A few weeks back I found myself sitting among a sea of entrepreneurs at an ‘Exit’ seminar organised by this magazine. Of everything on the agenda, I was most intrigued by a salutary tale being told by a speaker about two successful businessmen and the respective thriving ventures they had built over the course of ten years.
Both men had founded their enterprises with their own cash, had happened upon great business ideas, deployed sound business models and had put in an equal amount of blood, sweat and tears. The difference at the end of the road though was stark. Entrepreneur A was still owner of over 70 per cent of the business prior to selling it. However, Entrepreneur B’s share of his venture prior to exit was a mere two per cent. Or, to put it another way, ‘A’ raked in £14 million, while ‘B’ made a mere £400,000.
The difference in their rewards was down to how they had funded growth. ‘A’ had been fanatical about keeping as much equity as possible, deploying an array of canny practices in the early years and using a variety of more complex financial mechanisms in later years. ‘B’, meanwhile, had issued new shares to venture capital backers (when he hit trading problems) and new shares when he bought other businesses, developed new products or needed capital to move into new markets. In the end, he eventually made more money for his outside investors, venture capitalists and City institutions than he did for himself.
It’s a state of mind
To build your business from scratch without recourse to outside investors requires a tenaciousness and a bloody mindedness that few exhibit. In the early days, when you may only have recourse to personal finances and the operating revenues of the business ‘bootstrapping’ is the order of the day.
The main issue here though is that bootstrapping is only likely to get you so far along the growth curve. After you’ve cut costs, outsourced everything non-core, switched suppliers, reduced inefficiencies, and arranged as many marketing and advertising ‘contra deals’ as you can, you need to start being really innovative.
According to Mark Crossfield, a director at Bristol-based M3 Corporate Finance, which raises finance and provides transactional support for growing businesses, many smaller firms fail to secure bank or other funding (which doesn’t involve issuing equity) because they think they lack sufficient collateral with which to obtain a loan.
Says Crossfield, ‘we try to look at various debt options centred round the balance sheet or cash flow for leverage. We like to exhaust every asset route – properties, assets, stock – to get leverage for the business. For instance, you might be able to use future cash flow to drive out unsecured funding, although whether or not you obtain it will depend on the size of your business.
‘It’s about a state of mind, about thinking creatively,’ he says. ‘For instance, as well as the usual invoice discounting and factoring solutions (cash advanced by finance houses against outstanding sales invoices – see case study below) there is the relatively new option of payroll financing. ‘This is a good contingency way of getting growth and one that is flexible,’ claims Crossfield. However, as it is an unsecured loan to help you meet your payroll costs, you must be over a certain size and the charges may be prohibitive for some.
‘It might also be worth your while looking into areas such as loans and regional development grants, and creditor renegotiations/creditor financing,’ he suggests. ‘Ultimately, the funding option you go for [at an early stage] can depend on what type of funding you need and what you intend to do with it. For acquisitions, you might use a mixture of all of these and get a leveraged deal together, rather than have to dilute via a private equity deal.
‘A lot of companies will assume they can’t get the leverage so get an equity provider and suffer significant dilution. So, if you get a negative reaction from the bank, at the very least be aware of what’s hidden in the balance sheet and in your cash flow.’
Sell, lease and watch it grow
When successful businesses get to a certain size, no amount of clever efficiency gains or cash flow financing options are likely to deliver the funds needed to take you to the next level in sufficient time to exploit whatever business advantage you have. This is often because quantum leaps in size and scale require a commensurate financial injection.
Charles Whelan, managing partner at HW Corporate Finance, advises owners to take a long hard look at their business assets and where they sit within the overall commercial strategy. ‘If you’ve reached a certain stage and you and your backers don’t want significant equity dilution, you need to sit down and think, “What can I best get out of this business?” If you are a widget-maker, you might take a considered view on whether you should actually own anything that is not about making widgets. In this context, sale and leaseback of assets is great for freeing up cash for growth.’
