Selling The 'Crown Jewels'?

  • Market Overview

A lot of companies, large and small, may not survive this economic crisis. Some may need to sell off their ‘crown jewels’. Already, both locally and internationally, many investment holding companies are scrutinising their portfolios to identify any high intellectual property and cash generative businesses currently being held back by a corporate structure when they might benefit from being set free.

We at Deal Leaders Africa have over the years worked with smaller owner-managed entrepreneurial businesses to lift their growth. Increasingly over the past 18 months, we are being approached by entrepreneurial businesses and management teams that have found themselves locked within listed corporates where they feel their capability is not currently being maximised.

Being in this M&A niche in fact reminds me of why I left the corporate sector – it imposes a myriad of non-negotiable requirements on management who themselves no longer have any equity in the business. They are beholden to an investment company which 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 their survival purposes. A fast-growing entrepreneurial business need inputs, particularly of growth capital, when what is rather happening is they are being drained of capital through aggressive dividend pay-outs to the holding company. Instead of growing, the underlying business is extremely shackled, often with consequent reputational damage.

It is the human rather than financial element which is key here: there are management teams who are still functioning extremely entrepreneurially in this crisis, but desperately constrained by owners which are fighting for their financial survival in the current 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 their prized investment, thereby unshackling the underlying management team?

In a valuable IP business, it is the management team which 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 and which continue to give the founders considerable discretion. It is these discretionary incentives which are often withdrawn when the holding company needs cash. 

Prospects for mergers and acquisition (M&A) are attractive for companies in the R50m to R1billion, as the M&A market at the moment is recovering. Private equity activity in particular recovered quickly from the lockdown, fuelled by a low interest rate environment and general economic uncertainty. Investors are seeking stability and returns in the longer-term space. M&A transactions totalled US$25.7bn in 2020 in sub-Saharan Africa, according to Refinitiv’s investment banking analysis. While this was 62% less than that recorded during in 2019, the latter total was inflated by a single deal boosting merger activity to an all-time high.

That R50-R1billion range is ideal for transactions in our niche, as it includes companies which 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 management of the holding company has to be persuaded of its qualitative merits. Sometimes the approach comes from by 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. In particular, any non-negotiable issues must be settled and cleared out of the way up front. 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 their existing holding company, become the fulcrum of attention upon sale. Any acquiring company knows they are the heart of the business and so will go to lengths to tie them 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 also private equity firms which are excellent acquirers - but sometimes less so with their exit strategies.

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