Pandemic forces investment holding companies to mull selling businesses
M&A prospects are attractive for firms in the R50m-R1bn turnover range, as that market is recovering
Many companies, large and small, may not survive the economic crisis. Some may need to sell off their “crown jewels”.
Already, locally and internationally, many investment holding companies are scrutinising their portfolios to identify any high intellectual property (IP) and cash-generative businesses now being held back by a corporate structure when they might benefit from being set free.
We have over the years worked with owner-managed entrepreneurial businesses to lift their growth. Over the past 18 months we are being approached by entrepreneurial businesses and management teams that have found themselves locked within listed corporates in which they feel their capability is not being maximised.
Being in this M&A niche reminds me of why I left the corporate sector — it imposes a myriad of non-negotiable requirements on the management who themselves no longer have any equity in the business. They are beholden to an investment company that in many instances adds no value to the underlying business.
What is frequently found, especially in this difficult post-lockdown period, is that the holding company is in a tight cash flow position and is essentially milking their cash cow for survival purposes. A fast-growing entrepreneurial business needs inputs, particularly of growth capital, when what is rather happening is it is being drained of capital through aggressive dividend payouts to the holding company. Instead of growing, the underlying business is shackled, often with consequent reputational damage.
It is the human rather than financial element that is key here: there are management teams that are still functioning extremely entrepreneurially in this crisis, but they are desperately constrained by owners that are fighting for their financial survival in the recessionary environment.
While this is worse now than usual, the condition can exist at any time. An alternative we introduce to the scenario for the benefit of all parties is: would the holding company not be better off realising the capital of its prized investment, thereby unshackling the underlying management team?
In a valuable IP business it is the management team that holds power even when wholly owned by a third party. An entrepreneurial business cannot be separated from its top executives, and the business cannot be acquired or held without the complete buy-in and incentivisation of the management team that built it. Typically, the original founders would have short- and long-term incentives based on performance, which would continue to give the founders considerable discretion. It is these discretionary incentives that are often withdrawn when the holding company needs cash.
Prospects for M&A are attractive for companies in the R50m-R1bn turnover range, as that market is recovering. Private equity activity in particular quickly recovered from the lockdown, fuelled by a low interest rate environment and general economic uncertainty. Investors are seeking stability and returns in the longer-term.
M&A transactions totalled $25.7bn in 2020 in Sub-Saharan Africa, according to Refinitiv’s investment banking analysis. While this was 62% less than recorded during 2019, the latter total was inflated by a single deal that boosted merger activity to a record high.
That R50m-R1bn range is ideal for transactions in our niche, as it includes companies that have proven themselves but leaving space for further growth. It is typically the management of the underlying company that is eager to be freed from the corporate shackles, but before a sell-side mandate will be forthcoming the management of the holding company has to be persuaded of its qualitative merits.
Sometimes the approach comes from the management of the holding company, who are themselves aware of the quantitative benefits.
This hybrid quantitative and qualitative methodology requires a strong human approach, as the people fit is more important than pure financial merit. A united front by both management teams has to be put before any potential buyer.
For one management team or the other this may require some reality adjustment. Any non-negotiable issues must be settled and cleared out of the way upfront. Even with a united front by both management teams issues thereafter may still be introduced by the shareholders in the case of a listed company.
The target company’s management team, though often neglected by its existing holding company, becomes the fulcrum of attention upon sale. Any acquiring company knows it is the heart of the business and so will go to great lengths to tie it in.
This is a layer that sits below the core transaction, but for all that is critical to success. Sought-after methods are for the acquiring company to fund an executive share scheme within a special purpose vehicle, or a performance-based bonus scheme. Without such golden handcuffs, it is not uncommon for much of the original management team to resign.
In most instances we find that the acquiring company’s strategy is not to interfere in any way with the running of the underlying business from three years, dependent on business reality. We have found a niche on the sell-side of the M&A market. Entrepreneurial businesses have always been active in this space, but for the above reasons we are seeing corporates more involved as sellers, and private equity firms that are excellent acquirers — but sometimes less so with their exit strategies.
• Bahlmann is MD of Deal Leaders Africa.
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