The Role of the Board in M&A

ImageWhile the CEO and CFO will be responsible for driving a deal, it’s essential for other board members to play their part in providing robust input on whether an acquisition is in the best interests of the business and its shareholders. This begins by talking through the strategic fit of a target and continues with ongoing assessments of whether the integration process really is on track.

Terry Stannard, Chairman of interior furnishings company Walker Greenbank, says: “Once the initial excitement of an acquisition has taken place, the NED [non-executive director] has an absolutely critical role to play around reinforcing the milestones that have been set to ensure a successful acquisition is made, so that the integration and the synergy benefits are effectively managed…

“The NED needs to ground the executive team to ensure that the acquisition does actually create shareholder value and does not, like so many of them, become a rather wasteful distraction.”

Liz Claydon, UK Head of Consumer Markets at KPMG and a Partner in the Transaction team, comments: “I see a key role of other board members as being one of challenge: does this M&A strategy align with the overall strategy for the business? You see that playing out in their specific areas of expertise, be that the CIO [Chief Information Officer] in terms of how the different systems will integrate, or the HR Director in terms of the different culture of the target… Remember, the key priority for the board on behalf of the shareholders is that value is created.”

In practice, this means digging deeper into the transaction. Simon Denham, Founder of online trading concern London Capital Group, comments: “Many times an acquisition requires large synergy savings to back up the numbers. Synergy savings are notoriously hard to achieve and any number quoted by the CFO should be torn apart and re-analysed by the NEDs. In some circumstances it is wise to bring in outside consultants to go through the data, before going through the expensive bits of due diligence and legal costs.”

Much of this will be par for the course for a good NED; someone who knows how to walk the line by providing a healthy degree of challenge while also allowing the executives to get on with the job of driving the business. Jim Wilkinson, Chief Financial Officer at African investment concern Lonrho and former Group FD at online gambling company Sportingbet, comments: “The big danger obviously is that they get excited by the deal, as much as the management team do, and they race through [it].

“They really should be questioning why we’re doing it… [but] they need to be at a distance from the deal, remain impartial and be able to make a rational decision about whether it’s a good deal or not.”

Paul Staples, Managing Director of Investment Banking in Europe for BNP Paribas, comments: “A NED should aim to be a sounding board, facilitating – though seldom leading – a rigorous discussion regarding the wisdom of an acquisition. They need to display good judgement, understanding when to be supportive and when to put forward a more challenging perspective.”

In essence, the M&A process can be seen as a litmus test for the health of the executive and non-executive team. “Once a target has been identified then the whole board should be notified and the rationale explained normally by the CFO, but with assistance from the CEO,” observes Simon. “It is for the board as a whole to agree on whether the reasons for the acquisition are realistic, believable and attainable.”

A similar point is made by Mark Garrett, COO of global technology consultancy Ricardo. “The whole board should understand and agree to the rationale for the acquisition, but the rationale should be proposed by the executive team based on [how it fits with] corporate strategy,” he says.

Creating value

After the euphoria of signing a deal has passed, the danger is to just blithely move on to the next big thing. Bob Emmins, Finance Director for The Silver Spoon Company, which is a £250 million business within the grocery division of Associated British Foods, says: “The hardest thing about an acquisition is integrating it and thereafter achieving the objectives and financial goals. To succeed you’ve got to get your full team behind it, buying into those goals and recognising that they have an executive responsibility to deliver them post-acquisition.”

Anne Stevens, VP, People and Organisation at mining concern Rio Tinto Copper, says: “In recent years there’s been a big shift towards recognising the importance of getting the people aspects of a deal right.

“If you don’t get the people piece right… [and] if you don’t manage all the key stakeholders correctly then a deal, whether it’s a good commercial deal or not, is going to fall flat on its face.”

This is something that needs to be pursued by the board so everyone is clear that the original goals of the acquisition are being achieved and, if not, appropriate decisions are made to find out how to create value from the new company.

Bob says: “There needs to be a distinct view taken as to how the business or the cultural differences of what you acquire fit into your existing business… Increasingly, because it’s nearly all down to people, the HR director should have a greater say on whether the two businesses will fit together or, if not, where the clashes are going to be.”

As market conditions improve, corporates are finally loosening their grip on their balance sheets to make acquisitions. Yet it remains an environment where boards must demonstrate they are delivering long term, sustainable value. If that is to happen, directors need to work together and be fully aware of their roles and responsibilities on the M&A journey.

I hope to see you soon.

Matthew

www.twitter.com/criticaleyeuk

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Growing Pains for Private Equity

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With growth resolutely back on the agenda, many financial sponsors are rethinking how they should be supporting portfolio companies in an increasingly complex, global landscape. For attendees at Criticaleye’s recent Private Equity Retreat, assistance in the form of new contacts and forging a route to market are to be welcomed, but there was a strong push-back on firms interfering with how management teams look to execute on strategy.

Ian Stuart, Chairman of four mid-market PE-backed companies, including manufacturing concern Aspen Pumps, says: “The job of private equity is to back management and every so often intelligently challenge. But the point where PE sets out the strategy for growth, even though they are not the ones actually running the business is, I think, dangerous.”

While a fine line needs to be walked, there is an aspect to this which is cyclical. Keith Holdt, Investment Director at LDC, comments that over the past two years the firm has used more generalist managers to assist management teams, but “the ideal investment is one where the management is not only competent but knows what it needs to do to grow the business”.

Carl Harring, MD of HIG Capital, makes the point that as a company looks to evolve and develop, new personnel may well need to be brought in. “We always look at a portfolio company and ask: ‘What will the business look like when we’ve gone through a period of change with it?’

“A different style… [and] new blood may be needed in the management team as a business changes focus from cost saving to pursuing a growth agenda.”

Brighter outlook

The mood among attendees at the Retreat was noticeably upbeat in terms of businesses investing for growth and increased exit opportunities, not only via trade and secondaries but also through IPOs.

Glen Moreno, Chairman of media company Pearson and Non-executive Director of Fidelity International, says: “[There are] record levels of unrealised returns; many LPs are at their asset allocation levels and will want to see distributed gains in their portfolios…

“The exit potential is improving… The underlying demand is there for corporates to buy PE-backed companies. Secondaries remain important but don’t have the same positive impact as trade sales and IPOs on the PE environment.”

According to Thomas Kalaris, Distinguished Executive in Residence at the University of Chicago Booth School of Business, sponsors and businesses are emerging from the “mess of 2008” but there are also wider adjustments that need to be made. “Changes in demographics, geography and technology are fundamentally reshaping the global economy and financial markets,” he observes.

Understandably, if companies are to flourish in such an environment then the executive team must be able to candidly evaluate the skill-mix within an organisation and, particularly in a PE-backed entity, be focused on succession so that the next tier of leaders is seen to be coming through.

Bill Ronald, Chairman of ComplEat Food Group, a supplier of chilled foods, says: “Senior executives must regularly take time out to get together and debate where the business is in relation to its marketplace. You need to get to the stage where the strategy is simple enough that everyone around the table can explain it in two minutes…

“Never be complacent about people. You need to be rigorous about filling the roles that are required to develop the business for the next three to five years.”

