58Once institutional investment has been attracted to the company, the natural source of further funding should be these same institutions. However, to ensure that current investors will commit further funding requires management/investor relations to be sound and investors to have confidence in the management and board of the companies in which they have invested.

From my experience this is an area where academic managers of spinouts fall short. The differences in business and academic cultures that Lambert mentions become more apparent the longer the relationship persists, often leading to a breakdown in trust. This makes it very difficult for spinout managers to attract repeat funding from their investors, particularly when times are tough (and when they most need it!).

Part of this problem could be the difficulties associated with whether the spinout has any intellectual property that it can patent and the question of who owns the IP, mentioned above. But, assuming the company has secured its patents, another problem for investors is the value of the IP itself. To quote Lambert again:

‘Universities should adopt a more realistic approach to their IP rights. A lot of VCs believe that universities over-value their IP and put too high a price on it. Universities must realise that generation of IP might cost say £10, but bringing it to market is going to cost you £100 because you have got to develop, market and commercialise it.’ As the VC, quoted above, said: ‘You have to deal with all those academics who do not have a realistic idea of the value of their company or its IP …’ Another challenge for investors is the quality of financial forecasting contained in business plans. If the management of a company are financially and commercial naive, it highly likely that their business plans will reflect this and investors will be reluctant to invest.

University spinouts usually start life with ‘seed corn’ funding from their university, or from the government. Technology companies are cash hungry and their business plans often indicate that they will require repeated injections of capital for several years. So, a spinout needs to able to attract outside investment if it is to survive and prosper.

The first problem for spinouts is to attract the initial round of third party funding. To quote from the Lambert Report:
The quality of spinouts varies widely among different universities. The best way to judge quality is by looking at the ability of a spinout to attract external private equity. This indicates whether there is real market interest in the new company. At one end, Oxford has attracted private capital to 95% of its spinouts since 1997. But almost a third of the universities that created spinouts in 2002 did not bring in external equity for any of their new companies.’

133The first part of this question is complex and in the hands of the Patent Office rather than the directors of the spinout company. However, as the case of the researchers into monoclonal antibodies (lead by Cesar Milstein at Cambridge University) shows, the second can be very much influenced by the actions of its inventors. Milstein’s team developed the artificial version of natural monoclonal antibodies and were awarded the Nobel Prize in 1984 for their work. Before they patented their research they decided to publish their findings and by this action made it impossible to take out a patent. Once in the public domain, research findings cannot be protected by patent and all the potential commercial advantage of the research was lost.

Blame for these sorts of mistakes is sometimes levelled at the universities’ technology transfer offices. Critics point to the variable standard of the management of these offices, saying that many of them provide very little advice or help on what to do about patenting, licence negotiations or marketing of research findings or ideas. However, corporate mistakes are always the ultimate responsibility of the company’s management and directors.

45An MBO is a business sale where the buyers are the management of the business. Contrary to common belief, an MBO is an exit option available to any private business and not just the larger ones; nor is it necessary to have Venture Capitalists (VCs), corporate finance specialists, or banks involved, but as MBOs usually need outside funding, financiers of one sort or another usually play a part in the process.

The first step in answering this question is to establish whether the MBO needs outside finance, or whether the management can fund it with their own resources. Where the management does not need outside financial help, any business can qualify for an MBO. Where management does need outside financial help, the general requirements of suitability of a business for an MBO are the same regardless of its size, but size will determine what sort of outside investors are likely to be interested, because VCs are unlikely to be interested in a deal in which they are investing less than £500000. The general requirements of suitability can be summarised as a strong cash flow and management expertise.

85An ‘earn-out’ is different from a retention in that it refers to the circumstance where the ultimate purchase consideration is based strictly on a multiple of future earnings achieved by the business (and can go up or down); whereas with a retention the price is set beforehand, but the full amount is only paid when and if profit or turnover targets are met.

You will need to consider whether either a retention or an earn-out provision is likely to be requested by the purchaser and what your reaction to this will be. Your response is likely to depend on whether you need the entire sale proceeds immediately.

Selling the business yourself?