Selling property to maximise firepower and fuel growth is perhaps the best-known sale and leaseback technique, popularised in the past by high street retailing giants. As well as slashing your property management costs, it drives efficiencies by helping you to focus on your core business.
One venture to use this technique to considerable effect recently has been garden centres play Blooms Of Bressingham. It recently completed the sale and leaseback of its 26-acre freehold at Bicester with Blooms Properties Limited Partnership (BPLP), a 50:50 joint venture with LaSalle Investment Management, for £10.9 million. The joint venture will now provide Blooms with the finance to make acquisitions of rival businesses, with Blooms granting BPLP the first refusal on any property that is subsequently sold at the newly acquired sites.
Since announcing the sale and leaseback, Blooms has bought the business and assets of the Worcester Garden Centre and Stevenage Garden Centre, taking total portfolio garden centres to ten in moves that will boost the heated covered space from which it trades by more than 60 per cent over the next two years.
Selling it off, growing fast
Pure property and non-core business disposal have greatly strengthened the growth prospects of acquisitive £183 million global distribution venture Diploma, which operates in the life sciences, seals and controls sectors. By taking this cash-raising route, its shareholders have, like those at Blooms, been able to avoid serious equity dilution.
‘Over the years, we have funded our growth through cash flow from different sources,’ recounts chief executive Bruce Thompson. ‘Firstly, operating cash flow, because once you get scale in distribution you become a positive cash generator. Secondly, we have been fortunate in that we had land from legacy business that was surplus to requirements, and we have generated about £18 million over three or four years from the sale of three phases of land at Stamford for residential development.
‘Thirdly, going back a few years,’ he continues, ‘we went through a major restructuring and sold off a number of non-core businesses in areas like building products and specialist steels for £90 million, though we actually returned £70 million of that cash to shareholders. ‘So on the one hand, we generated cash ourselves, and have used that to make acquisitions, but we have also been in the position to make acquisitions through cash (no dilution), and in my view, that certainly strengthens your hand when it comes to negotiations.’
Diploma’s recent half-year figures to March were excellent, with Thompson announcing a 20 per cent rise in profits to £9.7 million on sales up 17 per cent to £63.5 million. Profits after the sale of that third phase of land rocketed higher from £8.3 million to £20.3 million, and Diploma closed out the financial reporting period with a fat £30.3 million cash pile that will help the business expand further.
Banking on the virtuous circle
Of course, the most obvious way to avoid losing control of your business and future rewards, is to build up a venture with strong foundations and good cash flows (easier said than done), and then borrow from the bank to fund organic and acquisitive growth.
This is exactly what chief executive Vin Murria of thriving software consolidator Computer Software Group (CSG) has done over the past three years. As well as being CEO, Vin is also a partner at Elderstreet Investments, which owns around 25 per cent of the business. She has been at the helm of CSG since 2002, steering its turnaround from a loss-making, moribund business to one that has just posted a 79 per cent improvement in sales to £25.9 million for the six months to February. Profits leapt even more, from £0.9 million to £2.35 million.
‘We have combined acquisitions with organic growth, buying seemingly weak businesses that actually had real value and underlying profits, but which had been run as lifestyle companies. What we have done each time is release the potential within.’
In all, CSG has completed ten acquisitions in the past three years. The first three were a mixture of cash and equity, the fourth was a pure cash deal, the fifth entailed ‘a little bit of equity’, but from there on in, all the acquisitions ‘have been about cash and debt, with no dilution’.
‘In the early days, you will need an element of dilution to get the ball rolling,’ concedes Murria, ‘where an acquisition is structured perhaps as 50 per cent equity and 50 per cent cash. But if you’ve got the model right, as you go along, you will end up with a bigger chunk of debt [or cash] and a smaller slice of equity, because the business should be generating sufficient resources for you to use cash flow to fund the bank debt. It then becomes a virtuous cycle.’
See also: Roundtable on SME finance and business growth – A discussion on SME finance drawing on the fields of invoice factoring, commercial finance and accountancy and the obstacles to business growth.