A similar point is made by Tania Howarth, COO of frozen foods company Iglo: “Incentivising the ‘mighty middle’ is a key challenge because they effectively do most of the work in the business without the pay-off at exit, and the last thing you want is divisiveness in this group.”

It puts pressures on leaders to create a long-term vision through which staff and investors alike can identify. Rob Crossland, CEO of employment services company Optionis, says: “There’s always an equalising pressure on short-term results in PE, but having a business centred on a goal and incentivising the workforce and other stakeholders to achieve it is something that I’ve found PE will buy into.

“We’ve been fortunate in that our investors have allowed us to try different things in order to move the business forward… [and] that relative freedom to experiment has created a positive environment within the management team.”

Unquestionably, the real problem facing both PE firms and management teams is around international expansion and globalisation. For PE, it’s a case of developing the know-how and reach to be able to make a difference as executives are faced with the need to form partnerships, make acquisitions, develop distribution channels and obtain licenses, on top of getting to grips with the regulatory and cultural unknowns (indeed, it was suggested that PE firms themselves may need to start looking to a more diverse pool of talent to meet these needs).

Building scale remains imperative for a company heading towards an exit.Glen says: “The key challenge for all of us [in business] is growth, both in economies and customer revenues. Management teams that can shift the business into high-growth markets, and new customer groups, will be rewarded.”

I hope to see you soon.

Matthew

https://twitter.com/criticaleyeuk

How to Maximise Value in M&A

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With the M&A market tantalisingly poised to reopen, it’s encouraging to find that management teams have the confidence to execute their plans for growth by completing ambitious deals. That said, only those companies that remain disciplined about selecting an acquisition target, and have a clear idea about how to integrate a new business, will generate real value and meaningful returns for investors.

David Turner, CEO of private equity-backed call centre firm Webhelp TSC, who has been given an £84 million warchest to fund acquisitions, says: “You’re looking for those businesses that are additive in terms of capability, so that it is different to the existing combination and it aligns to your strategic goals.”

In these markets, the case for a deal has to be crystal clear. Paul Walsh, who led a number of major acquisitions when he was CEO of global drinks business Diageo, comments: “You have to understand your objectives and what you’re trying to do. In [Diageo’s] case, are you trying to buy distribution? Are you trying to buy the local brand? The local management? You need to be very clear about that and it could be the case you need all three – just because something is out there and available, it doesn’t make it the right deal for you.”

A forensic approach is required if you’re going to maximise value from a transaction. Mark Garrett, Chief Operating Officer at technology and engineering consultancy Ricardo Plc, says: “We are constantly on the lookout for suitable targets and when one in particular starts to look right, we energise a small specialist team to dig deeper and review on a step-by-step basis so we can close the opportunity down at any time and try to eliminate any emotion or personal agendas from creeping in.”

It’s a case of separating responsibilities. Paul Budge, MD for the UK & Ireland at consumables distributor and outsourcing business Bunzl, comments: “The operational leadership is charged with finding the prospects, putting the case together and presenting it to the board… [whereas] the M&A team will actually run the transaction, in terms of tabling the offer, commissioning the due diligence and handling the process of negotiation.”

Deals on the horizon

Although there has been caution over M&A transactions, it does appear like things are finally going to pick-up. Sean Longsdale, Managing Director for Santander’s Structured Finance Group, says: “We’re seeing limited M&A activity from mainstream corporates, public companies or larger independent businesses looking to acquire…

“But we are seeing a very active private equity market, which has found renewed confidence, good volumes and leverages beginning to creep up a bit… In businesses that are stable, predictable and with strong market positions we’ve seen debt leverage of 4 to 4.5 times.”

Charlie Johnstone, Origination Partner at PE firm ECI Partners, comments: “There are more growth companies than we’ve ever calculated in the UK at the moment and a lot are interested in expansion capital… The big drivers of growth for the companies in our portfolio are internationalisation and M&A; we’ve done five bolt-ons in the last 12 months.”

Of course, deals are getting done on the public markets too. Adrian Gunn, CEO of recruitment agency Matchtech, which last month paid £4 million in cash for technology concern Provanis, says: “We’ve been giving [the City] a consistent message for the last few years… so I knew it wouldn’t come as any major surprise to the investment community as to why we went for it.”

Good fit

As ever, the integration of a new business will determine whether a deal is to be successful. David says: “[It] must be top down led and involve senior management from the acquired company. The way I’ve done this in the past is that you have a steering group led by the two leaders of the businesses, then you have a project team in place which has joint accountability from both leaders… If you get the integration right, you get very little problems coming back to the steering group.”

Julia Robertson, Group CEO of outsourced HR services provider Impellam, comments: “It’s vital to have absolute clarity of expectations, spending sufficient time listening carefully to the point of view of incoming management and communicating clearly, over and over again.”

I hope to see you soon.

Matthew

https://twitter.com/criticaleyeuk

The People Side of Global M&A

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Integrating a newly acquired business is difficult at the best of times but fusing a foreign entity adds cultural complexity which needs to be addressed. People are the most important part of any M&A transaction and, in order to retain acquired talent after the ink on the deal has gone dry, it’s vital that senior managers move quickly to make them feel an essential part of the ongoing strategy.

Setting the tone of the integration in the first three or so months will be crucial. “Make sure you sit down with your newly acquired colleagues and give them absolute clarity about why you bought their business,” says Martin Sutherland, Managing Director of BAE Systems Detica, a division of the FTSE 100 aerospace company focusing on information and data security.

“You should share the management plan with them so that they own the acquisition case as much as you do… In those first 100 days you need to make clear why the acquisition was done, what the new mission statement is and what the expectations are of the acquired management. You then have to work with them to assess the best way of achieving that plan using all of their current approaches and processes.”

Communication doesn’t necessarily need to be dictated by head office as managers on the ground should be well briefed enough to handle questions from employees, customers and suppliers. “The most common mistake is to leave the foreign entity to its own devices. Culture, practice and loyalty are not absorbed by osmosis and true integration will require a lot of hands-on involvement in both directions,” says Richard Harvey, Chairman of consumer products company PZ Cussons, and a former Group CEO of insurance concern Aviva.

“If possible, I would appoint an existing and trusted corporate executive to be the new local CEO in the country in question. If not, then at least one or more employees to be transferred in at director-level. The more exchange of executives both in working roles, and through management training courses and so on, the better.”

Personal touch

The acquirer must make sure they’re giving plenty of time to focus on the softer side of the deal. Richard Prosser, Chairman of car rental distribution provider CarTrawler, comments: “Many make the mistake of hauling people into head office, but if you really want to understand the nuances of the acquired business, get under the skin of it and relate to the people, you have to visit that country often and not just reside in the boardroom.

“For example, an Italian business that I bought was previously owned by the Catholic Church, which was quite a transition to being a UK-owned plc, and one of the most important things I did every year for ten years was to go to their annual staff party. It was set in a rustic restaurant in Parma and there were 60 people in the company, which meant that I could personally thank everyone for doing a great job.”

