TWO weeks ago, Amor, a successful, fast-growing technology company, announced that it was to be sold to US aerospace giant Lockheed Martin. Last week, the oil and gas company Bridge Energy recommended its shareholders accept a takeover approach from a Norwegian rival. These are just the most recent examples of a long-term trend in which both emerging and successful Scottish entrepreneurial companies – many of them too small to attract newspaper headlines – are acquired by overseas companies. Indeed, of the 21 high growth companies that we interviewed in 2009 for Scottish Enterprise’s study of high growth firms, five have since been acquired.
Should we be concerned by this trend? Does it matter who owns Scottish businesses? We need to insert an important caveat here. Both finance secretary John Swinney and Scottish Enterprise chief executive Lena Wilson were quoted as reacting positively to the Amor deal as being “good for Scotland”.
Clearly, the ability of Scottish entrepreneurs to build companies that are attractive to large, global businesses can be seen as an economic strength. But it might also indicate the existence of a “glass ceiling” preventing the development of substantial global companies based in Scotland. However, the presence of companies such as Aggreko, First Group, Stagecoach and Wood Group might challenge this view. Alternatively, it may reflect lack of ambition among entrepreneurs and investors.
Whatever the reason, does it actually matter that Scottish businesses are being acquired? It is certainly the case that acquisitions can have a positive impact on the acquired companies. Growth is facilitated as a result of access to the financial and management resources, marketing and distribution channels of the new owner. The credibility from being part of a global corporate group may also open up new markets and customers.
In addition, acquisition will normally trigger a period of “entrepreneurial recycling” as the internal shareholders in the company – the entrepreneur(s) and senior management staff – use their new wealth to start new businesses, become business angels or take on non-executive directors and mentorship roles. Meanwhile, investors receive a capital gain on their investment which, in the case of business angels, can be reinvested in other companies, and may put Scotland on the radar screen of institutional investors. All of this gives a significant boost to the entrepreneurial eco-system. However, there are also serious downsides.
The acquisition of companies such as Amor depletes the population of mid-sized companies – the type of company that is attributed to playing a key role in Germany’s economic success. It removes ownership and control from Scotland, continuing its status as a branch plant economy. There is a loss of top management positions in the economy. Supply chains may be changed following acquisition.
Most vulnerable are high level financial, legal and business services, which are often switched to the suppliers used by the acquiring company. And it creates vulnerability – corporate priorities do change over time, resulting in companies that were acquired by a previous management team being deemed of marginal significance by a new management.
In the case of small acquisitions, which usually involve relatively young companies, limited wealth may be created and the experience that the management team gains in growing a company is truncated. In both cases, this restricts the amount of entrepreneurial recycling to occur. Moreover, the assets of such companies are often largely in the form of intellectual property, with the decision to sell being influenced by the need for finance to scale up production. But the intangible nature of the assets means that such companies can easily be moved elsewhere by the new owners.
Acquisitions are part and parcel of the market economy and we are certainly not advocating that any future Scottish Government should prevent acquisitions of Scottish companies. Indeed, successful Scottish companies grow via acquisitions. The critical issue is how can Scotland derive more of the benefits and fewer of the downsides from acquisitions?
At present, one of the key policy instruments utilised by Scottish policy is the provision of venture capital through the Scottish Co-Investment Fund and the Scottish Venture Fund. However, this is potentially in conflict with the wider objective of the Scottish Government to build more “companies of scale” because inherent in this venture capital investment model is the need to exit at some time in the future to realise capital gains. This could be viewed as a “build to sell” approach towards industrial policy, which engenders short-termism in young entrepreneurial companies.
So, what needs to change? First, at present a trade sale appears to be the only option considered by investors and management seeking an exit. However, for mid-sized companies a stock market flotation on the Alternative Investment Market or the main market is also an option.
Despite this, it is surprising how few Scottish companies have taken this route in recent years. Indeed, just 3 per cent of AIM-listed companies are Scottish based. This option needs to be promoted more vigorously by the financial sector and indeed by the Stock Exchange itself (which appears to be too preoccupied with attracting international listings).
Second, too many Scottish companies get acquired prematurely, while they are still small. Such acquisitions typically generate limited financial wealth and managerial learning, thereby restricting the scope for significant entrepreneurial recycling.
They are also at risk of being relocated. Companies that are larger when they are acquired are more likely to be embedded in the local economy, making it harder for them to be moved.
A more joined-up financial system would help here. At present, growing companies can raise up to £1 million or so from the business angel community along with co-investment funding. However, raising further rounds of funding is problematic because of the lack of investors looking to invest £1-£10m and above. This often provides the motive to sell.
Third, there is a need for a mind-shift in entrepreneurial attitudes to give much greater emphasis on the long term. The message to entrepreneurs that growth needs to be based on equity rather than debt may have prompted entrepreneurs to seek equity finance prematurely, leading to early dilution and prompting the entrepreneur motivated to sell while they still have a significant ownership stake.
Similarly, the message to entrepreneurs that they need to be able to articulate an exit strategy when they are pitching for investment – again while fundamentally true – means that companies are being “built to sell” rather than grown with a view to create longer-term value.
On the basis of the, admittedly limited, evidence available we believe that a high level of acquisition of Scottish companies – especially premature acquisitions – is detrimental to the economy. Although there are often significant short-term benefits, the impact becomes negative in the longer term. This sell-out mentality is part of a wider systemic problem within the UK noted by a recent inquiry by the House of Commons science and technology committee. Scotland does have some significant global companies – but not enough; our economy needs more of them.
• Colin Mason is Professor of Entrepreneurship at Adam Smith Business School, University of Glasgow, and Dr Ross Brown is a lecturer in the Department of Management, University of St Andrews