By 2011 our position was bleak. Almost three years after the prepack, we again faced the possibility of insolvency, except this time more family members were wrapped into the business and the immediate impact would be catastrophic.
It was perverse, as the business was profitable by that stage, but legacy issues and a contracting cash position was pulling us under. The well-intended venture was now an ill-judged and terrible mistake. We needed something drastic, or the doors would need to come down.
Despite the initial challenges, we worked through the issues and completed the deal on acceptable termsMichael Kelly
(I can say now that irrespective of what happens in the future, that dark period will always be significant and incredibly valuable. Some of our greatest strengths as a business were really forged in the crucible of those times.)
Initially, we sought merger discussions with competitors of a similar size. There was logic to this; we believed that the market was fragmented, populated by small, owner-managed businesses, struggling to survive. There were obvious synergies and by consolidating and taking advantage of the economies of scale, these companies would have a stronger balance sheet and improved trading prospects. This view was not shared by the parties we spoke to, and the unwillingness to even explore the proposal was striking.
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Only one company responded in a meaningful way, and their interpretation of matters was quite different from our own. Their counter-offer was unexpected; they would acquire the business and assets for nil and we would be paid a small commission based on the profits of the business going forward. It was not exactly appealing.
(In corporate transactions, an arrangement like this, where the seller is paid on the basis of future performance of the target, is referred to as an “earn out”. On the face of it, an earn out might sound simple enough and it can work well, but it can carry considerable risk and it should be treated with caution by anyone contemplating it.)
My dad refused to accept this as our conclusion. He still believed in us. He tabled (and argued hard for) another option; we should acquire. He had identified a target, and opened initial discussions.
In a sense, the plan was simple; we would borrow, acquire the asset, add turnover and rationalise costs. To some, in the circumstances we were in, the notion of acquiring was absurd. As his sons, however, we are cut from the same cloth as dad. We liked the plan and we didn’t consider it a gamble. We understood the business and we knew we could deliver.
There is a glib and clichéd expression used in business: “Turnover is vanity, profit is sanity, cash is reality.” I don’t like this interpretation. Clearly, turnover in isolation is misguided. But, adding turnover and scale (notwithstanding the immediate profit position) has a place in business and can provide a platform for growth. It should not be dismissed. Two plus two can equal five.
The negotiation was very odd. Our initial approach was rejected out of hand. Upon our follow-up, we were told that we had 24 hours to conclude the deal – we would not be permitted access to the site, no diligence information would be made available, and no warranties would be provided. In terms of risk profile, the approach adopted by the seller rendered this deal off the chart.
(To explain, diligence is the process of investigation into the affairs of the target. It is used to understand the operations of the business, flush out problems and provide a basis for negotiation. Warranties are contractual promises that buttress the diligence, and provide a contractual remedy in the event that things are not as you have been told. Together, diligence and warranties are the cornerstone of most acquisitions, otherwise you are buying blind, and relying on trust.)
Despite the initial challenges, we worked through the issues and completed the deal on acceptable terms. Integration became the focus (and this is where many deals fail). To combine the businesses – and make them leaner, better and more profitable – required a clear and coherent plan and an element of ruthlessness.
For example, unfortunately “rationalisation” meant job losses. Sacking someone is not easy, particularly when they have done little wrong. You think about their personal circumstances. To the thought of them going home to their family to explain that they have lost their source of income. But, it is justified (and even ethical) by the broader obligation to the company, and to all the other people relying on the business (ie staff, creditors, families).
Ultimately, we stuck to our plan with an unforgiving determination, and as we approached 2012 we started to surge. We were profitable, and crucially we were cash positive on a monthly basis. This was a game changer. We had momentum and that is a wonderful thing in business.
In my next blog I will explain how we capitalised on that momentum over the next two years amid circumstances of sadness that went to the very core of our family business.
• Michael Kelly is a partner and corporate lawyer at MacRoberts