From the Lionesses of Africa Finance Dept
So we had a very interesting and busy week. It got us thinking that the issues we were seeing from the Lionesses sensible enough to give us a call and get our Head of Finance (‘HoF’) to simply ‘kick the tyres’ of deals before they sign (including one that was initially refused finance and has now gone back with a tighter and more rounded application) were probably representative of many issues that our larger membership was also facing and having to decide upon.
One other previous occasion was with the incredible Eugénia Langa (you can read all about her here) who in spite of huge successes with some major international companies, was finding it particularly difficult to get in front of the right people at one important company in Mozambique. Our HoF introduced her to the right person (who happened to be based in London) who not only opened the doors to the decision makers but even further, to the Directors, and suddenly - she had her foot in the door!
That was all anyone can ask of another. ‘Please just let me get my foot in the door, so I can show my value’. The rest was down to the brilliance and also huge value that Eugénia and her team could bring and indeed she got the deal.
He also told her that when next in Maputo he would meet her and see if there was anything else he could help with. Eugenia called us recently to tell us all the good news and also to tell us that indeed, he had called her from London to arrange a meeting in Maputo and had even been there waiting with a coffee when she arrived!
When Melanie told our HoF, there was a quizzical look as the answer came back: “But none of my pals promise what they can’t deliver.” and walked on… (and there were we thinking we had broken through the tough shell-like exterior last week with the amazing India Arie - oh well, back to the drawing board!).
Catching up with our HoF and placing a cup of coffee within easy reach (always a good start), we asked about raising cash through selling part of the business. So many Lionesses are currently asking us about this.
“Raising money through selling part of your company is never an easy thing to do. This is their business, their Baby….”
Recognizing our job would be easy this week, one coffee and the HoF can speak for hours, we started to make notes for our Lioness Weekender Blog…
So here is a small public benefit warning (the HoF continued):
Private Equity (‘PE’) or Venture Capital (‘VC’) is not for everyone.
We touched on this a few months ago when we stated the same and pointed out that selling part of your company comes with great obligations (as with all issues concerning legally binding contracts, the legals are there to state both your rights and obligations), the trouble is twofold:
We sign when we are dizzy from the excitement of the marriage (believe us when we say PE or VC players will not be wearing the same rose-tinted glasses as you).
Your obligations may not be immediately obvious from the legal agreement.
Don’t get us wrong, there is a great deal of good and essential work that PE and VC do, but this is a live minefield. Step very carefully into this area.
We have previously stated that unable to raise finance through normal banking routes has actually put the Lionesses in a strong position because we have had to build our businesses through profit made by ever increasing sales. We have also had to bootstrap our way, becoming highly innovative, always giving customers value and always creating a new exciting spark to keep their attention…
But what if you do need money to invest, to grow, to take over new markets, what then?
Firstly think very hard about why you need the investment. If you are kidding yourself and it is really just to pay running costs such as salaries etc, then you will always struggle to find an investor. They are looking for growth, results, profit, not to prop up a saggy cost structure. They are certainly not there to pay you a comfy salary.
If it is to save your company because of coronavirus related or other reasons, then any investor who seriously looks at your business will be calculating just how cheap they can get you (in those situations it will be painful, but possibly better for you to cut off the arm to save the body (yes, the HoF is always so vivid!), in other words drastically cut back to allow you and your business enough life to fight another day).
If you have won a tender and now have the contract and need cash for deposits on goods or to allow the larger customer a 30 or 60 day credit (yet your supplier needs a deposit on order and balance paid ExWorks), then that contract is worth something and can be monetarized with the right banking partner. We at the Lionesses Team have those contacts.
If finally you do want to go down the route of bringing in an investor then be totally unimpressed by the headline figures and instead look ‘under the hood’ of this shiny new car to see exactly what you are getting into bed with (the HoF ignored our smiles at such mixed metaphors and continued.…)
What do we mean by this?
Here is the example our HoF showed us.
Lioness sells 50% of her company to an investor for US$1million.
Lioness knows her company is now valued at US$2 million.
