Partial exits: a balancing act
Article Date: Apr 30 2007If 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 per cent 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.
Not too hot, not too cold
David Rasche, executive chairman of insurance IT specialist SSP Holdings, knows how to walk this tightrope. ‘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 SSP at the time meant that £10 million could be released, which was spread between management and staff, while Lloyds Development Capital (LDC) took a 30 per cent stake in the business.
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 ‘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 per cent and the chief operating officer had 25 per cent, while the other two directors had ten per cent. 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, suggests that nowadays there is less automatic suspicion when business owners want to release capital. He says: ‘I think previously there was the mindset: “If they’re selling, should be 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.’
Hidden dangers
Though private equity funding may have its advantages, it isn’t always the best option. It tends to mean a transfer of partial control to the investor, and risks further disruption to the business if that investor wants to exit five years down the line or even sooner.
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.’
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 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 per cent of their shares.
Questions of autonomy
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 per cent stake now and, while that makes me the largest shareholder, I obviously don’t have control. Fifty-five per cent 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.’
It’s a point expanded on by Howard Leigh, director and founder of Cavendish Corporate Finance. 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.’
Business XL (from which this article is taken) regularly runs seminars on exit strategy. Click here for more details.
