Invest to Exit by Dr. Tom McKaskill - HTML preview

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12

Executing the Exit Strategy

O

nce the strategic value has been determined and a number of potential buyers identified, the next task is to build an execution plan which will achieve the strategic sale. In a very simple deal, say just involving the sale of established IP, the process may be achieved in only a few months, however, more complex situations will take much longer. If the business has to be prepared for due diligence, restructured to improve its value and buyers have to be contacted and relationships established, it is likely that process will take at least two years. It is likely that the process of preparing the business for sale will involve hundreds of activities spread across a number of individuals. All these activities have to be planned, monitored and reviewed on a regular basis. In addition, the normal activities of the business need to be planned, executed and monitored. Implementing a reporting structure to ensure that the business is run efficiently and major objectives are achieved is an essential part of the exit strategy.

The diagram below sets out a structured process for preparing for a strategic sale.

 

Strategic Trade Sale Strategy

 

Alignment of interests

• Directors, managers and key employees
• Build after-sales scenarios
• Agree trade sale objectives

Due Diligence

• Audit Contracts
• Review OH&S
• Business plan
• Due diligence file
• Professional tax advice
• Develop incentives
• Standardize agreements
• Audit infrastructure
• Protect IP

Strategy

• Review assets and • Build relationships capabilities • Understand
• Select potential buyers acquisition processes
• Review valuation • Build scale capability

Sale Negotiations

• Competitive tension
• Define value for buyer
• Negotiate Contract

As you can see the process involves reducing risk in the business, developing the strategic assets or capabilities of the business, assembling the deal team, building relationships with buyers and then undertaking the competitive bid process. Without a proper project plan in place and widespread agreement among all the stakeholders to the plan, it is unlikely to be well executed.

Managing the Business

The process of securing the strategic sale starts by putting in place systems and processes to manage the daily operation of the business.

Angels and VC investors typically invest in start-up or early stage businesses and normally before they become very sophisticated in their management and governance processes. While many early stage ventures are started by excorporate executives, their personal experiences of working with enterprise wide performance setting and monitoring systems is likely to be non-existent. Even entrepreneurs who have managed ventures before may not have experienced a well designed reporting system.

Of course, many Angels and VC investors themselves do not have this experience. Just because they have high net worth, or because they have sold their own venture or have held a senior corporate job, does not ensure that they have personal experience with a quality performance setting and monitoring system across an enterprise or in working with a Board of Directors. Yet this is what the Angel and VC investor needs to have implemented within the investee firm if they are to properly prepare it for sale to a large corporation.

Very few investee firms can be expected to have sophisticated systems or good governance processes. You can anticipate this when you look at the typical firm in which an Angel or VC investor invests:

• Start-up or early stage venture;
• Immature products or products still at design or prototype stage;
• Often emerging markets;
• A management team that may not have senior management experience;
• Gaps in the management team experience;
• Almost certainly a lack of formal management reporting systems;

• Lack of key performance indicators, lead indicators, individual targets and budgets;
• Probably a business plan but a lack of operational detail.

If the Angel or VC investor is to guide through the process of preparing for a strategic sale, they have their own issues to cope with. The Angel and VC investor must deal with:

• Limited time to spend with each investee firm;
• They are normally only a minority investor;
• They are not running the business on a day to day basis;
• They may not be experts in the underlying technology or marketplace;
• They don’t have the time or the knowledge to make operational decisions.

While Angels may be regarded as ‘hands on’ investors, this is not the same as day to day management. Without adequate performance setting and monitoring systems, they are effectively working in the dark. No doubt they have chosen a specific investment because they do feel comfortable with the marketplace and with the potential of the business and no doubt have also taken into account where they can add real value to the product/market or other aspect of the development of the business. But they are still not there day to day making the decisions.

