A venture into partnership

I joined the venture capital industry in its infancy almost 30 years ago working for its then only inhabitant 3i (ICFC). The most enduring development in this time has been the increasingly mature approach to relationships between venture capitalists and investee companies. The old style of leaving management well alone and relying on original investment judgement has no part in what is now a well-populated, successful and self-confident industry. In its place is a willingness to guide, advise and even interfere.

The closer relationship between investor and investee is not confined to management buy-outs, where institutions often have outright control, but is also seen where minority stakes are held. And it isn’t just born out of disaster or when an exit opportunity presents itself.

The partnership between investor and management team begins even before investment during due diligence. As members of the venture capital team get to know more about the business, they identify with the business plan produced by management.

A shareholders’ agreement sets out the parameters within which the relationship works. This will cover items such as limits on capital expenditure in line with agreed budgets, the necessity to get investors’ approval for acquisitions and disposals, remuneration levels and so on. Remuneration and audit committees in line with the Greenbury and Cadbury codes will act as checks and balances.

Usually an independent chairman is appointed. Such people may start out as appointees of the investors but, in my experience, they very quickly cut the apron strings and become genuinely objective.

The selection of a chairman is important. They must be able both to work in harmony with the management and bring something extra to the party.

This could be an understanding of the workings of the City but, in many cases, it will be relevant industrial experience and an ability to act as a sounding board for the team.

The investors will also appoint one of their own executives to the board.

Years ago this would have been resisted by private companies but today is welcomed and, indeed, an unwillingness to accept a seat can be viewed with suspicion.

The investor-director should spend time getting to know the business and its key executives. He or she will take part in planning sessions and be a member of the team. As a director of the company, the fiduciary duties are clear. Agreement at the board to a course of action may reasonably be construed by executive members as investor approval.

However, formal investor approval may be required and will not always be readily forthcoming. The investor-director needs to exercise skill, judgement and sensitivity. This is vital when things begin to go wrong.

Investors may have the legal right to veto capex or acquisitions but if executives’ plans are constantly thwarted frustration and resentment can result.

The help investors can give varies: they can introduce portfolio companies to one another to develop business; bring a whole range of experience to bear on the planning process and take a detached view.

The investors represent their own shareholders who will expect them to take appropriate action whether that means appointing additional management or, at times, removing management that is not performing. Usually changes like this are agreed on at the time of investment but circumstances can arise later which justify further change.

Preparing for an exit also involves delicate handling by the investor-director. It is important that suitable financial incentives are in place for management but the whole team has to be committed to float or sell at the right time. This is often more to do with hearts and minds and personal ambitions than pure financial inducements.

Like venture capitalists, lenders are more involved in a private company’s progress than they used to be. The recession in the early 1990s prompted big banks to establish work-out groups. Forcing businesses into administration was not producing the best results and more creative solutions were needed.

Banks, through covenants, have early warning of problems and usually work with management teams to maximise value for themselves while simultaneously saving a business from break-up.

Venture capitalists and bankers both have access to talented business managers who can be ‘injected’ into problem companies to help them overcome temporary or even long-term problems. Despite the different security arrangements, return expectations and legal rights, debt and equity providers often work together quite harmoniously in order to protect, enhance and realise their investments in times of trouble.

Robert Smith will be speaking on ‘Venture Capitalists’ and Bankers’ roles’ at the 1996 biennial English ICA three-day Conference for Accountants in Business. The conference will be held at the Belfry Hotel, near Birmingham, from 2-4 October. The conference fee is # 851.88. For further information, call Trudy Fisher at ACC customer services on 0171-920 8800 (ref: 754).