Entrepreneurs on the outer
Monday, May 5, 2008/
As the economy slows, boards and investors are shunning entrepreneurs with aggressive growth plans in favour of managers with more conservative strategies. JAMES THOMSON explains how entrepreneurs need to adjust.
By James Thomson
As the economy slows, boards and investors are shunning entrepreneurs with aggressive growth plans in favour of managers with more conservative strategies. SmartCompany explains how entrepreneurs need to adjust.
The market is turning against entrepreneurs. As the economy slows and the credit crunch bites, leaders with a focus on aggressive growth are being dumped or forced to re-think their strategy by worried boards and investors.
Destra founder Domenic Carosa has been dumped as chief executive. Investors have wiped 47% of the value of Gerry Harvey’s retail giant Harvey Norman and almost 30% of Kerry Stokes’ Seven Network since the start of the year.
Pub baron Tom Hedley is undertaking a “strategic review” of his hotel property trust after receiving a hammering from investors. Richard Webb, a co-founder of digital media group BlueFreeway, recently resigned as director citing differences with the board.
So why are entrepreneurs on the outer?
Perhaps the person best placed to answer that is Eddy Groves, chief executive of embattled child-care company ABC Learning Centres, who summed it up best when he said: “The world has changed.”
Groves is the perfect example of this trend. Less than a year ago, ABC was a market darling. It’s shares were trading at around $8, the company had a market capitalisation of more than $3 billion and Groves was expanding into the United States and Britain.
Then, in late 2007, the world changed. The sub-prime crisis in America developed into a full-blown credit crisis and companies with debt found themselves under scrutiny. ABC managed to refinance its $1.43 billion debt facility, but that did not stop investors selling the stock. Things came to a head in early February, when rumours that ABC had breached its debt covenants spread throughout the market.
The rumours weren’t true, but investors didn’t stick around to find out. ABC Learning shares fell $3.74 to $1.15 in two days. Groves and his wife were then forced to sell their shareholdings – once worth a combined $300 million – to meet margin calls.
In the last month, Groves has been forced to sell part of ABC’s US business to pay down debt. There have been wholesale management and board changes and new chairman David Ryan has effectively clipped Groves’ wings, pushing him to focus on the company’s core Australian business and wind back ABC’s aggressive overseas expansion strategy.
It’s been a personally humbling fall for Groves, who has been left with a stake in ABC worth less than $10,000. Admirably, he’s been philosophical about the experience and brutally honest about the lessons he’s learnt. “Companies were rewarded 12 months ago for growth, and clearly companies are rewarded right now for being prudent in their capital management and capital structure,” he said on a recent conference call. “As an entrepreneur my focus was on growth. When you see it change in the world markets like we’ve seen in such a sharp, timely fashion, you have to adapt.”
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Investors are also adapting to this rapidly changing new environment and ruthlessly pruning their portfolios. Companies with too much debt – even if it is the result of recent expansion – are being dumped. Matthew Riordan, portfolio manager and small cap fund manager Paradice Investment Management, says the move away from entrepreneurs is part of the broader investment cycle.
“We are just seeing a cleanout. The market’s been good for four straight years and now we’re seeing consolidation,” he says. “There are a lot of companies out there whose business model wasn’t questioned in the good times. Now they are coming under scrutiny and in the case of some of these companies, investors want nothing to do with them.”
That said, Riordan has sympathy for executives who have been caught out by the speed with which the market has changed, given that it is less than 12 months since the market was questioning the strategy of any company that wasn’t aggressively using debt to fund growth. “People were telling these companies they weren’t working their balance sheet hard enough. Now those same people are telling them they’ve got too much debt.”
So how should entrepreneurs react to this new environment?
Quickly, according to Martyn Strickland, managing director of corporate turnaround and advisory firm 333 Capital. So far he has only seen a few instances of private company boards actually replacing entrepreneurs that have a growth focus with managers that possess a consolidation focus – but he expects to see more entrepreneurs dumped as the economy slows. “That’s a standard response from boards,” Strickland says.
Entrepreneurs who act now still have time to save their job and their company, but they must be able to prove to boards and investors that they can adjust their strategy to survive and prosper in a downturn. “Different times require different leadership.”
Doron Ben-Meir, the founder and managing partner of Prescient Venture Capital, says the reason boards get worried about entrepreneurs in a downturn is because too many people associate entrepreneurship with risk taking. “My view is that a good entrepreneur is a person who is driving the business but also has a full understanding of what is required to manage the business.” He uses the example of Seek founders Andrew and Paul Bassatt. “There’s no doubt that they are entrepreneurial, but they have executed well and they are exceptional managers.”
As we enter a new phase of the business cycle, entrepreneurs need to re-examine their business and decide what management skills their business needs. They may possess some of those skills or they may need to hire another manager that does.
Whatever your decision, boards need to be convinced of the strategy. “You have to be able to articulate the rationale for a course of action. If you can’t do that, you are not a good entrepreneur,” Ben-Meir says.
It might also pay to be aware of what investors now expect from companies and managers. Remember particularly that fund managers will become more conservative in a downturn, sticking with more conservative and stable companies in order to avoid posting negative investment returns.
Riordan says that where his investment team was prepared to take a punt on a company with a good growth story 12 months ago, they are now looking carefully at companies’ profit profiles, debt levels, cashflow and exposure to parts of the economy that will struggle as business conditions soften. Fund managers and analysts will look to increase the amount of research they do on a company, so be prepared to take their calls and explain your strategy.
Finally, it’s worth remembering Ben-Meir’s advice that entrepreneurs should be looking to grow in the good times and the bad. “You are looking for opportunities to build business. It’s just a question of what you are trying to achieve.”
If the best decision you can make is to stop looking for deals and start consolidating your business, don’t be afraid to take it. “That is an entrepreneurial decision in itself.”