too hot, not too cold
Like Duffin, Moss notes that a delicate balancing act is required. He says: “If a business owner wants to release too much equity, then the person who is paying is going to be nervous. Similarly, if you’re releasing too little, then you might not have achieved what you wanted.”
In short, the pitch has to be absolutely right and convincing. Moss says: “If it’s wrong, then commercially you’re sending a signal that says: ‘I want out of here’. That’s where the balance lies. There has to be a significant amount of equity left in the business afterwards.”
David Rasche, executive chairman of insurance IT specialist SSP Holdings, knows how to walk this tightrope dextrously. “We undertook a partial exit because we were successful. We did it in order to develop the business, but clearly when you do these things you’re looking also to take out some of the capital growth,” he says.
The structure of the business at the time meant that £10 million could be released, which was spread between management and staff. As for another party coming into the business to buy the equity, in this instance Lloyds Development Capital (LDC) took a 30% stake.
Rasche says difficulties during this type of manoeuvre only arise when a controlling stake is lost: “There were several equity houses competing to come on board because they saw it as a good business to invest in. We could decide what terms we wanted.” He adds that LDC placed its senior director, John Swarbrick, on SSP’s board and that the other members appreciated and “welcomed the experience he brought to the business.”
A life of leisure?
Known to give directors licence to spend more time on the beach than in the boardroom, partial exits can raise concerns about funding a ‘lifestyle business’.
Generally, such worries are valid if one person owns the majority of the company. Rasche explains that in the instance of SSP’s partial exit, the shares were nicely spread: “I owned 40% and the chief operating officer had 25%, while the other two directors had 10%. We were all motivated and wanted to continue.”
Similarly, a perfectly legitimate reason for a partial exit is that the person who started a business could be purely an innovator. This type of individual may need a commercially streetwise partner to come in and generate hard sales.
Duffin refers to this sort of business owner as a ‘mad scientist’. He says: “What you might be good at is design and putting together the technical capabilities of a product. What you may not be so good at is the commerciality of something, such as understanding how the market is broken down into segments.” Essentially, this is the capacity in which Duffin joined washroom specialist Enviro-Fresh. The business was sold at the end of last year to Rentokil Initial for £9 million.
Mark Ligertwood, a director at mid-market private equity firm Dunedin, says that assessing the motivation of the executives when buying into a business is important. “Naturally, we’ll assess the amount of capital they want to release and whether it’ll enable them to turn their back on the business and not really worry about it any more,” he explains.
“Even if that is the case, we’d look at how crucial that person is to the business and whether they had brought in professional management teams to run the operation effectively in their absence.”
A more common practice
Whereas in years gone by brows may have instinctively furrowed when a business owner wanted to release some capital, Ligertwood suggests that nowadays there is a better understanding of wealth and its management: “We’re more accepting that people suddenly want to ‘de-risk’ because it dawns on them that they have 80 or 90% of their risk tied up in one business.
“I think previously there was the mindset: ‘If they’re selling, should we really be buying?’ Generally, however, I think there is a greater acceptance now that people are looking for liquidity and, I guess, they want a more flexible way to fund their lifestyle.”
Howard Leigh, director and founder of Cavendish Corporate Finance, observes that when a business owner discusses releasing equity, it’s useful to try to envisage what will happen when things don’t quite go according to plan. He says: “You have to make sure you have real and genuine control – which is not necessarily the same as owning most of the equity – by having some tough negotiations on actually controlling the business when you miss the budget or miss some other parameters.
“You need to ensure that you have authority over proceedings and understand that if you have a private equity investor, they will want an exit in – as a rule – three to five years. If that doesn’t work for the business, you may be better coming up with a pure debt package.”
An alternative exit
Another form of partial exit is through the recapitalisation of the business or a float. This is precisely what Rasche did last year with SSP. Since bringing in LDC in 2004, the company has doubled in size and has bought four more businesses.
After a strategic review assisted by one of the ‘big four’ accounting firms, where options were considered such as refinancing through additional outside capital or even a sale, it was decided that opting for an AIM float would be for the best.
“The main reason for this was that if we’d taken another VC on and refinanced, our terms wouldn’t have been as good as through our initial one, as they’d have taken a greater share of the business,” Rasche says.
With an eye on international expansion, SSP raised £31 million. Rasche says it was at this stage that LDC sold more than half its shares and other management and staff sold just over 20% of their shares.
Going public evidently changes the business, notably in terms of control due to stricter financial and corporate governance requirements. For Rasche, these were compromises that had to be made to facilitate the company’s growth.
“I guess on the basis that you’re a listed vehicle then you’re a different beast,” he muses. “I have a 16% stake now and, while that makes me the largest shareholder, I obviously don’t have control. 55% of the business is now owned by the City.
“If you’re running a company that you want purely to be your type of business, then a flotation might not be the right route for you. A friendly VC or bank debt might be a more workable alternative.”
A good fit
It’s a point expanded on by Cavendish’s Leigh. He says: “You need to understand what it is you are trying to achieve and find a structure that is appropriate for your business. There are venture capital trusts for smaller deals or some private equity houses which like these kinds of transactions; you need to identify the one that suits where you are going.”
Rentokil Initial’s Duffin comments: “If you release so much equity that you lose majority control, then the dynamics of the business change overnight. It’s at this stage that you discover whether the private equity house or VCs have an ulterior motive about stepping in.
“I’m not saying that will always be the case, but some do because they have a bigger picture or a bigger plan than your own.”
Exiting a business can do strange things to those around you as the prospect of receiving money comes close to reality. While it may be more of a feature with full exits, Duffin states that generally, “the greed is phenomenal.”
He explains: “People react and respond to you in a particular way because the greed takes over [towards completion]. You have to stay true to the way you have always done business. Hopefully, this is in an honest and open manner.”
Examples of avarice taking hold include members of the management team feeling undervalued at their slice of the sales exit bonus or complaints that the value of the company is too low.
A potentially more damaging issue can arise over the sale-purchase agreement, which carries a set of warrants and liabilities for those who are closest to the deal: “It’s a different form of greed, where shareholders or board members will want to ensure they can mitigate their risk onto other members of their team,” says Duffin.
The success of a partial exit depends on tough negotiations and being crystal clear in your mind about what the endgame is both for you and for the business.
“It is all about communication,” says Duffin. “I think your job as an MD or CEO is to ensure that your investors or shareholders are aware of what it is you are going to do. If you are prepared to release equity in your business, then it allows you to gain other skills from people and it should be able to help you achieve your ultimate goal.”