Cultural issues shouldn’t be underestimated. Howard Kerr, CEO at standards and training provider BSI and a former MD of World Gas Thailand and Chief Executive of Calor Group, says: “The biggest problem is when you have people in head office who just don’t understand [a different] way of doing business. When we bought businesses in Thailand and Taiwan, I was the guy in Asia, and I spent as much time arguing with my people in HQ as I did speaking with the target company in Asia, because they just didn’t appreciate the cultural sensitivities and didn’t have the personal experience of having done it themselves…

“In Asia, it’s about getting the trust and confidence of the individual and it takes time to make sure people really understand what you’re saying. Sometimes you’ve actually got to protect them from your head office to make sure you don’t lose the deal.”

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Beyond the facade

Trust will only truly be created once the realities of the deal come to light. Not everything will have been covered in the due diligence and acquirers need to probe for any discrepancies.

Keith Butler-Wheelhouse, Non-executive Director at specialist plastics products manufacturer Plastics Capital, and a former Group CEO of multinational technology concern Smiths Group, explains: “Most businesses are sold professionally these days; there’s a prospectus and the numbers and market data are polished, and it omits anything that’s not great… As the buyer, you should be looking for the things in the business that, if you were buying it [without the help of advisors], you would consider to be the major risks. You need to test those questions with the management once they’re over the wall and ask them what they consider to be the biggest risks in the forecast over the next 12 months.

“The skill is in mitigating some of those risks and driving the path between the very optimistic way that something is always sold and the realism of what might go wrong. Then, during the integration, there won’t be any surprises. But unless you ask the right questions, you won’t get under the skin of it quickly or get the honesty you need from the management.”

The purpose of the deal has to be clearly defined on both sides if the two separate businesses are to be combined successfully. Aleen Gulvanessian, Partner at law firm Eversheds, says: “Our experience shows that acquisitions can succeed or fail as a consequence of good or bad integration planning. This should run alongside the acquisition contractual process with integration teams set up to ‘hit the ground running’ on deal completion.”

David Turner, CEO of French outsourced contact centre specialist Webhelp TSC, which acquired UK-based HEROtsc in February, comments: “It’s at board level where the deal is done and, to get our people onboard fast, the first thing we did was to bring the two management teams together at the senior level. We had a vision and knew at a high level what integration should look like but we didn’t have the detailed plan before going into the deal as we wanted the two teams to design and build the content.

“We’ve just had our first steering group meeting of that integration plan, which included myself and one of the owners of Webhelp, and appointed one person from each of the businesses to manage the project for us and lead a series of work streams to deliver the content behind it. Because of that, we’ve got two sets of management teams feeling as though they own the programme and that there is a process where their views get heard.”

Yetunde Hoffman, who recently stepped down as Global HR Director at Imperial Tobacco, where she was responsible for HR integration following the FTSE 100 tobacco firm’s acquisition of the Spanish-French joint-venture, Altadis, comments: “Town hall events and cultural integration workshops will help management understand the values of the acquired organisation and the values of the people that come with it. Having opportunities to share opinions about the integration is absolutely crucial because it impacts engagement and the ability of people to work effectively together.”

A similar point is made by Alison Esse, Co-founder and Director at change management consultancy The Storytellers: “What’s important is that you create a shared vision and then you start to shape your organisation, its rewards and processes around that vision, and look at the cultural side of the business as soon as possible.”

Plenty of transactions that looked great on paper have been ruined due to poorly thought out integration plans. Howard says: “An awful lot can go wrong in the first 100 days and if you lose the hearts and minds of the people who are joining you then, in my experience, it’s very difficult to get it back.”

Own Goals in Cross-Border M&A

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The acquisition of a foreign company figures highly on the agenda of many executive teams as the quest continues for new markets and improved economies of scale. Such transactions pose a considerable amount of risk and that’s why management must ensure the strategy is sound and the legal and cultural differences are understood, so a clear plan for integration is in place once a deal has been signed.

There will always be an element of risk associated with purchasing another business, domestically or abroad. Here are five of the most common howlers that CEOs need to avoid when they decide to go shopping overseas:

1) Assuming too much

It’s a dangerous game for management teams to make assumptions about foreign markets. Jim Wilkinson, Group Finance Director at online gaming company Sportingbet, says: “Every country has a different culture to the UK, with different rules and regulations, so you need to understand everything from holiday times, payment processes, bonuses, how they actually work, levels of remuneration, and how quickly people expect integration processes to happen.

“In the US, for example, where I’ve done a couple of acquisitions, management have expected all the redundancies to happen straight away, whereas in other countries, particularly in parts of Europe, they don’t expect redundancies to happen at all. Understanding how people expect you to manage them afterwards is important.”

Aleen Gulvanessian, Partner at law firm Eversheds, comments: “Local teams mustn’t be left to make assumptions which might be inappropriate in the foreign country, so you conduct the transaction in the way you would locally at your peril when dealing with a cross-border acquisition. It’s very easy to think that there won’t be a problem and just not be aware of something potentially critical.”

There will be differences, legal and otherwise. Ian Bowles, CEO at software provider Allocate, says: “It’s a mistake for an acquiring company to automatically assume that their way of doing things is absolutely correct and try to do things exactly in the way they would in their own territory, and I’ve been a recipient of this rather than a manager of it.

“There are legal and process differences and you need to understand the working environment and customer environment. You’ve got to be culturally sensitive when you acquire something overseas. You can endorse corporate standards but you’ve got to do it in a way that is acceptable to the team you’ve acquired or you’ll create misunderstandings and false barriers that’ll make smooth integration more difficult.”

Nothing kills a deal quicker. Jim says: “The biggest single mistake is cultural, where people assume that it’s the same as the country they’ve already operated in, and if you want to destroy value very quickly then do the acquisition and watch the management team walk as you end up with a rudderless company.”

2) Inexperienced management

As an acquirer, you need people you have absolute faith in on the ground. Paul Budge, UK & Ireland Managing Director at consumables distributor and outsourcing business Bunzl, says: “Because we’re very decentralised as an organisation, when we do an acquisition, the person that’s going to run that business, whether they are from the acquired company or our own resources, is going to be working remotely, so it has to be someone we absolutely trust.”

Bob Emmins, Finance Director at ABF Ingredients, says: “You’ve got to have a local presence. You can’t run it from the head office or another geography. You’ve got to have people that know the geography, the language and customers, the legal practices in particular and some of the local nuances that are applicable in that market, otherwise you’ll be very lucky to conclude the deal and you will not integrate it.”

It’s a case of getting the balance right. If the acquirer brings its people in and drives change too quickly or, by equal measure, too slowly, then the value in a company can quickly be eroded. Alan Howarth, Non-executive Chairman of telecoms specialist Cerillion Technologies, says: “The first 100 days of any M&A activity is key to an enhanced future business. Too often there appears to be a lengthy period of inertia where fear of the unknown travels across the combined business.