You can sell your business through a business transfer agent (company broker), or you could decide to handle the sale yourself. If you decide to handle the sale yourself, you should address the following questions:

Am I able to establish a fair market price for my business? Will I be able to put together an attractive memorandum of offer document? Will I be able to find someone who wishes to buy my business? How do I best structure the sale transaction? Am I in a position to provide some of the funding? How do I arrange a suitable handover and how long should this be for? If I want to continue to be involved in the business after sale perhaps as a consultant), how do I go about this?

Vendor finance

It is sometimes difficult for purchasers of a small business to borrow money to finance their purchase (particularly where goodwill value is a major part of the price), unless they can provide security outside the business, such as a house that still has some clear equity value. One way of overcoming this difficulty and still achieving your asking price would be for you to provide vendor finance. This is an issue that requires careful thought by the vendor.

Retentions

In a trade sale of a small business it is not unusual for a purchaser to keep back a specified portion of the purchase price until it is proved that the business can retain its customers or clients, (i.e. its turnover or sales levels). The withheld portion of the purchase price is called a ‘retention’. It will usually be held in trust until the trial period has expired. When the performance conditions are met the retention is paid to the vendor.

The value at which you dispose of your interests is central to any exit option. In some processes, such as a public listing, you will receive expert advice on your business’s probable value. In others, such as an MBO, the value could be worked out between buyer and seller. In a trade sale, however, the seller usually needs to set an asking price upfront and has to rely on his own judgement, or that of his advisers, to establish the amount. This is a problem for most business owners because neither they nor their accountants are usually business valuation experts.

Where you fix your own price for your business in a trade sale you must bear in mind that the price at which the business is listed for sale (that is the asking price) often determines how quickly the business will be sold and/or whether it will be sold or not, because: although all prices are negotiable and business people expect to haggle, if you start with a price that is far too high, potential purchasers are unlikely even to begin the first stages of negotiating; • you will have started off with unreasonable expectations and will find it hard to accept what might, in the event, be a reasonable market price.

It is better to face up to what your business is really worth at the beginning, rather than going through the costly and stressful business of trying to sell a business that is over-priced. Think carefully about market value based on sound valuation principles and not subjective issues like ‘this business owes me the best years of my life.’

You will get a better idea of how to value your business once you have read Appendix 1. You should also seek professional advice from a reputable business valuer. Make your decision on an asking price for your business once you have all the relevant facts and received outside advice.

A sale to a third party on the open market (known as a ‘trade sale’) is the method of disposal most private business owners think of when they consider disposing of their businesses, and it is still the way most private businesses are sold. Most businesses in most industry sectors are suitable for a trade sale and there are usually no special attributes that the owner or the business need if it is to be disposed of through this route. The key question that an owner should ask when considering a trade sale is:

‘Is this the best way for me to maximise my financial return (and, perhaps, my personal satisfaction) when exiting my business, or should I be thinking of different options?’

A general understanding of all the main exit options available to you will help you to answer this question with authority. If, having achieved this understanding by reading this chapter, you still believe that a trade sale is the optimum exit option for your business you should then look into this method in more detail. For this I can recommend Selling your Business for all it’s Worth, by Mark Blayney, published by How to Books Ltd. As most businesses are suitable for a trade sale, the issues that need considering are often more to do with your own financial position than the
position of your business. Some of these issues are discussed below.

A family succession involves passing on your business to a family member. Most private business owners with children, or who have a close relationship with a younger relative, would like to go down this route if possible. Unfortunately, even those with close relatives such as children, often find that their heirs are not interested in, or capable of, taking over the running of the family business.

Although desirable from the point of view of personal satisfaction for the owner, family succession can be the most difficult exit strategy of all. The greatest problems are that family and business goals and cultures often clash, objectivity is often absent and emotion rather than business practicality takes over.

The other major issue with family succession is the time and effort needed to prepare an heir for the task of owning and running a business. This is usually accomplished through a five-stage process of:

1 Learning the business operations.

2 Doing: that is partaking in all aspects of the business’s operations.

3 Managing all aspects of the business.

4 Leading other managers as a preparation for running the business.

5 Outside experience, which can be undertaken at any time during the grooming process.

As you can see, the successful grooming of an heir could take many years and should start early in the prospective heir’s business life. I would advise those owners considering this path to set aside at least 10 (and preferably 15) years for the task.