The Exit Strategy: What investors look for in a business

When investors sit for pitches, they expect to be told about an exit strategy. This includes a tale of future acquisition or IPO.

Nowadays, these contingency plans have become more creative. Take, for example, BodeTree.

In an article about creativity being a hook for investment, co-founder Chris Meyers unveiled the unconventional route he took.

“We started with two verticles: franchising and banking. This move enabled us to begin to isolate the value of each respective channel and package it for a potential sale.

“Next, we expanded the business through acquisition so that we had the cash flow necessary to support the company independently. At this point, we were in a position to do two things.

“First, we could sell our banking channel as-is at a valuation that made sense for more buyers. Second, we managed to retain the franchising segment of the business, which was profitable. This allowed us to offer investors an outsized and, far more confident, return.”

Tim Smallbone leads Inflexion Private Equity’s enterprise team. In The Supper Club’s latest guide, Planning for Scale, Sale & Beyond, Smallbone shares what he would normally look for in a business.

“We look at each company on its merits as businesses will have different drivers in their respective markets. But one important matter is whether there are any obvious vulnerabilities, namely issues out of their control such as forthcoming legislation changes.”

These are a no-go for many investors, he explained, as it’s a variable you cannot control.

He added: “Beyond this, the business must provide something worthwhile for customers, as this leads to decent margins and that’s crucial. A diversified customer base is equally as important, since overreliance can be risky.

“If we see a rhythm of profitable growth backed by a solid management team, we will take a closer look. We want strong net margins of 15-20% and robust growth, but don’t look for specific sectors or types of business we’re open to different opportunities.”
There must also be an element of continuity, whether it’s the founder or someone else who knows the business intimately and is able to manage change.

“Finally, we look for good alignment with us as the investor so tend to avoid management buy-ins, as alignment and continuity can be trickier there,” he explained.

A possible high valuation is also a factor in deciding which business to go with. So profits are important, as well as how they’ve been maximised.

“We look at the predictability of earnings and rates of growth, making recurring revenues particularly attractive,” Smallbone said. “Valuation is an art rather than a science and so we look for the potential of a business where can it go, and is management sufficiently motivated to drive this?

“Ultimately, we are only the temporary owners so we will think about the eventual exit and how to get there. Could it be an IPO or sale to a strategic trade buyer, for example ”

Smallbone suggested that founders look beyond capital. What else do they want from an investor?

One of the most common mistakes founders make, Smallbone explained, is failing to tap into an investor’s knowledge.

“Part of our role is to help founders understand the range of options available to them,” he said. “While our role is to provide capital, we can also introduce lawyers, accountants, and corporate financiers to help them make more informed decisions.

“Another mistake is not thinking through succession planning. Founders can get caught up crystallising value and getting the deal done without thinking about who will take the business forward after they step away.”

Research reoccuringly coughs up the fact that too few companies think of succession planning as important. Legal & General suggested it was particularly prevalent amongst family businesses, where 58% don’t prepare to pass on the baton.

Talking about the private equity field, Smallbone explained that the need for a change at the top was an opportune moment for a deal to be made.

“If you want to exit within five years, that is a great time to bring on board a backer who can help you get out with two bites of the cherry,” he said. “A key point is the founder’s willingness to remain involved for a period of time if the founder wants a speedy exit, trade is a better option than private equity.”


This article was originally published on Real Business.

ESG Training – Become a Leader in Environmental, Social & Governance

ESG training, increasing your understanding of environmental, social and governance, can make a world of difference. ESG impacts how your company performs; it affects the planet and people and contributes to a better society. ESG is going to dominate many major business decisions for decades.

The Corporate Governance Institute has created, along with leading, global ESG experts and partners, the first self-paced, fully online certificate in ESG.

This certificate was created and developed by directors for directors. Click here to learn more about the first ESG for Directors certification and download the course brochure.

You can now become the champion in your organisation who brings practical ESG insight to address the environmental, social and governance factors already impacting your business.

Bring your knowledge of ESG to the next level. You will learn:

  • Key ESG concepts: Gain a solid understanding of ESG and be in a position to share the multiple opportunities with your board.
  • ESG investing: Take an in-depth look at the organisations approaching ESG effectively, how they are gaining from this and the strategies your board needs to adopt for similar gains.
  • ESG data: Be clear about the need for quality ESG data and how to interpret it. Learn the best ways to incorporate ESG and sustainability reporting in your organisation.
  • Performance: Learn how to persuade the board to build an ESG integrated organisation that links processes, systems and culture to core ESG values.

What is ESG, and why should businesses care?

ESG is how a company behaves itself when it comes to the environment, the people it interacts with and the wider community it which it operates. Investors, business leaders, employees, and the general public increasingly care about environmental, social, and corporate governance issues.