“The desire for change – always underestimated – is seldom found beyond those that initiate any such programmes. So the board has a responsibility to communicate the advantages and consequences the changes will bring to the new corporation. All too often, senior executives work very hard in this period but in isolation.”

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3) Post-deal lethargy

Another danger is that the process of integrating two businesses can be lost on executives. They get excited about the value creation on the balance sheet but forget the hard part lies in knitting the companies together. Aleen says: “We find that where the acquirer is disappointed with the target they’ve acquired, it’s often because you’ve got a different team dealing with the integration post transaction to the team that was involved with actually doing the deal.

“You should be thinking about integration during the course of the deal process. Where your team doing the deal overlaps with the one conducting the integration post acquisition, you tend to find the most successful transaction.”

Jim says: “You need to keep control of it from your head office; you can’t just leave it up to the local team. This means a lot of time is spent on the phone and it requires frequent visits to the country while you’re conducting the negotiations and due diligence, and once you’ve made the acquisition you need to physically be there.”

There are no shortcuts. Alan says: “In my experience, both in terms of mounting an international acquisition and more importantly integrating the target organisation with the host, success revolves around the understanding of culture and change. The more you appreciate the drivers and operating style of the acquired business the greater your likelihood of successful integration. Due diligence pays scant attention to the less quantifiable measures when the key to integration is ensuring that a new corporate message can be embraced by all parties.”

Bob comments: “People can get wrapped up in doing the deal and money talks, so money can often be used to get over the normal negation tactics to conclude a deal. But when you come to integrate it, if you haven’t thought about that market and put the right local resources in place, you are just destined to fail. You’ve got to have knowledgeable local resource with local connections.”

4) Poor use of advisors

Aside from having seasoned non-executive directors who know what to expect, it makes sense to invest in quality advisors as they can make an enormous difference during negotiations. Jim says that “you need local advisors as the local tax rules, regulations and laws are important, so you need people that know what they are doing”.

Bob says: “Third party advisors are the voice of reason that prevents you from going headlong into the pitfalls. They should not just be encouraging you to do a deal because they get a healthy commission on completion, but they have got to do more to protect the risks. For a longer-term benefit for their customers they need to be helping that customer ensure that the integration is successful.”

5) No plan B

Surprises in M&A are rarely of the good variety. Things will go wrong. That’s not to be cynical, but when you have volatile market conditions, different ways of operating and cultures and large sums of money involved, it’s probably wise to expect the odd hiccup along the way.

Simon Braham, Investment Director for cross-border M&A at private equity firm LDC, explains that contingency plans are crucial when a business begins to operate internationally and makes acquisitions, such as putting in place someone whose role is to specifically liaise between the domestic board and local management in order to ensure that any fires within the business are spotted and extinguished quickly.

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A lot of M&A loses momentum because management focuses solely on the deal and loses interest in implementing the rationale for increasing the size and presence of the business. Few companies can afford to be that lackadaisical in their thinking anymore. As Don Elgie, CEO of insight and communications agency Creston, puts it: “The key point is that acquisitions stand a greater chance of success if there is a strategic reason for them, rather than just financial roll up.”

That’s true regardless of where you’re buying a business, although acquiring abroad will undoubtedly present a greater test in terms of putting your ideas into practice, largely because of there being more variables to overcome.

Nevertheless, it’s not something to be shied away from. “Acquiring companies in faster-growing overseas markets gives UK companies an opportunity to more quickly build up scale and buy into the growth of these quickly expanding economies and markets,” says Simon. “Importantly, cross-border M&A offers a very strong alternative to what could be a higher risk and importantly slower ‘greenfield’ organic growth strategy.”

Just be sure your team are up to the task and the reasons for expansion have been examined. Pankaj Ghemawat, Criticaleye Thought Leader and Anselmo Rubiralta Professor of Global Strategy at IESE Business School in Spain, warns: “It’s the oldest mistake in international business, companies going overseas when they’ve succeeded at home.

“If you’re Walmart and you’ve mowed down Sears and K-Mart at home, obviously there’s a tendency to think: ‘If we can do this in the US retail market we should be able to do it in South Korea, Brazil or elsewhere.’”

Exits: A Question of Quality

Don’t be deceived by Facebook’s $1 billion (£629.8 million) purchase of Instagram, a company that is less than two years old and has yet to make a profit. In the real world, those companies looking to sell need to show a track record of reliable earnings and prove that there really is the potential for substantial growth.

Nigel Guy, Chairman of recruitment company The Cornhill Partnership, says: “The challenge for anybody buying a business until now has been the uncertainty of what levels of earnings you’re buying… The worst thing in the world, if you’re a buyer or seller, is to be involved in a transaction where halfway through you discover the numbers are going soft.”

A strong dose of realism is required. “There was a time when just turnover and EBITDA [earnings before income, tax, depreciation and amortisation] were enough to put a story together that got a reasonable valuation, but that’s clearly not the case anymore as it is so much more competitive now to get exits,” says Richard Adey, Chairman of JCC Lighting.

Within the boardroom, there has to be alignment on the timing of a sale and agreement about what an appropriate valuation could be. Paul Brennan, Chairman of hosting software company OnApp, says: “During any recessive cycle, buyers can say that your earnings aren’t growing at the rate that they were and they’ll bump down your valuation. So if you’re targeting an exit, you have to make sure everyone has a reasonable and rational view of what the exit value might be.”

Easier said than done, perhaps, but there is no shortage of potential buyers for UK businesses, especially on the international front. Peter Hemington, Head of M&A for professional services firm BDO, says: “We’ve seen lots of overseas interest on the buying side. The UK is perceived to be cheap and is getting attention from India and even the US.”

When it comes to valuations, Peter notes there is something of a “weird imbalance” in the market. He explains: “If a company is any good, it should get a healthy price. We have seen small businesses going for big multiples of EBITDA because, on the other side of the equation, there are massive amounts of unused private equity funds and corporate balance sheets stuffed with three or four years of uninvested cash. Deal volumes are low, but prices are relatively high and deals relatively straightforward to transact.”

Never the bride

For fair to middling companies, it continues to be hard to stir up interest. Chris Hurley, UK Portfolio Managing Director for private equity firm LDC, says: “Things are tough out there but high quality businesses with a competitive advantage are still attractive to PE and trade buyers alike. If you’re a ‘me too’ business and there is nothing distinct about you, then you are going to struggle to sell in today’s market.”

The challenge is to make a business stand out from the crowd. Chris, who recently worked on the £148 million sale of lingerie and swimwear specialist Eveden Group to Tokyo Stock Exchange-listed Wacoal Holdings Corporation, says the strategy was always about developing the business beyond the UK market.

LDC made its initial investment in Eveden back in 2006. Clearly market conditions changed dramatically and Chris reflects that after a period of de-gearing the business, a key decision was to make an acquisition in France in 2009 to drive on Eveden’s pan-European penetration. “It’s an extremely strong business and brand, notwithstanding it being consumer facing,” he says.