They also have a major role in preparing the business for a number of possible outcomes, additional rounds of investment from other Angels or a VC, a trade sale or an IPO or for independent growth. In order for the business to be successful, each one of these outcomes really needs the business to be running effectively and efficiently. It is in preparing the business for these possible outcomes that the investor has his most important mission in the business. This is the critical value that he brings to the table – steering the development of the business at a strategic level and guiding the management in establishing and working with proper controls.

As the business develops and the number of employees grow, the task of monitoring at an operational level will become increasing more complex. This is where a range of guiding mechanisms and controls help. While the business is small and everyone is working closely together, the amount of information needed to be formalized is slight, but as the business develops and grows, no one person is able to assimilate all the different activities of the business and ever more information about what is happening inside and outside the business needs to be collected, understood and acted upon.

The task of the investor in most investee firms is to anticipate these needs, educate management on the need, what type of systems etc are needed and assist them in planning the necessary changes. Nothing can be more damaging to a growing business than to find itself without adequate planning and operational control systems.

In planning for a strategic exit, those planning systems need to be in place to ensure that day to day operational activities are undertaken effectively and that those tasks required to get the exit deal done are acted on and monitored. At the same time, it reassures the buyer to know that good reporting systems and governance systems are being used to manage the business.

At an operational level, the following reports and actions might be considered:
stage one: up to 10 employees

• Quarterly financial statements
• Monthly cash flow reports
• Monthly creditor and debtor reports
• Quarterly budget performance
• Annually revise the business plan
• Monthly list of priorities for each manager
• Monthly action plan for each manager
• Monthly review against action plan
• Monthly review of critical KPIs
• Board meetings quarterly

Stage two: Up to 30 employees

• Monthly Financial statements
• Monthly budget performance
• Quarterly revised business plan
• Quarterly report on lead indicators
• Major topics reviewed at each Board Meeting
• Board meetings every two months
• Job descriptions for all manager and supervisor jobs

• External advisor on employment terms and conditions and compliance issues

• Part time CFO
stage three: up to 100 employees

• Full time CFO
• Weekly Creditor and Debtor reporting
• Weekly sales performance reports
• Weekly project completion progress reports
• Training of senior management in employment compliance issues
• Job descriptions for all employees
• Formal annual performance reviews for all employees

At an operation level, early stage ventures are especially sensitive to cash flow more than anything else and yet they often lack the knowledge and discipline to manage it carefully. Traditional financial reports are not designed for this purpose and, in any case, making profits is not the same as having enough cash to be solvent. Thus part of the discipline that an Investor should insist upon is rigorous and detailed cash flow analysis. Every member of management should be involved in the analysis of cash flow since every activity within the firm has an impact on cash availability. Management should be sensitive to how cash is being generated and used as well as how they can impact it through their own actions and decisions. Only by working with the detail will they assimilate this information. It is the area of greatest risk to the emerging venture.

One way to bring this lesson home to an inexperienced management team is to have them prepare a worst case cash flow. This report sets out the cash projection of the business using different layers of cash inflow and outflow. The beginning layer has only committed cash flow. That is, only cash inflows that the firm can reliably count on and only cash outflows that the firm is committed to in the foreseeable future. The report is usually prepared over individual weeks for three months and then monthly for a further 6 – 9 months depending on the horizon for projects under management.

Worst case cash inflows would normally include:

• Cash at bank
• Aged accounts receivable (expected date of payment)
• Work in progress completions (date of invoice plus collection period)

• Recurring payments on customer agreements (support fees, royalties etc)
Worst case cash outflows would normally include:
• Aged accounts payable (expected date of payment)
• Purchase order commitments (date of invoice plus expected payment period)
• Recurring administration, office, payroll, tax expenses. (excluding aged payables)

This should produce a cash flow balance (surplus or deficit) for the planning period. A shortfall may be met with an existing line of credit or bank overdraft, use of credit cards and personal loans from shareholders. A difficult situation should result in an examination of customer accounts to see if any payments can be pulled forward through follow up activity, early payment discounts etc. WIP payments might be pulled forward by early completions and bring forward invoicing. Payments to suppliers might be delayed where this can be arranged with the supplier.

