This is the third of three articles by UK-based law firm MJ Hudson looking at how to ensure you achieve smart exits for your portfolio companies.
Clean breaks?
After many years of intensive incubation by its founding corporate group, a venture’s day-to-day finances, opera–tions and support functions are likely to be intertwined with those of its group.
In an ideal world, the venture being sold would have been developed in, or spun out into, a separate entity, and would now be operating independently, albeit often with a continuing close commercial relationship with its former corporate group. In practice, one or more of the following issues is likely to render a clean break elusive.
Intellectual property (IP)
- Who owns, and uses, the know-how and IP developed by the venture?
- Does the venture rely on the know-how or IP of its founding corporate group, or vice versa?
- Would the founding corporate group be prepared to allow the venture to consider using its know-how and IP, and, in particular, any trading names and logos?
- What value is attributable – including in respect of reputation and goodwill – to IP that the founding corporate group will want to retain?
IT, machinery and other fixed assets
- Who owns the IT systems – including software – and fixed assets used by the venture, and how valuable are they?
- Are adequate alternative systems and products available on the open market, or would the venture remain reliant on its founding corporate group, and therefore exposed on cost?
- How quickly and at what cost could the venture transition to its own IT arrangements, or purchase or lease replacement fixed assets?
- Does the venture rely on the provision of goods, financing – including guarantees – or services from its founding group?
- Are all such arrangements documented, and on arm’s length market terms?
- Does the venture’s founding group effectively cross-subsidise its operations, or vice-versa?
Employees and managers
- Are all key staff employed by the venture? If not, what would be the impact of their retention by the founding group?
- Would the venture require additional staff, for example to carry out back-office functions currently shared with the founding group, or have too many staff? Note also that, on a business transfer, individuals employed outside the venture but whose work is dedicated to it may also transfer automatically under law.
Premises
- Are the venture’s premises owned or directly leased from a third party, or does it rely on its founding group for free or cheap premises?
- How quickly, and at what cost, could the venture find alternative premises? Are the current premises strategically important?
Save where separation is particularly tricky – in which cases a pre-sale restructuring may be in order – the solution is typically to agree a limited transitional period during which any shared IP, assets and services continue to be provided to the venture. In the meantime, the venture will source replacements or agree longer-term arrangements, for example, for the use or transfer of critical IP. The key document to be negotiated by the parties is the transitional services agreement. While it is typically short-lived and functional in nature, negotiation is to be expected on the critical areas of scope, cost and duration of services (see box).
Conclusion
This series of articles has highlighted some of the key traps to avoid when planning the sale of a corporate venture, but the take-away message is a positive one – with a robust valuation, well-run due diligence process and a considered approach to separation issues, your corporate venture should be on track for a smooth sale, and a successful transition to full commercial and financial independence. Preparation, preparation, preparation – including, of course, the commissioning of expert professional advice – must surely be the mantra of any smart exit.
The founding corporate group, motivated to achieve as clean a break as possible, is likely to push for:
- Restrictively-defined services, which impose minimal, or no, performance targets.
- Services to be priced at market rate or, failing that, the historical price charged intra-group, or at cost, if services were previously subsidised. Ideally, the selling group would want the flexibility to revise pricing if its costs increase.
- Limited duration, and no continuing obligations or exposure once the agreement has expired.
A buyer will negotiate for:
- A broader scope of services, perhaps including an ability to call on the selling group to provide any previously shared services that were overlooked when implementing the sale.
- Pricing at cost, or at least favourable rates.
- A longer period, perhaps with a right to extend, to allow the buyer to shop around, plan and implement its replacement solutions in good time.