By contrast, Richard, who joined JCC Lighting last year, has deliberately opted to rein in the company’s expansion strategy: “We do sell internationally but I specifically closed some operations to concentrate on the UK market. You have to be really focused; at a certain stage in a business’ development strong international growth is a requirement but I don’t see that for us now as there is such an opportunity in the UK. The danger is that all you do is spread yourself too thinly.”

It’s an approach that demands both discipline and confidence. “You don’t carry legacy, you just kill it,” he says. “We have halved the number of products in our range as otherwise you end up managing your past as opposed to your future – and you have to clear your debt too and be really focused on it if it’s there.”

The fact is that executive and non-executive directors have to palpably work harder to achieve value as it is rare, outside of the tech sector at least, for buyers to purchase solely on the promise of future earnings. “What’s happened is that the middle-tier deals that were getting done at over-inflated prices no longer really happen,” says Chris. “Values have fallen because people can see there is nothing special about them.”

Simon Burke, Chairman of Bridgepoint-backed arts and craft retailer HobbyCraft, says that when it comes to PE firms, “the old notion of trying to achieve 30 per cent IRR [internal rate of return] and a three-year exit has gone out of the window”. He explains: “PE houses are now much more focused on the overall levels of return and are flexible in terms of timings. Investments have commonly got four, five-year or sometimes even longer horizons. Sensible PE houses are sensitive to creating the right moment in a company’s evolution to exit rather than looking at watches the whole time which, if I’m honest, is a much more intelligent strategy anyway and probably more likely to maximise value.”

Zero hour

Whether it is a trade sale, secondary buy-out or a flotation, there are genuine exit options for businesses at present. However, if the right results are to be achieved in these exacting market conditions, the CEO and chairman need to be working together and communicating openly as simmering tensions can fast become calamitous as a sale draws near.

It comes back to alignment. Paul says: “Some might be pushing for an exit and some resistant; there will be different personal views and all will be valid. If you are going to target an exit you need to know the primary shareholder’s mandate.”

This can create challenging situations, as the management team which has built up a business may not be right to take it to the next level for a sale. Simon comments: “It’s best to talk about the exit up front and get everybody on the same page from the start. That gives you a template for later on about what your objectives are. The biggest difficulties occur when people have wildly different expectations and you’re approaching the point of sale and things haven’t been resolved.”

Advisors have an important role to play too. Aleen Gulvanessian, a Partner at law firm Eversheds, says: “You need to be totally ready before the process begins, identify problems early and solve them before embarking on a sale; the cleaner your company appears, the smoother the sale process will be. Even if the buyer is prepared to take certain risks, you need to remove potential liabilities because it does affect the price. Don’t give buyers cause to get nervous.”

Although the latest incarnation of dotcom companies may be proving an exception to the rule, the difference today is that buyers generally want to see real revenue. “It’s much more about what channels you’ve established and what partners you have,” says Paul. “From the exiting party’s point of view, you have to do your homework. If your business neatly fits into the gap of a competitor’s portfolio, you need to be able to explain that with reference to accounts and really show why your company fills the gap in the marketplace or blocks off other competitors.”

The financials and story for growth have to be watertight. “It’s not just about trading,” says Simon. “It’s a question of where a business is pitched in the market, what opportunities it still has and how you can prove those opportunities.”

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon.

Matthew

www.twitter.com/criticaleyeuk

Getting Real Value from M&A

The long expected surge of M&A activity as companies with strong balance sheets picked rivals up on the ‘cheap’ hasn’t come to pass. Good companies have held their value and management teams understandably want to know exactly what they’re buying before putting their reputations on the line by giving the green light to a transaction.

Basic emotions are at play – no one wants to risk overpaying or regret selling too cheaply. Likewise, embarking on a strategic acquisition is tough when markets remain unpredictable and a five-year plan seems too much like a leap of faith.

Christopher Clark, a Partner at BDO Corporate Finance, says: “Lots of companies are looking to do deals but having that sentiment and the confidence to actually execute is the difference at the moment. With the current uncertainty, people are more cautious and are maybe not willing to pay the price in case of obstacles that might come their way.”

As always, the figures have to add up for a deal but the smartest management teams will now place as much importance on the cultural as the financial due diligence. Nigel Guy, Chairman of recruitment group The Cornhill Partnership, says: “Businesses need to look at acquisition targets from two perspectives: how does this change my competitive position… and what does it do for value? Does it make the business more attractive to be acquired down the track and is it going to get the right level of return?”

There has to be a solid case put forward that makes it clear to stakeholders and members of the board how a target complements the business. Jim Wilkinson, Chief Financial Officer at online gambling company Sportingbet, says: “Non-executive directors play an important role in approving a transaction pre-deal… There should also be a strategic overview of why the deal is important and what the acquiring company expects to get out of the transaction – then a consideration of whether this makes sense and its likelihood of realisation.”

Chris Stooke, Chairman of insurance broker Miles Smith, says: “A lot of the success depends on the cultural fit – unfortunately, not enough planning tends to be done around the post-deal implementation period. There can be a lot of focus on completing the transaction but not enough on the first 100 days and the first year is where the acquisition is integrated into the business – people focus on their day jobs but the trouble is that a transaction requires a lot of focus away from the day job to make it work.”

The rule of the thumb is to put together a team that drives the post-deal transition so that systems are integrated (such as finance departments) and culture clashes are spotted early. Sarah Murphy, Group HR Director at engineering concern Ricardo, says: “People expect you to make changes in the first 100 days. So if you lose that opportunity then you are far less likely to make the acquisition and integration a success.”

Bernie Waldron, a Criticaleye Associate and Non-executive Director at IT company IPPLUS, says: “Think about the integration plan like any other major set of change projects. Decide how important they are relative to other changes going on and whether they need dedicated resource to drive them. In any case, the resource and cost needed for integration should be planned and factored into the business case.”

Sanity checks

Still, the question remains that, aside from distressed M&A, deals are thin on the ground and a lot of the prices for the best companies – certainly in the mid-market – may be seen as at the top end of the scale, especially where private equity firms are competing in fierce bidding wars. For Tony Cowling, a Criticaleye Associate and former CEO, Chairman and now Life President of the market research multinational Taylor Nelson Sofres, argues that an opportunity is definitely being missed.

He says: “The best time to acquire should be at the bottom of the business cycle as there are lower prices, a less arrogant workforce and longer growth prospects. Although the economy is unpredictable at the moment, in my experience it is generally better to buy good companies when they are down than to buy poor companies when they are up – remember a rising tide lifts all ships.”

Sam Ferguson, the CEO of information management company EDM Group, who has led two acquisitions during the past six months, takes a slightly different view: “I don’t think there’s ever a good or bad time. In 2008 and 2009 people thought lots of bargains were going to come on the market, but in the years leading up to 2008 people were paying silly multiples for not great business and they’re the ones that have got problems today. But if you bought the right business for the right multiple back in 2007, it would still be a good buy today. It’s possible I would have bought these two companies at any time, but if we’d have had to pay any more I wouldn’t have bought them.”

