Ready, set, wait…

A friend in a large PE house recently told me they listed one of their portfolio companies, “in just six weeks”. Such boasts are frequent in the private equity world when stock markets are buoyant. But the claim hides the huge amount of hard work needed to get a business ready for a flotation.

The decision to list is not the start of the exit process, but marks a point in time when the company has probably already completed more than 80% of the necessary preparation. As an investor in high growth businesses, our role is to help our portfolio companies and their management teams to prepare for an exit. The process starts soon after we invest and we exit readiness should be maintained throughout the life of the investment. But this is easier said than done when combined with the day-to-day challenges of scaling up the operation or launching the business in new markets. Without applied effort, there is a tendency for exit readiness to sit firmly in the ‘important but not urgent’ category.

Yet well-prepared management teams are obviously better placed to take advantage when the IPO window opens. The opportunity to float a business often only exists for a short time. Companies that hit the market early will typically raise more money than those which are slower off the mark, floating at the end of the cycle when weary institutional investors that have already filled their boots with new stocks.

Exit-ready businesses can also command a higher value in an M&A negotiation. When a potential acquirer makes an approach, it is important for a company to have a due diligence data room set up, roles allocated, contingency plans in place and adviser relationships established. This allows senior management to spend their time evaluating the strategic value of the business to the acquirer and securing the best possible price and terms for the deal.

Companies preparing for an exit need to ask themselves some important questions. Are the board and management team aligned around the exit strategy? Does the management team have experience of exiting a business, or would they benefit from training? Who are the top ten most likely acquirers – not just the firms but the individuals whose role it would be to evaluate the opportunity and to recommend an acquisition? Are advisers in place – lawyers, accountants, corporate financiers? Is the company’s house in order, including systems and controls, revenue recognition policy, employment contracts, property leases, etc?

You get the point. Exit readiness involves a mind-set that combines operations, strategic planning, business development and finance. These are all activities that should be bread and butter for most senior management teams. They just need to take the extra step to make exit readiness part of their working culture. The fitter a company is for the race, the better its chance of winning. Our job as an investor is to be the company’s personal trainer.

Estimated reading time: 2 min

 

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    1. If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
  2. You are unlikely to be protected if something goes wrong
    1. Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker here.
    2. Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
  3. You won’t get your money back quickly
    1. Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    2. The most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
    3. If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    1. Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    2. A good rule of thumb is not to invest more than 10% of your money in high-risk investments. https://www.fca.org.uk/investsmart/5-questions-ask-you-invest
  5. The value of your investment can be reduced
    1. The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    2. These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

 

If you are interested in learning more about how to protect yourself, visit the FCA’s website here.