Added in the next layer are the most likely additional sales to customers. This might be actual named prospects or additional work to existing customers. Alternatively, in a high volume business, it could be the minimum level of repeat business the firm experiences at that time of the year. On the expenses side, the report would start to layer in discretionary expenses, cash permitting. This might include new employees, new equipment, office expansion, additional product and market development costs and so on.

Additional layers of less probable revenue and less urgent discretionary expenses are added to gain a complete picture of the business under worst, most likely and best case scenarios.

Every business has a critical time horizon for new business. If the cash inflow looks weak and it cannot be improved in the short term, then management and the Board are warned well in advance and they can start to take corrective action. These may include switching resources to income generation, cutting back on expenses, deferring some projects and making staff redundant.

Other reports should be developed within the business to focus on critical areas. These might be for sales lead tracking, quality control, project completion and so on. Every business has aspects of its activity that provides an early warning of problems to come, either too much activity or too little. These lead indicators are the monitoring points within the business. The investor needs to help management identify these and help them design monitoring systems to track them. Policies can then be developed for when management and/or the Board need to be informed and action taken.

Part of the contribution that an investor makes to an investee firm is to help them work with external investors where they have not experienced this before. Entrepreneurs that have been used to making their own decisions, deciding on their own priorities and setting the direction of the firm without having to gain approval from a 3rd party, will find this very challenging and confronting. But if they wish to grow the business and bring in additional external funding, take the business public or secure a strategic buyer, then this is an environment and a discipline that they need to learn. The Investor can help by leading the way, showing them how a Board works and how they can make positive use of the Board.

Many firms implement standard financial reporting for the Board but fail to adequately deal with strategic or risk issues. The investor should develop a schedule of major issues that should be dealt with at Board level. I have set out below a possible list of topics. Some may be more appropriate at later stages in the growth of the business.

The investor may play many roles including mentor, coach, consultant and sounding board for the management team. But he/she also represents minority investors, external investors and, hopefully, future investors or a buyer. Establishing the right systems, setting the right direction, building the right culture and developing the right disciplines is an important contribution that the investor makes to executing the business strategy.

Proposed major topics for Board Meetings
1. strategy

• Review of overall direction of the business.
• Where do we want to be in 12, 24 and 48 months.

• What are the major changes in the organization that we should be planning for.
• Summary of a SWOT analysis for each product/market. What major changes should we be making at that level.
Input: Strategy paper from the CEO
Output: Approved strategic initiatives

2. Acquisitions and Integration
• Review of landscape.
• Check on current criteria for targets.

• Review of targeted acquisitions and whether the firm is at the stage of building relationship and/or discussions.
• Review of likely acquisitions and or gaps that would be useful or are needed to be filled.

• Review of integration issues with current acquisitions.
• Discussion of integration capacity and policies.
Input:

• Review of marketplace in each of the firm’s major sectors. What companies are operating in each one. Where are the possible targets that conform to the acquisition criteria.
• Update on relationships with approved targeted businesses.

• Update on negotiations of those businesses approved to proceed.
• Review of integration issues and problems associated with acquired businesses.
• Criteria for acquisitions.
output:
• Changes to integration resources and policies.
• Identification of target markets and possible target businesses for analysis.

• Approval to proceed with relationship building.
• Approval to proceed to acquisition discussions.
• Update on acquisition criteria.

3. Budgets
• Discussion of major assumptions underlying budget preparation.
• Review of performance statistics across the business.

• Review of capital expenditure, product, market and staff development plans.
input:

• Proposed budget with current year end forecasts. Including proforma year end Balance Sheet and Income Statement compared to current year forecast. Projected cash flow on monthly basis.