Some companies are already making strides towards meeting significant ESG goals; others are earlier in their process.

This guide is meant to set the ESG table for boards still in the early stages of addressing the issues.

ESG stands for environmental, social, governance

ESG stands for “environmental, social, governance” and is a set of non-financial corporate performance indicators being used to measure the impact that companies have on the environment, their people, and society.

While many third parties are working to address this issue, there is no universally adopted framework for measuring and reporting ESG.

Large investors like BlackRock are increasingly more interested in corporations that support societal goals rather than focusing narrowly on shareholder returns.

ESG training is about the world and its people, not just profits

BlackRock CEO Larry Fink wrote in 2022 that corporations should aim to maximise their positive social impact and shareholder value.

In 2019, nearly 200 CEOs of the United States’ largest companies rejected a decades-old policy that defined a corporation’s primary purpose as shareholder return.

Their new purpose would be to “not just serve their shareholders, but also deliver value to their customers, invest in their employees, deal fairly with suppliers, and support the communities in which they operate”.

According to a 2020 McKinsey study, 83% of executives and investors expect ESG programs to provide more shareholder value in five years than today.

ESG training can drive shareholder value

Another factor driving ESG is employee expectations. Employees expect more from their employers. They are also more willing to use their power.

You can look at Google’s global walkout in 2018 as an example, in which 20,000 employees walked out of work to shed light on harassment and discrimination inside the company.

Due to all these factors, companies that don’t focus on ESG may soon find themselves at a competitive disadvantage.

What are the three pillars of ESG?

Let’s briefly look at the highlights of the three pillars within ESG: environmental, social, and governance.

Environmental

The environmental aspect of ESG examines how a business impacts the environment. Everything from a company’s operations to the natural resources and every step it takes in the supply chain can be included.

Many corporations find it difficult to disclose climate-related information. The fact that industry-specific standards are evolving and indeed converging is positive.

Social

The social component, by far the most challenging of the three, relates to how a company navigates its workforce and its place and activities in the context of society at large, including politics.

In the “S” category, major movements like #MeToo and Black Lives Matter are driving much of the narrative. These movements are propelling historically challenging issues to the forefront of corporate boardrooms.

Governance

Institutional investors and proxy advisory firms have focused on governance for such a long time that it is the most mature of the three pillars. Governance relates to how a company makes critical decisions and can include a broad range of issues, including board diversity, CEO succession, executive compensation, and more.

The next steps for the board

ESG reporting can seem like an enormous task. Boards are increasingly addressing ESG issues, with nominating and governance committees taking the lead.

First and foremost, it is imperative to understand what has already been said internally and externally about ESG and what steps are being taken to follow them up. Disclosure should be factual and not aspirational.

In a changing world, board members must have the ability to navigate new and updated thinking.

Boards must continue to engage with stakeholders on what ESG metrics are meaningful for their companies to measure and disclose.


This article originally featured on The Corporate Governance Institute

Cap On Damages Amounts To Informed Consent

Cap On Damages Amounts To Informed Consent

Capping the amount a solicitor can take from a client’s damages is enough to show that the client gave ‘informed consent’ to the deduction, the High Court has ruled in a judgment affecting 400 conditional fee agreements.

In Swann v Slater & Gordon, District Judge Rouine sitting in the High Court in Birmingham also held that no fiduciary duty could arise during the process of negotiating a retainer.

Regional costs judge Rouine was tasked with dealing with more than 400 ‘solicitor and own client’ costs assessments being brought against national firm Slater and Gordon. Swann was the lead case, with the judge asked to determine a number of preliminary issues to then be applied to the wider caseload. In an order dated 12 March he found in favour of Slater and Gordon on all points before him.

Each retainer contained a provision capping the client’s potential liability at 25% of their damages. DJ Rouine said the existence of this cap had a ‘magnetic attraction’ in terms of informed consent.

He added: ‘Being told that there is a cap, and what that cap might be, is more than sufficient information… for the purposes of obtaining informed consent from a client for deductions to be made from their award of damages.’

DJ Rouine said it would be an ‘impossible task’ for a solicitor to ‘provide a client with specific advice as to every scenario and every level of damages which might be awarded and the impact that such an award would have on the sums which the solicitors say could be deducted from the award of damages.’

He added: ‘The realistic and pragmatic approach… is for the client to be made aware of their potential maximum exposure to a deduction from damages.’

DJ Rouine also considered whether any breach of fiduciary duty could have occurred in relation to the retainer. He said he accepted Slater and Gordon’s arguments that a fiduciary duty cannot arise while ‘the process of negotiating the terms of the retainer relating to the solicitor’s remuneration remains ongoing’.