In other words, it’s a case of not succumbing to deal fever. “Often companies make acquisitions simply thinking bigger is better,” says Tony. “Acquisitions should always be strategic. If the target does not fit into your strategy then it – and the new employees – do not have a clear role and purpose in the new organisation.”

Identifying the right acquisition target is the easy part; finding the formula to make the new business integrate with the existing one is where many executive and non-executive teams fail to make the grade. According to Sam, it has to come from the top: “The CEO is going to be held accountable so they need to be involved in the buying and the integration. Whether it’s hands-on or via your chosen people – you’ll be held accountable over its success or failure. I can’t see any reason why a CEO would buy a business that’s material in size and not be heavily involved in making it work.”

Maybe that direct accountability is another reason why deal volumes are on the low side at present.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon.

Matthew

www.twitter.com/criticaleyeuk

M&A and the School of Hard Knocks

Caution reigns supreme in boardrooms when it comes to giving the green light to an acquisition. Once the good times do return, that ‘go-slow’ mentality will in all likelihood be replaced by aggressive strategies which are supposed to land with a bang but invariably end with an embarrassed whimper.

So what are the principles that the executive and non-executive members of a board need to stick by if corporate acquisitions are to deliver real advantages and returns for shareholders? Don Elgie, Founder and Chief Executive of PR and communications business, Creston plc, states: “There must be a strategic rationale, balanced with an accretive profit rationale. These must be laid down well in advance.”

Roger Buckley, a Corporate Finance Partner at professional services firm BDO, agrees, noting that “you need a clear strategy for acquisitive growth and a clear view as to the criteria of the type of business you want to acquire”.

In theory, that’s straightforward enough. But the fact is that plenty of acquisitions that appeared like matches made in heaven have failed, and the days of gathering a war-chest to engage in ambitious buy-and-build strategies no longer creates excitement among investor and financial institutions. They want clarity and assurance, not entrepreneurial exuberance and bullishness.

Reality bites

John Allbrook, Executive Chairman of IT finance provider Syscap Ltd, comments: “You’ve got to have a strong, compelling strategic story supported by the shareholders, whether they are private or public. Certainly in this market, people are looking for a little bit more than just cost synergies; they’re after a clean, clear strategy and one that makes sure people are not overpaying for the transaction.”

In fact, the notion of proposed ‘synergies’ takes on a chimerical aspect in the dark art that is M&A. Colin Mayer, a Criticaleye Thought Leader and Professor of Management Studies at Said Business School, Oxford University, says: “There are systematic biases that people introduce when they value potential acquisitions. They look at a possible target and the synergies that can be made when acquiring a company without thinking about what might happen if those synergies fail to materialise.”

Positive as opposed to wishful thinking needs to be carefully weighed-up, especially where the remuneration of the executive team is pegged to the overall market cap of the acquiring company. “Non-executives should be casting a very critical eye over any proposed acquisitions, particularly large ones. It’s one of the most important roles they have to play,” says Colin, adding that there is an interesting issue about why so many value decreasing acquisitions have gone through. “To what extent could it have been possible for non-executive directors to have provided a more [disciplined appraisal] of what the executive team were doing?”

Value for money

Even if the strategy is sound, there is a strong suspicion at the moment that prices are too high. Aleen Gulvanessian, a Partner at law firm Eversheds, says: “Corporates are being a lot more thorough. They aren’t prepared to take risks as much and are not as entrepreneurial as they once were – that’s partly led by the fact that frequently they aren’t being financed as well. Banks aren’t lending without ensuring that thorough due diligence has been done. They want to understand that the assets being bought are valued appropriately.”

Properly crossing the t’s and dotting i’s for the financial and legal due diligence may be a formality nowadays, but perhaps a tougher problem is to assess some of the more intangible qualities. John says that, for him, “it’s as much about cultural due diligence and whether the two businesses will be able to exist side-by-side”.

Don says: “We really go to town to learn the truth of the aspirations of the directors. You need to spend time with them and really dig down. I spend a lot of one-to-one time with directors understanding their motivation and ambitions and make my judgments based on the sincerity of their comments as to what their aspirations actually are.”

If a transaction is to make the grade, then the first year after the target company has been taken over is key. Siva Shankar, Corporate Finance Director at SEGRO plc, a commercial property investment and development company, says that “most M&A failures happen in the ‘integration’ phase, generally due to unrealistic expectations being set up front”.

In a competitive market, particularly during an auction for a business in a hot sector, the resolve of management teams and NEDs will be sorely tested. Colinsays: “The first movers might make reasonable profits before the others realise there is an important area to make acquisitions. But the ‘me too’ companies that come in later are the ones who are really operating in a highly competitive environment where there is frenzied bidding going on.”

Don takes the view that it’s better to keep away from the crowd when eyeing-up a potential deal. “We’ve always tried to avoid the auction process as it can destroy shareholder value as there’s a tendency to overpay. We don’t do deals that aren’t earnings enhancing immediately.”

On one level, the principles for M&A are obvious. But it is pride and an element of greed in the deal-making process that can make seemingly sensible strategies veer off course, along with a lack of focus when it comes to actually executing those proposed ‘synergies’.

Kevin Appleton, the former Chief Executive of aerial equipment business Lavendon Group, says: “Having a clear, common idea of where a fair price for the business might sit avoids either party being drawn, even sub-consciously, into favouring self-interest.”

It remains to be seen whether boards and financial institutions will adhere to a genuinely results-based approach to M&A once the markets are in full flow again.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon.

Matthew

www.twitter.com/criticaleyeuk

The M&A Board Game

The M&A Board Game

“The most important thing is to have a board member or a board committee that is engaged in the oversight of the acquisition process. You’ll find that typically it is the CEO and COO who have to work through the actual integration details.”

In many instances, the high-failure rate of mergers can be attributed to a lack of engagement by the board. All too often, the focus is on quick gains rather than addressing the cultural and operational challenges of integrating another company, not to mention the issue of ensuring that long-term value is embedded into a business.

Pascal Colombani, Chairman of car parts manufacturer Valeo, comments, “It requires a lot of work from the chairman to make sure that different cultures can work effectively together. This can take many forms: selecting what the two companies do best in terms of governance is obviously important, and [to allocate] committee chairmanships is also seen as a key step towards good integration.”

The process of bringing two cultures together needs to be managed strategically. Dipesh Shah, Non-Executive Director of JKX Oil & Gas plc, says, “The most important thing is to have a board member or a board committee that is engaged in the oversight of the acquisition process. You’ll find that typically it is the CEO and COO who have to work through the actual integration details.”

It’s a point taken up by Jeremy Small, Group Company Secretary for insurance provider Axa UK plc, who says that in order for the board to not mistake legal completion for the end of the deal, they should give NEDs oversight responsibility for the integration.

He explains: “This is helpful as it clearly delineates responsibility. The executive team, usually in the form of an integration steering committee, is responsible for running the integration process and they report to an NED-led oversight committee. The latter can, and should, operate at a more strategic level, monitoring progress against integration targets and providing advice and direction when needed as well as reassurance to the whole board.”