OK so far (although it is unlikely that an investor if they are going for 50% will stop there, they will want 51% to ensure they pull the strings, but that for another discussion).
Lioness believes that she still has 50% of her company.
Hmmm, this is where it starts to get interesting…
Putting aside for a moment the day to day running of the company where no longer can the Lioness do something on a whim (because she is now governed by board decisions and agreed budgets between herself and the new Investor), let us go back to the contract between the Lioness and the new Investor, the purchase agreement.
What is ‘under the hood’ as our HoF calls it, or for the rest of us, the ‘small print’…
The Lioness will assume because she owns 50% that when the company has grown and the investor say in 5 years, wants to cash out (the PE/VC investor will want an exit at some point, to realize their investment). Another investor is found or perhaps you have really made an impact and there is an IPO (Initial Public Offering/Stock Market Launch). The happy Lioness will assume that she will get 50% of the proceeds.
(Please note before we continue, the HoF pointed out that nearly everyone falls into these traps, not just Lionesses.)
So back to our happy Lioness and back we go to the original purchase agreement and there in black and white is the clause:
Following any sale, Investor will receive 100% of proceeds up to the value of their investment (so the first US$1mil is all theirs).
This is called a ‘Liquidation Preference’ and check the small print for these, their investment has a protection. So you sell your company for only US$1 mil, you will see nothing of it, zip, nana, zero.
Sometimes there is a ‘Multiple Liquidation Preference’, which means you only start to get any share of the proceeds from the sale once the investor has been paid 100% of a multiple of their initial investment… Yes, nice! So sell for US$2mil and the investor has a 2x Liquidation Preference and you guessed it - you still get nothing out of a sale of US$2mil.
Following this then, yes, you each get 50% of the extra.
But guess what - there is something called ‘Participating Liquidation Preference’ (the HoF was getting quite animated).
With ‘Participation’ if it states ’50% Participating Liquidation Preference’, the investor participates in not only the normal 50% but ‘double-dips’ into your proceeds as well by 50%. So you get an extra US$1mil in the sale? The investor gets their US$500k and then takes 50% of your US$500k - lovely !
The reason the Investor will argue, is because it was only because of their involvement and their investment that you were ever able to sell your company for a multiple of the original valuation. If you are so determined to keep 100% of your business and it is worth very little, 100% of very little is always going to be very little, but with their cash, knowledge and assistance, this is why you now enjoy a valuation higher.
We stopped for a moment to catch our breath and asked the HoF if this was legal.
“Please remember there is nothing wrong with this. If the business owner needs finance and decides to sell part of their company, this is a negotiation. The PE/VC is indeed bringing their skills, knowledge and cash - think of the Dragon’s Den and how so often the final decision rests not only on the cash, but what they can bring to the party in the form of knowledge, contacts etc. Never underestimate the power of a good PE/VC deal, but you do have to go into these with your eyes wide open.”
Find these clauses and then negotiate. It’s much easier when you actually recognize what they mean and by that I mean - what they truly mean”.
So what else should we be looking out for?
Accrued Dividends, Pre-Money Valuation, Anti-Dilution Clauses, the HoF was into his stride now, but recognizing we were close to publishing hour we decided to leave those to another day.
As we rose to head back to our desks, the HoF gave us one last bit of advice.
Let’s keep things simple. There is nothing wrong in any legal document or term sheet to simplify by stating “for the avoidance of any doubt, this means…..”. In this situation, let’s spell out in a Term Sheet what the 50% ownership actually means. The easiest way of doing this is to ensure there is a basic structure such as this within the Term Sheet:
Gross Proceeds = sale price + surplus cash + cash from option exercise (if there is one)
Net Proceeds = gross proceeds - debt - transaction costs
Proceeds to ordinary shareholders = net proceeds - liquidation preferences (inc ‘participation’ ones) - dividends (such as accrued)
And this, we all agreed as the HoF headed once more to the coffee machine, is why companies pay the big bucks in deals to advisors…
Stay safe and keep in touch!