Minority stakes: The pros and cons
Monday, November 19, 2007/
Allowing a larger corporation to take a small stake in your business is an option, but there are traps. The entrepreneur needs to weigh up the benefits with the restrictions and loss of flexibility. By TOM McKASKILL.
By Tom McKaskill
Allowing a larger corporation to take a small stake in your business is an option, but there are traps.
Large corporations will often suggest that they take a minority stake in an emerging business. They might be seeking an insider’s view of a developing technology and want to be able to pre-empt competitors by making an offer for the remaining shares before the business is up for sale.
They may want the business to invest in additional capacity and capabilities to support an alliance relationship. Alternatively, they may wish to invest in the business as a corporate venturing opportunity to gain a higher than average return on funds employed.
The entrepreneur may be interested in selling part of the business in order to cash up part of his or her investment. If the shares are invested in the business, it might be a cheap source of capital or a way to gain greater attention from a strategic partner. Alternatively, it might be used as a hook for a possible future sale.
Minority investments do not come without their problems. Few knowledgeable investors make minority investment without conditions. These might include veto power over executive remuneration, raising new equity or debt, capital expenditure, dividends and so on. They will normally include a position on a board of directors, and the right to replace the executive team if agreed performance targets are not met.
An emerging business that has little formal reporting and no board of directors will suddenly find themselves with a major change in their performance evaluation and governance environment.
However, for the entrepreneur this can be a way of accessing equity funds and it could be linked to access to resources, technologies, networks and knowledge. It is sometimes undertaken to secure a strategic customer or strategic partner who can advance the progress of the business. It often forms the basis of an acquisition where the parties have a chance to get to know each other and the investor has time to fully evaluate the benefits and risks of an outright purchase.
There are, however, traps – and the entrepreneur needs to weigh up the benefits with the restrictions and loss of flexibility. The agreement may come with a first right of refusal on the issue of further equity or on the sale of the business. Such a restriction might scare off potential investors and buyers. There is also the risk that the investor will not step up to putting in the resources to assist the business leaving the entrepreneur with an ineffective, if not hostile, minority shareholder.
What the entrepreneur needs to assess are the benefits of having the corporate investor over the alternative of an angel or venture capital investor, or even if it would be better going it alone without the interference of an external investor.
If, however, significant progress can be expected by bringing the corporate investor on board, then the risks may be outweighed by the benefits. Certainly, the likelihood of an outright sale to the corporate investor would be greatly enhanced with a minority investment. The difficulty then would be to ensure that a reasonable market price for the business could be achieved in the absence of a competitive bid.
Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.