Siva Shankar, Corporate Finance Director at commercial property and development company SEGRO plc, recommends that key performance indicators are brought into play to highlight the true health of the delivery of a merger. “The carefully selected KPIs should measure all the vital signs of integration success or failure and be quickly digestible,” he says, noting that short-term incentive schemes can also be introduced when integration milestones are reached.

Gwen Ventris, Former COO, Europe and Executive Director for energy and environmental consultancy AEA Technology plc, also stresses the importance of targeted remuneration: “Reward for success should be cumulative with actual payments taking place at least two years into the plan to ensure that key players remain with the business and are focused on what can be extremely challenging work.”

Shades of perfect

Anyone who has been closely involved in a deal will know that it’s impossible to get everything right. Intellectually, there may be a strategy for how a takeover ought to be done, but even the smallest transactions are likely to contain a host of highly charged problems and emotional surprises.

“The scale and nature of deals can be complex, time consuming and extremely demanding for key executives who can very often be suffering from deal fatigue by the time they reach closure stage,” says Gwen. “These early stages of acquiring can be dominated by finance and legal matters which naturally demand the attention of the board, whereas integration can be perceived as a more operational matter and therefore ‘business as usual’ to the board.”

Invariably, the opposite is the case. Sir Peter Mason, Chairman of Thames Water Utilities Ltd, observes, “Post-close, at the end of what will have been a challenging period, the board shouldn’t congratulate itself as ‘job done’. In fact, the job is only just starting if the integration is to be executed properly.”

Carlos Keener, an M&A expert and founder of M&A integration specialist Beyond the Deal, says, “Executive teams can lose interest or they just focus on running the business. They may not have sufficient governance processes or people in place to make sure that integration goes well. You could argue that the reason this happens is because the board is pushing them in that direction…They are reacting to what the board is telling them is the priority. I still think there is a role for a greater awareness by boards of not just what integration is likely to entail, but what positive role they can play in making sure that executives can deal with it properly.”

Weak foundations 

In the zeal and enthusiasm to execute a deal, it’s easy for compromises to be made in terms of the appointments made to the board, which compound the difficulties posed by integration. Clearly, if the appointments are more based on political horse-trading than actual merit, the subsequent inefficiencies in the boardroom may lead to in-fighting and a lack of leadership that can infect an entire organisation.

“The seeds of the difficulties are planted when concessions are made for a recommended merger, such as who is going to get a position on the board,” comments Dipesh. “You can end up with a top heavy structure which cannot be sustained for too long.” Gwen argues that “making appointments as a ‘reward’ for pulling off the deal, without due reference to the future strategic agenda, skills and capability requirements, rarely works”. Likewise, problems can arise from the acquiring company dominating the executive and board composition of the new entity. “This…may undermine the morale of the acquired company’s executives, leading to disillusionment, resistance to change and [finally] key employee turnover,” she adds.

Alison Carnwath, Chairman of commercial property company Land Securities Group plc, states that due care and consideration has to be given to the blend and make-up of the NEDs: “Chairmen, with their nomination committees, should always pick the best boards for the medium to long-term. During negotiations of friendly mergers, this task can get overlooked and not addressed. Sometimes the executive roles are agreed, along with the chairman, but others are told that decisions will be made at a later stage post-integration. This creates uncertainty throughout an organisation. Similarly, non-executive directors are often selected capriciously and boards can become very large to avoid difficult conversations.”

Change is inevitable

The term merger is slightly misleading as there is usually an acquiring company driving the deal, meaning there will be casualties where there is operational overlap or underperforming service lines. Julia Robertson, Chief Executive, UK & Europe Staffing, Impellam Group plc, says: “In a newly merged organisation, people know that change will follow so don’t patronise them by pretending it won’t…Strong and decisive leadership is essential. Putting together a ‘politically correct’ board in an attempt to satisfy all parties is likely to lead to stagnation.”

Jeremy says: “The most common pitfall regarding board composition tends to be one of two types: total dominance by the acquiring company’s executive team or ‘man-to-man’ marking of taking individuals from each side. Neither works particularly well as the first tends to erode remaining morale among the target executives and staff, while the second often leads to deadlock and a lack of action either because it is very difficult to enforce decisions or because no one wants to commit to making them.”

There will never be the perfect acquisition or merger, which is why so many of them are judged to be failures based on of the ‘synergies’ proposed at the bidding stage. As ever, there has to be candid and direct communication between the executives and the board about how the deal can be executed, along with a plan about what the integration process will be so that long-term value is at the heart of the transaction. In theory, there are five key questions to ask:

•    Post completion of the deal, if the board is top heavy, when can it be streamlined?
•    Does the board have oversight of the executive team on integration?
•    How are individuals being incentivised to deliver results?
•    What compromises have been made to complete the deal?
•    What is the timeframe for merging the two businesses?

Carlos says: “We find most of the challenges of helping companies to integrate are because of decisions that were made pre-deal or due to the lack of sufficient assessment of problems – or wilfully ignoring them – just to make sure that the deal happens. There are always going to be challenges in any deal, be it cultural or operational. It’s vital to recognise what the issues are so they don’t bite [the company] two to three years later into the deal.”

If joined-up thinking and basic accountability aren’t codified, things can soon go wrong. Dipesh comments, “You can talk a good story and say that this is what you are going to do by meshing the companies together to create a new culture, which will sustain ‘us’ into the future. You can tell a good story, but when you actually start implementing [the integration], that’s when you do need to knock them together.”

It’s a big task. One that the board as much as the executive team need to embrace head-on.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk

What Makes for a Successful IPO?

The margins for error when taking a company public have always been slim. That’s truer than ever given the on-going market conditions, meaning that for those management teams considering an IPO, it’s vital to put in place a board that has pedigree and traction with investors, and to ensure the business is robust enough to hit the numbers post-flotation. Woolly fads and blue-sky ventures need not apply.

John Whybrow, Chairman of AZ Electronic Materials, says that if a new chairman is to be brought in, then they need to be involved three to four months before the actual float: “Typically, the new chairman will join the board as a director or chairman designate if the company is in the public domain; if it’s not then he will join as director. The chairman can then find out what is going on and start to set things up for when the company goes public.”

It’s generally agreed that the key elements to have in place pre-IPO include:

• Strong financial results

• A respected management team

• Experienced and influential non-executive directors

• Steady earnings (preferably with recurring revenue streams) in demonstrably high-growth sectors

• A sensibly priced business at IPO

AZ Electronic Materials, a private equity-backed concern which makes chemicals and materials for flat panel displays, LEDs and other devices, listed on the Main Market in October last year, raising just over £380 million and achieving a market cap of £914.2 million. “AZ is a classic flotation,” comments John. “It worked brilliantly – we floated at 240p and at the end of the first day were up 7 per cent. At the end of three months, we were 25 per cent up. The people who bought the shares felt good because they felt they had paid a reasonable price; equally, the private equity firms were not greedy as they didn’t maximise the price.”

