Non-core assets may greatly complicate raising equity financing, finding strategic or financial partners, or selling a business.

This article will first deal with what is a non-core asset; why non-core assets may complicate a transaction; and what can be done about non-core assets.


What are non-core assets?

Non-core assets are assets that are not necessary for a company to carry on its business in the ordinary course. Examples of non-core assets owned by a manufacturing or service company might include:

• Real estate that is lying idle, or generating passive investment income from third parties;

• Shares or bonds that are not related to the company’s main line of business;

• Subsidiaries or investments in other companies unrelated to the company’s core business.

Provided that the above assets are not required to create the liquidity necessary for the company to carry out its core business, these may be considered non-core assets.


Why non-core assets might complicate a transaction

There are two main reasons why non-core assets may complicate a transaction.

First, investors very often do not wish to purchase non-core assets when they are buying or investing into a company. A few such situations I have experienced in the past:

• Investors in an energy company did not wish to purchase several residential building lots owned by the company;

• Investors in another company did not wish to purchase two cottages owned by the company;

• A company that had two core businesses, construction and aerospace, was unable to attract investors into either core business until the two businesses were fully separated.

In the first case, the owners of the company sold the building lots to family members of the owner just prior to closing of the sale of the company, triggering a significant capital gains tax and land transfer taxes. In the second case, the purchaser bought the company, essentially acquiring the cottages at a zero valuation. In the third case, over six months of restructuring were required to separate the two business lines, before offering them to investors, thereby delaying the company’s access to capital.

The second complication has to do with valuation of the company in question. How should these non-core assets be valued? As demonstrated in the second example, non-core assets were sold at zero valuation, in order to avoid delaying the transaction. So valuing of non-core transaction really depends on the time frame in which a transaction is contemplated. The more time is given to spin out non-core


What may be done about non-core assets?

An evaluation of what should be done with non-core asset should be part of any transaction planning or business exit planning exercise.

Whether an asset is core or non-core is often a question of judgement. For example, is an owner-occupied office building, warehouse, or plant core or non-core? This is often a judgement call.

I can’t emphasize enough the need to give this issue careful consideration well before a transaction is taken to market. I know one company in the food industry that has been on the market for over three years. Over a dozen investors have performed due diligence on this company, and they all backed out, primarily because a company-owned plant was located on highly priced downtown urban land, and the seller insisted on realizing full value. No company in the food business was willing to pay a premium for the development potential of this real estate. Such companies will either be “hard sells,” or an investor may buy such a company “on the cheap,” opportunistically unlocking the value of the non-core assets.

Remember, a privately held company is one of the most illiquid forms of investment imaginable. Keeping your company devoid of non-core assets is an important way of increasing liquidity.

This article deals with the types of provisions that may be contained in a shareholders’ agreement. The list is not at all exhaustive. Generally each jurisdiction has a corporate law, which sets out certain standard procedures and ways in which decisions are made (e.g. minority protection rights, etc.) in the absence of a shareholders’ agreement.

In the same way as a prenuptial agreement, a shareholders’ agreement is necessary if the parties want to deviate from the way that the law would normally operate. Sometimes it is possible to set out the entire understanding of the shareholders in the articles of association of the company. In certain instances, however, a shareholders’ agreement may work better than reliance on articles of association.

The intent here is merely to highlight some of the more important issues:

Decision making at the general meetings of shareholders: What is the quorum, decisions by simple majority or supermajority, special veto rights.

Constitution of the board and voting: How many members? What is a quorum? Who votes? Who may exercise a tie-breaking vote, etc.

Decision-making on the board: Are decisions made by a simple majority, or supermajority? Are there certain classes of issues (e.g. raising additional equity, acquisitions, mergers, liquidation, etc.) which may require supermajority.

Appointment of board of directors: Who appoints the officers of the company? Is each appointment made by the assembly of shareholders? Or do certain shareholders or classes of shareholders have the right to appoint one or more directors on the board?

Appointment of officers: Is the CEO, or are other officers appointed by a simple majority of the board? Or are certain officers to be designated by certain supermajorities of directors? Does any board member have veto power over appointment of officers?

Raising additional capital: What triggers a capital call? What happens if one or more shareholders cannot keep pace with the capital call, will they be diluted? If so, to what extent?

Ensure arms’ length transactions: minority shareholders need protections against special related party transaction, which may siphon off the assets of their company to the sole benefit of the controlling shareholder.

Rights of first refusal: When one shareholder wishes to sell, other shareholders often want a right to buy the exiting shareholder, to ensure that they are not co-shareholders with strangers, or worse, hostile parties.

Put and call options: Can one shareholder opt to sell his shares to other shareholders (put option) or can a shareholder opt to buy shares of another shareholder (call option)? If so, at what price? Pricing the shares of privately held companies involves complex valuation issues typically performed by investment advisors.

Drag along and tag along rights: If a shareholder decides to sell shares, can he trigger an obligation of other shareholders to sell on the same terms (drag along rights)? Or if there is one shareholder who sells, can another shareholder decide to tag along with such transaction, and sell on the same terms at the same time (tag along rights)?

Dispute resolution: Will there be mediation, arbitration, or resort to a court system? Under the laws of what country?

A shareholders’ agreement can be complex and can take weeks or months of negotiation. The devil is always in the details. Very often parties negotiate it with undue haste, only to find that if their relationship breaks down with other shareholders, the shareholders’ agreement does not provide adequate protection or clear path for remediation. It is well worth involving an experienced lawyer, and investing the time and effort necessary to negotiate and execute a shareholders’ agreement up front.