• Proposed major changes to budget from prior year with justification.
• Capital expenditure proposals with justification.
• Product development proposals with justification.
• Market development plans with justification.
• Staff development plans with justification.

output:
• Approved budget
4. risk Assessment

• Review of all insurance coverage.
• Superannuation/pension review.

• Review of internal controls including a report from Auditors with recommendations for changes.

• Market risk assessment.
• Business risk and disruption assessment.
input:

• Review of insurance coverage across the business with recommendations for changes.

• Auditors report on internal controls plus recommendations.
• Internal review by CFO and recommendations.
• Market risk assessment by CEO.

output:
• Approved changes to insurance coverage.
• Approved changes in internal controls.
5. Organizational Review
• Review of Board of Directors performance including individual contributions, gaps in skills and changes in Board composition.

• Review of roles and responsibilities of Board members.
• Review of Directors compensation, allowances and support.
• Review of Senior Management compensation.
• Succession planning across the business.

• Review of the use of options, profit share, bonuses, allowances and other incentives for the business.

• Methods of performance measurement and rewards.
• Review of turnover, sick leave, absenteeism, health statistics.
• Review employee survey.
• Review customer survey.

input:
• Survey of Board members on personal experience of the Board meetings and suggestions for improvement.
• Independent review of Directors compensation and recommendations.
• Proposals from the Chairman on Board on composition, roles and responsibilities
• Independent review of Senior Management compensation with recommendations.

• Assessment of the performance of CEO, CFO, Company Secretary, and Senior management by the CEO in consultation with board members.

• Review of current staff incentives with recommendations.

• Review of current performance measurement methods with comparative statistics of performance with industry standards and across units with recommendations for changes.

• Review of statistics across the group on turnover, sickness, absenteeism and health issues by business unit with recommendations.

• Employee survey results
• Customer survey results.
• Succession plans to supervisor level across the business.
• Succession plans for critical employees (R&D, Sales, etc.)

outputs:
• Approved changes to compensation for Directors and Senior Managers.

• Approved changes in options and other incentives to staff.
• Actions to be taken with respect to succession issues
• Actions to improve staff morale, retention, health and performance.
• Actions to improve customer satisfaction.

6. Compliance and Regulatory Requirements
• Review of Health and Safety regulations that impact the business.
• Review of tax reporting, statutory filings and financial reporting.

• Review of policies with regard to bullying and harassment, sexual and racial discrimination, equal opportunity and maternity leave
• Assessment from Corporate Lawyers and Auditors on compliance performance and recommended actions.
• Annual General Meeting (AGM) preparation including approval of dividend, changes to constitution, Board membership, etc. inputs:
• List of regulatory requirements and regulations that impact on the firm with current compliance experience and recommendations.
• Incident reports on any staff compliance problems.

• Report from Corporate Lawyers and Auditors certifying that the firm has complied with all reporting and filing requirements over the last year.

• Recommendations for AGM.
outputs:
• Approved changes in internal procedures and policies.
• Actions required to bring the business up to date with statutory requirements.
Division/Business Unit Reports.

In addition to a special topic that will be dealt with at each Board meeting it would be useful for each of the major business units to have an opportunity to present their current business plans. This should include:

• Description of the business
• Organizational data (locations, size in revenue and staff)
• Organization structure
• Principal activities
• Competitive landscape and how they compete for business
• Wins on the board, things they have achieved, successes etc.
• Problems, challenges, issues
• Recommendations.

It should be presented by a Senior Manager that is nota Director to give them the opportunity to meet the Board and get some feedback from the Board.

 

Do it for yourself and for the buyer

A comprehensive planning system backed up by good performance setting, review and accountability systems provides a strong base for managing a business, especially in difficult times. As an investor you should be insisting that such systems are installed to allow you to better monitor and influence the direction of the business.

Always keep in mind the end objective. What will help convince a buyer that the business is being run efficiently and effectively? Clearly a comprehensive planning and reporting system. Your investment in current systems may well help get the ultimate deal over the line.