Securing an outside investor can be both a blessing and a curse for growing firms. On the plus side, new shareholders can bring cash, experience and sound counsel. But external investors don’t back companies because of their heightened sense of altruism – they want to make money. The downside is that relationships can become strained if your business strategy doesn’t pan out as planned. In the end, you may decide your current shareholder is more trouble than they’re worth.
Prolonging a troublesome investor relationship past the point at which you clearly should have parted company can backfire. In the worst-case scenario, investors could launch the ultimate commercial coup d’état and oust you from the enterprise you started.
See also: Help, my aggressive angel investor is trying to sue me! – Here, we talk to a company founder about their nightmare encounter with an angel investor.
This, of course, is the fate that befell advertising agency darlings Maurice and Charles Saatchi in the early 90s. The brothers had embarked on an audacious acquisition programme (culminating in an improbable and ill-fated bid for Midland Bank), all the while making their eponymous agency Saatchi & Saatchi one of the biggest firms of its kind in the world. But as the acquisitions mounted, so did the debts and a colossal wave of investor disdain. Unsurprisingly, both brothers eventually departed.
Because their company was listed on the stock market (and the siblings were fantastically famous) the Saatchi soap opera was played out in the full glare of the media spotlight. But private ventures are prone to the same problem of negative publicity, even if, as Alan Bristow, managing director of corporate finance firm Icon, points out, ‘Private companies don’t tend to make the headlines.’ So it’s best to resolve shareholder strife before it threatens to bring down your empire.
The dangers of disillusionment
Tension between a business’ management team and its shareholders can arise for a plethora of reasons. As Andrew Millington, corporate finance partner at business advisory group Mazars, elaborates, ‘The business may be underperforming, missing key targets, being consistently in breach of its facilities or offering limited exit opportunities.’ Alternatively, relations between the two parties may simply break down on personal grounds.
Regardless of the circumstances, such tensions can be severely damaging, at the very least because they will almost certainly distract a management team’s focus away from running the venture. ‘Significant time and effort can end up being devoted to managing tricky investor relations and that usually means the boardroom becomes less effective,’ Millington continues. ‘In a difficult trading position it can make an already precarious situation worse.’
The situation can become even more unstable if the investor has a significant or majority stake in the business. With a 25 per cent holding, for instance, a shareholder will have the right to block any special resolutions the management team is trying to put through, while a 50 per cent interest grants an investor a wealth of additional powers, including the ability to hire and fire directors. Should a shareholder’s stake exceed 75 per cent, they would have the clout to do more or less whatever they wish.
The rights a company has to oust a problematic investor are not clear. Alasdair Steele, partner at law firm Travers Smith, notes that, ‘The starting point will always be to look at what agreements are already in place.’ If the initial agreement signed when an investor joined the business stipulates the criteria through which that investor must exit, the company will have a chance of legally removing them. If not, they will struggle, as ‘the law generally doesn’t take kindly to the removal of assets or property from an individual,’ says Steele.
‘It’s probably best to specify from the start how you’ll remove someone if you have to in the future, drawing up a contract everyone signs. That way, you start with a blank piece of paper and you can write what you want that’s most suitable for your business,’ he explains.
But the downsides are twofold. Firstly, any ground an investor concedes to you through such an agreement is likely to be reclaimed by them elsewhere – through veto powers over management appointments, plans, budgets and the like. Moreover, possessing an easy route to ditching an investor may be counterproductive. Such agreements can make it all too easy for management to protect their own interests and apportion blame for problems by making the shareholder a scapegoat, leaving the real issues at the heart of the problem unaddressed. That’s not likely to go down well with fellow investors.
On balance, says Steele, such agreements are ‘definitely worth thinking about, but it’s very much down to personal taste and they should only be exercised as a last resort, when directors and shareholders really aren’t talking to each other.’
