why investors start at the finish

Posted by in Investing, Opinions

I have said in a previous post that the true relationship with an investor only starts when the money comes in. This is because the (professional) investor is generally investing with the primary objective to make an economic gain at the end of a defined period. As such, they are very focussed on the finish before they even start – their ‘exit plan’. Perhaps a simple point, but one which has multiple implications as the investor will be looking to step away in a short(ish) time horizon which may be significantly shorter than the life of the business itself and of the management team involved.

The generally accepted routes that investors will consider for their stake are as follows:

Trade sale – i.e the business being acquired a corporate entity;

Financial acquirer – a Management Buy-Out, Management Buy-In, further development funding, replacement capital etc….. any process where the funder is a professional financial institution/investor;

Flotation – public listing of the business;

Adminstration – the least preferred of all routes.

In each instance the rationale for why, when, who and how one of the first three options above will occur will require informed consideration prior to investment.  A well prepared business should have considered this from both their own and the investor’s perspective before engaging in an investment discussion.

For example, if a trade sale is the most likely route pertinent questions are:

–          Who are the likely acquiring candidates?

–          Will the business ‘fit’ with likely acquirers strategies in the given time horizon?

–          What are the key criteria trade acquirers will use to assess whether the business is an attractive acquisition candidate?

–          Are management/other shareholders happy to sell to trade at that point?

–          Will the management team work well within a corporate structure in the future?

If on the other hand it is a likely exit to a financial acquirer:

–          Is the current team capable of taking the business to the next level?

–          What will be the rationale for further finance in the future?

–          Where will the future growth come from to attract the financial party?

–          What will be the future investor’s likely exit plan?

–          What are the aspirations of other shareholders at the time the investor exits?

The above are only a short list of example questions all of which have ‘if not then what’ implications.

The best analogy I can think of about why this is important is to compare a professional investor to the mortgage lender on your house. If you buy a house using a mortgage you want to understand the criteria under which your mortgage can be recalled by your lender. You don’t want the scenario three years in where your mortgage is ‘called’ through a fundamental misalignment of interests that disrupt your life planning as the mortgage lender tries to exit their investment in you.  Equally the mortgage lender wants to understand how their investment in you is going to be returned and in what time horizon. Effectively both parties have in place a (albeit simple!) exit plan. Where the exit plan doesn’t work for both sides the ‘investment’ shouldn’t happen.