Ian Thomas, managing director of climatetech investment specialist Turquoise International, considers the challenges and opportunities for low-carbon SMEs contemplating a trade sale.
As the demand for sustainable businesses grows, low-carbon SMEs are increasingly attractive to strategic buyers. However, for established companies with green credentials, planning an exit via trade sale (as opposed to IPO or sale to private equity) comes with a specific set of challenges. From navigating regulatory issues to ensuring the longevity of their business ethos, founders must approach their exit strategy with a playbook that can differ compared to traditional enterprises.
Focussing on exit
Whether you operate a low-carbon transport platform, are a low-waste inkjet coatings innovator or supply a herbicide-free weed control solution (all of which are portfolio companies of Low Carbon Innovation Fund 2, or LCIF2, of which Turquoise is fund manager), the ultimate aims of founder-led, investor-backed businesses are to secure a profitable exit and ensure the longevity of the company under new ownership. In the UK, this often means a trade sale to an acquisitive corporation (as opposed to the US, where IPOs are more common). However, this critical period in a company’s journey can have numerous pitfalls if not carefully considered.
Culture considerations
For founders, the culture of the acquirer is an important consideration given that they are passing over control of the business they have developed from scratch and are likely becoming employees of that company for a period of time. Investors will be more focused on the financial returns but, in some cases, may be receiving consideration partly in the form of equity and/or an earn-out, in which case they too will have a strong interest ensuring that the acquirer is the right party to take the business forward. These considerations must be balanced against the terms of the transaction including, critically, the price being offered.
Many founders in the climatetech space will have strong personal convictions around environmental impact of their businesses. This is mirrored in the climate impact commitments that their venture capital investors have made to limited partners in relation to fund portfolio companies. Therefore, both will be seeking to ensure that a trade sale provides a likelihood that the business will continue to deliver impact under new management.
Ensuring value proposition alignment
Equally, the business being sold must offer a value proposition to the acquirer, in terms of financial metrics, technology and/or carbon impact. Ensuring alignment between the start-up’s value proposition and the strategy of the acquirer before entering into a full-blown acquisition process is a prerequisite to securing a successful outcome. For the seller, understanding the key drivers of the acquirer’s interest is important in deciding whether or not to proceed.
An SME preparing for a sale need to get its financial house in order, ideally having at least a couple of years of audited accounts available but at a minimum a data room containing a complete set of management accounts together with supporting information. It is not uncommon for hard-pressed start-ups to have some gaps in their records which need to be filled before the acquirer’s due diligence gets underway. Similarly, the data room should contain details of all material commercial contracts, employment records, intellectual property filings and anything else that supports the value of the business.
Depending on the seller’s business model, a buyer may also be interested in carbon accounting and compliance issues, such as greenhouse gas emissions, carbon credits and supply chain audits. As with accounting matters, third-party verification provides greater assurance and underpins deal value. Of course, the seller’s founders and shareholders may well want to see similar information in respect of the buyer.
Keeping emotion out of negotiations
Sale price is always a very sensitive (and, at times, emotive) topic for both founders and their investors. Both will have a view on value; however, in our experience, this is ultimately almost always determined by market conditions, in particular the number of genuinely interested, potential acquirers for the business. Determining the latter requires a managed M&A process to engage as many potential suitors as appropriate. Having discussions with very few parties, much less only one, deprives the seller of a market perspective and places it at a disadvantage in negotiations.
Seeking assistance
Depending on the experience and resourcing of the management team, selling companies may wish to appoint a corporate finance adviser to assist them in the process. This also has the advantage of creating a layer of separation between buyer and seller during the inevitably difficult parts of negotiations over price and other deal terms. It is important that founders and management are able to preserve their relationship with the buyer given the likelihood of employment lock-ins potentially for one or more years post-acquisition.
For companies ready to go down the trade sale route, plan early and strategically, allowing a year or more from start to finish. With forward planning, low-carbon business founders can achieve a lucrative and mission-aligned exit, ensuring both financial success and lasting environmental impact.