Everyone felt they had gained from the transaction. At the moment, that’s quite a rare and distinguished feat as the reality of the new economy often means that expectations need to be lowered when it comes to valuations and estimated returns on investment. Nicholas Garrett, Head of IPO Executions at JP Morgan Cazenove, concedes that the public markets continue to be challenging: “A number of IPOs have been pulled in the last few weeks and the ones that got away haven’t traded particularly well. What will make a good IPO is a sound investment case for continued growth, priced at a sensible discount to peer group companies.”

A test of values

The issue of price has certainly been the sticking point for many potential M&A deals over the past 18 months. It’s the same problem which is causing potential floats to sink without a trace. “Unless vendors coming to market can be more realistic about valuations, I sense that the situation is going to be much the same in the near future,” adds Nicholas.

John states that this is where an incumbent chairman, certainly when PE firms are seeking a float as a full or partial exit, has a key role to play. The chairman can mediate with the firms and the banks and, to an extent, the management team, to make sure that “things happen sensibly” as the damage and loss of confidence in a company if the share price nosedives immediately after an IPO may be irrevocable.

The other, equally crucial task for the chairman-in-waiting is to find the right non-executives who have the appropriate knowledge and experience for steering a public company. “After the float, many of the directors will resign immediately,” says John. “As soon as you have a new chairman and a chairman of the audit committee, you have to build a board pretty fast – when we went to market there were three independent directors and I kept the two sponsors [PE firms], but they’re not independent, so I needed to recruit four non-executives pretty quickly. You also need a company secretary, otherwise the burden falls to the CFO.”

Charles “Chip” Goodyear, the former CEO of mining and resource giant BHP Billiton, recalls that the highest standards of governance were essential for an international company with listings in multiple countries. “Listing rules mean that you require a certain number of non-executives and independent directors, but that was not inconsistent with what we were doing anyway.

“What the company did do as a result of its listing in London and Australia, plus its publicly traded securities in the US, was to adopt the most rigorous standards in the markets we operated in. As we looked at policies and procedures, we determined to take the high ground where it existed across those jurisdictions.”

Chip claims that this didn’t pose a challenge at board level as everyone bought into the principles. “The bigger issues involved the integration of the organisation – once you have the framework of taking the high ground, then that’s the way it has to be… It was as important internally as it was externally for the company to make it clear that this was its position. So you had to be consistent with that as you were dealing with multiple cultures and histories across the organisation.”

Nicholas states that the question of governance and assembling a well-known and respected board is growing in importance: “We are seeing an increase in overseas companies coming to the London market. With some of these companies, where there is an overseas owner or founder who might be selling only 25 or 30 per cent of the company into the market, investors might be looking to the new board of directors to act as a protector or counterweight to the founder or owner of that business.”

Into the maelstrom

The reasons for floating a company must be watertight. If a management team hasn’t thought their strategy through, then in all likelihood they will be cruelly exposed when embarking on investor road shows. Robert Drummond, chairman of clean energy concern Acta and former chairman of the British Venture Capital Association, says: “Management needs to understand how to demonstrate their model in simplistic ways. They can have as many as a hundred presentations to large groups of people who have not got a day to hear about how a business works. Rather, there will be five minutes to explain the basic business model so any investor can understand it, and then there might be another 15 or 20 minutes to explain it in further detail. If they can’t do that, they’ve got problems.”

A lack of realism over numbers won’t be tolerated. Wiser heads in the City know that the best trick is to manage expectations by under promising and then over delivering, but it’s a lesson that many still find hard to learn. “New investors are looking for stability and growth,” says Robert. “That means they don’t want shocks; they want stable sectors and a business model that is easy to understand. Most IPOs tend to show tremendous growth prospects but, even if that’s achieved, it may not turn into profits.”

Robert states that the golden rule is not to go for an IPO “when the growth rate you are predicting is significantly greater than the growth rate you have achieved”. By this, he means that if a company has had 50 per cent growth for the last year-end, no-one is going to feel confident if a management team starts touting growth of 200 per cent for the year ahead.

Sam Smith, the Chief Executive of small-cap broker, finnCap, which works with sub-£100 million market cap companies primarily on the Alternative Investment Market (AIM), insists that rushing into an IPO is a mistake: “The management has to be certain they are putting forecasts into the market for a year and maybe even two years and hit them. What you can’t do is miss your numbers in your first year. Credibility, as we all know, takes a long time to recover.”

Naturally, the experience of the management team and the balance of the non-executive directors need to be right, but it’s the financial shape of the business that investors will scrutinise. Nicholas says: “The market capacity to invest in companies and the volatility of the market are two areas which hold back IPOs… I don’t think that investors have a mass surplus of cash to invest in equity markets – when they are looking at IPOs, some investors are considering other stocks to sell in their portfolio to make way. That heightens the investment decision for them.”

Sam questions the behaviour of some advisors, primarily serving small-caps, who encourage early-stage companies to go public before they are ready for the sake of a fee. “What you don’t want to do is to agree to IPO when you don’t know the market and you don’t have the track record to deliver on your forecasts or have the right board in place. If you try to rush through an IPO in those circumstances, then something will go wrong.”

First and foremost, the company must be fit for purpose. Added to this, the business has to be robust enough to deal with the pressure and strain of the flotation process itself. “It’s very time-consuming for the management team to go through an IPO,” says Sam. “If you have your two key people, the chief executive and the financial director, spending three months writing documents, doing the due diligence, putting the processes in place and going on investor road shows for two to three weeks, it can put a huge strain on resources. At the small-cap end, where the market is only just recovering, trying to take that amount of time out to do an IPO is a big decision.”

Nic Snape is the CEO of mapping technology specialist 1Spatial. Rather than go for an orthodox listing, he took the opportunity to reverse onto AIM in 2010 through a shell company, IQ Holdings.  Although the initial plan to float back in 2008 was shelved as the global economy crashed, the management team did choose to keep in place the reporting processes and procedures for life as a public company. “We basically decided to operate as though we were a plc,” he comments, noting that they also adopted IFRS accounting.

Notwithstanding this preparation, Nic acknowledges that the switch from being a private to public company is dramatic. “We always took the attitude that all the money we earned we’d put back into the business,” he says. “So any profit was always paper anyway – but now it isn’t, it’s intrinsically connected to the value of the business. Whereas previously we’ve carried quite a lot of goodwill and capitalised software development and amortised it; that may not be the appropriate way to run the business [now we’re a public company]. We have sort of restructured the balance sheet and the finances so we can maximise the profitability going forward. It is different, without a doubt.”

No-one seriously expects the IPO market to pick up significantly in 2011. This is partly because investors and fund managers remain extremely wary about the quality of the trickle of companies being put forward by advisors given the low valuations (in short, why would you come to market at the moment?), and because private equity firms are currently paying top dollar to snap up the most promising, scalable businesses.

Looking ahead, 2012 may be an altogether busier time for market-makers. For those companies considering an IPO, the sooner they start preparing by slotting together the various pieces of the IPO jigsaw, the better they’ll be placed to raise meaningful sums to grow the business, make acquisitions and ultimately to deliver healthy returns to investors who showed the faith.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon

Matthew

www.twitter.com/criticaleyeuk