Corporate Advisory Inisghts- Hostile Takeovers Pt 2: Ordered Chaos

The business jungle

The business world is very much like the jungle, with different species having different survival methods!

Some are moral, some are immoral. Some are legal, some illegal.

Some make their intentions known, others hide them.

The most dangerous are the ones that appear moral but are immoral, hide their intentions and who use the legal system to their advantage!

In the merger and acquisition space, some will purposely create conditions for their prey to fall victim, so they may take advantage through what appears on face value to be a benevolent hand.

As grim as this may sound, at Royce Stone Capital as part of our corporate advisory services we make it our business to know what the worst of the worst can do. We work in realty, not in the fairy tale world of how things should be!

Because we aren’t’ just corporate advisors, but we work in finance, private loans and investments. We understand the aggressive psychology of investors seeking to buy equity at a discount, and the defensive nature of business owners wishing to sell equity at the highest valuation.

This article will shed light on situations that our corproate advisory services have been engaged in, both in an offensive and defensive capacity.

Scenario 1 Delayed payment terms to induce a takeover.

A business with revenues of circa $200M (principal) contracted work to a SME business (target business) with revenues of circa $30M. The SME business was in a highly labour-intensive industry and worked on low margins.

The larger business deliberately started to contest the quality of work the target was providing, with payments being delayed beyond 90 days, which significantly damaged the free cashflow of the target business.

The larger business was aware of the margins the smaller business was working on, and more importantly that the target business could not afford prolonged litigation costs against them if they opted to go that way!

To make things worse, the target had a high concentration risk of their revenues coming from the principal business.

6 months later, the target business started to dispute the issues with their principal client and shared their cashflow problems.

The principal business then offered them an equity injection to solve their cashflow problems if the target sold 51% of their equity at a 60% discounted valuation. Threating them, that without their contracts their business would be worth nothing.

Our corporate advisory remedies

The target business was referred to us for our corporate advisory services, which consisted of four main remedies.

Business action 1: Legal action and new contracts.

RSC brought in an extremely competent contract lawyer to handle the disputes with the principal client, and to redo their contractual paperwork. Furthermore, we brought in an extremely strong litigation lawyer to put the principal client on the defensive.

Business action 2: Private lending

The second point of defensive action we took, was to remedy the immediate cashflow problems of the business. This was done by securing the client a number of private loans from our private lending services, to ensure the free cashflows of the business were brought to healthy levels. This also meant our client was not at the financial mercy of the hostile party.

Business action 3: More revenue.

We introduced the client to a business networking group specifically focused in the construction industry, and our RSC clients. To reduce the concentration risk of clients that they had. This in the long run would increase the value of the business.

Business action 4: Correct structuring.

We set up the necessary accounting, legal, key personal contracts and SPV structures to ensure all the necessary hygiene factors were put in place to make the business a compelling acquisition target in future. Which is all part of our corporate advisory services.

Business advisory results

We were able to protect our client from a hostile takeover strategy being deployed by their main client. By providing the immediate liquidity the business needed when conventional banks wouldn't fund them, we were able to ensure they didn't have to take the offer of the hostile party to save their business!

By “dressing the bride” and ensuring the client had the right foundations, the business was set up for success to be sold at a much higher valuation in future. Our company structuring also ensured our clients key business and personal assets were protected from any future litigation or business liabilities.

Scenario 2: Bad circumstances, poor management and debt.

A SME business turning over $40M (principal) had contracted out work to a smaller SME business turning over $20m (target). The target business had key client relationships that would complement the principal business, industry specific intellectual property, and a management team the principal was looking to absorb.

The target had a about a 30% concentration risk of revenue from the principal, and the business had about $5m in business debts that it was obligated to pay to creditors.

The owner of the target business due to personal circumstances was unable to operate his business properly, additionally key legislative changes made the target business incur certain losses.

Due to the owner of the target business being unable to effectively do his role properly, he overlooked key contractual obligations in his delivery of work to the principal business (our client). This meant the principal business had grounds to hold back several million dollars in payments,.

Due to the mismanagement of the target business, the business faced serious insolvency risk, if it continued on its current trajectory.

The target business who at its peak would have been valued at $15M, was looking for an equity injection to get itself out of trouble.

As corporate advisors to the principal business, we were responsible for helping structure the deal for the target to be acquired on very favourable terms. We structured a deal, where our client would agree to take over the debts of the business (circa $5M) in return for 100% ownership of the business (a 66% discount), with key personnel of the target business taking shares in the new SPV for the acquisition.

Phased equity purchase

We created a phased equity purchase agreement over 12 months, that would increase our clients voting rights as each progressive payment was made. This gave our client time to raise the necessary funds, to execute the phased purchase.

Furthermore, we created a new shareholder agreement that gave our client control over key decisions with consent of the target, even whilst being a minority shareholder. This also involved amendments to the company’s constitution.

Loan to the target business

We created a loan from our client to the target business to provide immediate cashflow relief for the target. This loan came with security rights over the target business in the form of a GSA and personal guarantees. More importantly we carefully engineered the permitted use of funds.

Providing a loan was integral, to helping give our clients a degree of control until 75% of voting rights were achieved.

Renegotiation of debts owed by principal.

The management team of both parties came to an agreement regarding the previous works done, and that the works should either be brought up to standard or be discounted.

Corporate advisory results

Overall, our client achieved a 66% discount on the purchase price of the target business by simply offering to take over the debt obligations of the target and by providing immediate financial relief, with a structured share equity split in the new SPV for the targets management team.

If as a function of time, the target business decided it couldn’t fulfill to bring the works previously done to standard, then this would further discount the purchase price, as it would get rid of our client’s debt obligation.

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