The good news for entrepreneurs with troublesome backers is that, in most cases, an amicable separation agreement can usually be reached and disaster therefore averted. ‘What you have to remember is that among investors everything is for sale at the right price, and it’s very rare that you come across someone unwilling to negotiate,’ comments David Beer, boss of business angel network Beer & Partners. ‘Most people become rational when it comes to money and most investors would rather have a cheque in their hands than a load of hassle.’
Institutional investors, such as venture capitalists and private equity firms, claim to be particularly rational in this way. They argue this is because they are juggling multiple investments at once and if one is causing trouble they would far rather secure some form of exit (and move on to the next investment) than end up with an unproductive millstone around their neck.
‘If you’ve fallen out with your venture capital backer you should sit down with them and ask what is it they want from you,’ Travers Smith’s Steele advises. ‘Preventing a problem from deteriorating is crucial. And before you think about replacing them, remember that venture capital firms often have the power to remove a CEO, although they tend to avoid this as its bad for their reputation.’
Individual investors can prove even more difficult to deal with, as minor disputes have the potential to escalate into genuine personality clashes. ‘There’s a lot of money involved in these situations and people can get very emotional,’ says Icon’s Bristow.
Negotiation will almost certainly prove to be the strongest weapon in your armoury. For Beer, the secret is to remain calm. ‘Negotiations have to be conducted on civil terms. If you do things aggressively the whole process becomes very difficult.’
‘You need to look at the circumstances surrounding the disgruntled shareholder,’ agrees Bristow. ‘Identify what has changed and try to think about what it will take to buy that person out.’
Engineering the buyout
If the relationship has broken down irretrievably, a buyout is the most likely route through which an investor can be displaced. One course of action is a straight management buyout (MBO), funding the purchase either through the individual or collective reserves of the management team, or with the aid of the banks or finance houses. But this form of pure MBO is not viable if funds are not available, so in many cases an alternative backer (be it an individual or institution) will have to be identified.
Various corporate finance and business advisory firms – including Corbett Keeling, Icon and Livingstone Guarantee – can assist in this buyout process, but the problem is, as Mazars’ Millington indicates, ‘In order to replace an existing investor with new funding, the management team will need to prepare a credible plan. This must recognise the present situation, acknowledge whatever issues a company faces and be realistic. After all, any new investor will be cautious.’ That guarded approach is not necessarily a major problem in itself but it does mean that the board must be prepared to address and be patient with all the concerns an outsider is likely to have. In particular, Bristow indicates, ‘You need to prepare an answer to the key question they are bound to ask: “If this company is so good then why does the departing investor wish to leave?”.’
Fortunately, conditions are currently ripe to attract investment from the private equity community. According to KPMG’s Private Equity Group, which tracks UK buyouts with values over £10 million, transactions with a total value of £4.78 billion were completed in the first quarter of 2005, at an average value of £137 million; an increase of 28.4 per cent on the same quarter last year. Private equity individuals or firms are always looking for the right opportunities to invest, particularly in terms of already profitable, strongly trading businesses with plenty of growth potential. So if you can prove that applies to your company, they may be willing to plug the gap left in your funds by your exiting investor.
There has also been a recent rise in secondary buyout activity, where a company acquires a stake in another business from a departing shareholder, rather than purchasing directly from the business. ’Between 30 and 40 per cent of buyouts are going down this route,’ states Jim Keeling of corporate finance house Corbett Keeling. ‘This is a growing trend, probably driven by the fact there’s a lot of private equity money around at present.’
Regardless of which buyout route you opt for, it’s important to remember it’s illegal for a company to loan incoming investors cash or assist in the acquisition of its own shares.
Last, but by no means least, management teams must remain realistic in terms of the buyout process itself. Things may seem to be progressing smoothly, but until the process is complete there’s also a danger the picture will rapidly change. It is, as Bristow suggests, ‘Purely a matter of the personal pressure points of your departing shareholder.’ There is nothing to prevent an investor from turning round at the last moment and stating that they will only leave providing they get ‘X and Y’ in addition to what has already been agreed. In that situation, you may find they have you over a barrel and you’ll need to call your lawyers.
Never take anything for granted.