John Bellew: Waiting for your taxi – some thoughts on exits
By John Bellew, Head of Private Equity, Bowmans
”Waiting for your taxi
Which taxi never comes
Waiting for your taxi”
Ian Dury and the Blockheads
– Waiting for your taxi
Waiting for your taxi is a pretty good metaphor for how many in the private equity industry seem to feel about the exit environment currently.
Although you cannot control the external exit environment, you can give yourself the best opportunity to control your exit by being smart when investing. In other words, you should be able to order the taxi, specify its time of arrival, negotiate the fare and even replace it with an Uber if its late.
Part of exit planning includes considering the universe of potential buyers, so that the business can be positioned and developed as an attractive purchase. Unfortunately, all the planning in the world can be undone by poorly negotiated exit provisions in the shareholders agreement.
Negotiations should be used to flush out and discuss different shareholders’ investment horizons and objectives; and to reach a common alignment around how exits will work. Exit timelines can be particularly important. Management shareholders and private equity investors may want to realise their investment in the medium term, but the private equity investor may prefer management remain invested in order to deliver a business with a stable management team. A founding member of a family business may regard the investment as inter-generational and long-term. The company may want a black economic empowerment (BEE) shareholder to remain invested for the long-term to secure it’s BEE status while the BEE shareholder may also want to exit to realise their investment.
The investment objectives of different shareholders differ. For the private equity house, the quest for alignment should not come at the price of a messy or encumbered exit. The objective must be to retain control over your exit and flexibility around how you exit. The exit process should be as unencumbered as possible. If you have several management shareholders, try and reduce the complexity by aggregating them into a management vehicle which speaks for the collective and separates economic entitlements from other shareholder rights.
It is typical in South Africa for a selling shareholder to be obliged to afford fellow shareholders a right to acquire its shares in preference to third parties, either by way of a right of first offer or a right of first refusal (pre-emptive provisions). The clauses can become complex and time-consuming, with differing rounds of offers or differing tiers of those accepting offers.
Internationally, private equity investors typically insist on unencumbered exits, retaining the ability to freely sell their shares. Over time, South Africa may move closer to this standard, but we are not there yet. If you need to concede a pre-emptive right, your three objectives should be:
The period required to run the offer process should be as short as possible with a simplified process.
You must be able to run the process before identifying a third-party buyer. No third-party buyer wants to make an offer that simply sets the floor price for other shareholders to exercise pre-emptive rights.
Following completion of the pre-emptive process, there should be a meaningful period of time for you to find a buyer, negotiate and conclude a transaction.
Allied to a short or no pre-emptive process, you could try to obtain a drag-along right, where you can force other shareholders to sell to your buyer on the same terms and conditions. This will allow you to sell 100% of the business and access a control premium. If you succeed, you may have to concede a tag-along right to your fellow shareholders. To protect yourself against being dragged at an unattractive price it is often beneficial to provide that the drag-along can only be exercised if certain minimum financial thresholds are met.
Outside of the pre-emptive provisions, you should try and retain a right to run and complete an exit process, if an exit has not been achieved by a certain date. If the exit process is via a listing, shareholders should agree to customary lock-in periods and ideally, key management should agree to remain employed for a period post the listing.
Finally, here’s to hoping that your exits (unlike the taxi which never arrives in the song) go smoothy. Good luck.
This article was originally published by the Southern African Venture Capital and Private Equity Association.