Conceived in 1995, AIM claims to be the most successful market for growth companies in the world, with over 1,164 companies listed from all over the world as of April, 2011, roughly a quarter of which are non-UK companies. The market is an alternative to the London Stock Exchange for smaller growth companies seeking growth financing. Total market capitalization as of April 2011 exceeded GBP81 billion.

While 2005-2006 seems to have been the peak year for number of admissions (300 to 400 companies admitted each year to the exchange, raising in the range of GBP 15-16 billion each year), activity has decreased in the recession years (GBP 5-6 billion in each of 2009-2010 and only GBP 2 billion until April 30th of this year). Nevertheless, there is a steady number of new firms admitted (22 before April 30th of this year), with many market observers saying that the number of issues is likely to increase.

What might be surprising to the reader is that a company doesn’t have to be that large to be listed on the AIM. The AIM can also accommodate early stage companies and venture capital companies. Approximately a third of the companies have market capitalizations of less than GBP 10 million. The average market capitalization is around GBP 70 million.

Listing on the AIM, as with most stock exchanges, requires a high degree of quality and transparency from the interested firm. There should be some breadth and depth to the management team, good corporate governance implemented, ideally good growth prospects, solid customers, a good strategy, a unique selling proposition and a defensible market niche with barriers to entry.

So when might a Central European business owner choose to list on the AIM, as opposed to the WSE? Both stock exchanges offer excellent options.

First, it depends what constituency you wish to target. If business owners wish to define their company as Central European, and wish to raise their profile with Central European investors (who are often also clients or consumers), then the WSE may be the preferable option. For a company that wishes to position itself globally (both global emerging markets as well as in more developed Anglo Saxon markets), AIM would tend to offer the better positioning.

Before making the choice as to where to list your company and raise capital, a check-list of items to check would include:

• The legal and regulatory environment affecting your company, and your listing;

• The cost of listing, and your advisory relationships;

• The likelihood of having research coverage for your company, and liquidity thanks to an active following by investors.

Whether listing on the WSE or AIM, business owners of small- to mid-sized companies should plan to spend somewhere in the range of 6-10 percent (or more) of the capital raised for advisors and stock exchange fees. While a part of this would be by way of a success fee, payable only in the event that capital is raised, probably more than half of the amount would be by way of fixed fees (for lawyers, auditors, listing fees, etc.) that would be payable even in the event that a listing did not succeed.

Although many business owners equate an Initial Public Offering with hitting the jackpot, there is also a degree of risk involved, as well as ongoing disclosure requirements and the cost of complying with legislation and regulations.

Acquisitions by Central EuropeanCompanies in North America
since January 1, 2009 (click on image to see larger view)

Source:Mergermarket 

As I now mark the one-yearanniversary of commencing this syndicated column, I hope no one willmind if I use this occasion to talk about my new book, “BusinessExit Planning: Options, Value Enhancement and TransactionManagement,” published by John Wiley & Sons, available onAmazon and other retailers. This book is very timely from a CentralEuropean perspective, where numerous businesses were founded orprivatized in the early 1990s, and the original owners are preparingto pass the torch to the next generation, or the next owner.

The book is designed toprovide owners of mid-sized businesses with the knowledge required tocarry out a transaction for the first time, whether it is attractingfresh equity, finding a strategic financial partner, or selling aminority or majority interest in a company. Often this requires aparadigm shift on the part of business owners.

It covers two majorsubjects:

• Business Exit Planning: Selling your business is not the only option. There are many others to consider, such Management Buyout, Initial Public Offering, or inter-generational transfer (passing the business to your children or next-of-kin).The pros and cons of each option are discussed in some detail. How should a business owner establish objectives? Can you forecast the valuation of your business? What is the best moment to begin the sale process? How might you enhance the valuation of your business before transferring ownership? How can corporate governance affect the value of a business?

• Transaction Management. What are the steps to a transaction? What can the business owner expect at each stage? What are the core competencies required; will you need outside advisors? How should you organize and manage your team? What kind of a process should you run? When should you grant exclusivity? How do you keep the process confidential? When should you tell your staff?

There are three key themesto the book:

1. A Business Exit shouldnot be a spontaneous process, but the result of careful planning.Planning needs to cover everything from planning retirement, taxplanning, what will be done with proceeds of sale. Part of thedifficulty for business owners is the multidisciplinary nature of theplanning effort.

2. Business owners tend tounderestimate the preparation and time required to exit. Mostbusiness owners begin negotiations long before they are truly ready.

3. There is often amismatch in negotiation strength between investor and seller. Forbusiness owner doing a first transaction, facing a professionalstrategic or financial investor who has often done dozens oftransactions, is no easy task. This may often be remedied byappropriate preparation and selecting the right moment to take acompany to market.

Lack of business planningis not an isolated problem; it is something of an epidemic, being amajor contributor to the number of bankruptcies in most countries.According to official statistics, one third of bankruptcies in theUK, for example, are caused by lack of succession planning. Eachyear, many thousands of businesses self-destruct. While Schumpetermight argue that “creative destruction” is a normal part of thecapitalist system, this type of self-destruction of businesses isusually entirely avoidable with sufficient advance planning. And thatwould have massive implications for employees and families ofbusiness owners.

This book is an updatedversion of my earlier edition, “Unlocking your Company’s Value.”It is currently under translation into most Central Europeanlanguages (Polish, Czech, Hungarian, Bulgarian, Serbian, Albanian),appearing later this year in these languages. Negotiations are underway with publishers in Romania, Croatia, Turkey and Greece.