The judgment also distinguished Swann from last October’s ruling in Belsner v Cam Legal Services, in which Mr Justice Lavender found that informed consent had not been given. DJ Rouine noted that he was not bound by an earlier High Court decision, and said the existence of a defined cap on the client’s liability amounted to a ‘a very significant factual difference’.

The judge refused permission to appeal.

The original version of this article was first published in www.lawgazette.co.uk By Rachel Rothwell

COVID-19 and the Frustration of Leases: Lessons from Hong Kong

The original version of this article was first published in University of Oxford Undergraduate Law Journal by Alexander Yean

[1]With many parts of England subject to severe COVID-19 restrictions that have mandated the closure of non-essential shops, it is likely that many tenants are being forced into financially untenable positions. Subletting and assignment are commercially impossible in the current climate, and the difficulty of finding new tenants means that it would be illogical for landlords to agree to early termination. It is therefore pertinent to consider the potential application of the doctrine of frustration to leases, which would have the effect of automatically discharging the parties’ obligations thenceforth.[2]

At the time of publication, I am not aware of any reported cases in England and Wales of frustration being pleaded in respect of a tenancy dispute relating to COVID-19 or the attendant restrictions. Among common law jurisdictions, the Hong Kong Court of First Instance has led the charge, and its November 2020 decision in The Center (76) Ltd v Victory Serviced Office (HK) Ltd[3] may well set the tone for any upcoming tenancy disputes relating to COVID-19.

This note will begin by summarising the current position in English law as regards the applicability of frustration to leases, before analysing how the law has been applied to the COVID-19 situation in the Center 76 case. I will then argue that while the outcome reached in the Center 76 case was just, English courts should not adopt its ratio when approaching similar cases that may arise in the near future, and should instead seize the opportunity to re-examine the law on frustration as applied to leases.

Frustration and Leases: Where the Law Stands

The starting point of any analysis must be the National Carriers case[4], in which a majority of the House of Lords[5] first accepted, in principle, the proposition that a lease was capable of being frustrated. However, because frustration was not actually made out on the facts, and because there has been no subsequent case where frustration has been successfully pleaded,[6] that proposition remains obiter even today.

At time of publication, the position currently stands as follows: while the proposition that leases are capable of being frustrated seems to now be universally recognised,[7] this is strictly speaking not binding as a matter of law, so it is still technically possible (albeit practically inconceivable) that a claim might fail on this preliminary basis. More significantly, when frustration is pleaded in respect of leases, the standard required for a successful claim is exceedingly high. An illustrative recent case is Canary Wharf (BP4) T1 Ltd v European Medicines Agency,[8] in which the European Medicines Agency failed in its claim that a 25-year lease for its EU headquarters which commenced in 2014 had been frustrated due to Brexit, because the lease was assignable and the property could be sublet.

The Center 76 Case

It is against this backdrop that we turn to the Center 76 case. The tenant, a flexible workspace provider, had a five-year lease of a 76th-floor office in The Center, a skyscraper in the heart of Hong Kong’s Central district, which commenced in September 2019. Since February 2020, the tenant had failed to pay the rent and other charges, and in June 2020 the landlord commenced proceedings for possession and to recover the arrears. The action succeeded, and summary judgment was given in November 2020. Of present interest is the fact that the tenant’s submission that the lease had been frustrated by disruptions caused by social unrest and COVID-19 restrictions was rejected as ‘unmeritorious… moonshine’.[9]

DHCJ Ho’s reasoning for rejecting this submission[10] is twofold:

‘The Defendant has not adduced any evidence to show how long the disruptive events and/or COVID-19 pandemic were expected to last during the unexpired term of the tenancy or at least for a long period of that unexpired term.’

‘Furthermore, the Defendant’s conduct in holding onto the Premises instead of surrendering them is inconsistent with its claim of frustration. Its refusal to deliver up possession of the Premises is evidence of its lack of good faith in this defence.’

While the decision is unsurprising on the facts, both grounds of DHCJ Ho’s judgment raise interesting points of general applicability.

The First Ground: the Duration of Interruption

It is good law that the duration of the interruption of use (specifically, whether the duration is a significant proportion of the original lease) is a critical factor in determining whether a lease has been frustrated. On the facts of the National Carriers case,[11] access to a warehouse being blocked for 20 months in a 10-year lease that had 5 years left to run was held to be insufficient to make out frustration. This is sound, because it would have been disproportionate and unjustified to automatically terminate the entire contract on account of one-third of the remaining lease being disrupted.

Indeed, this proposition dates back at least as far as the Cricklewood case (heard in 1944),[12] wherein Viscount Simon LC held that retail disruption caused by WWII restrictions was not capable of making out frustration, because

‘the lease at the time had more than ninety years to run, and though we do not know how long the present war… [is] going to last, the length of the interruption so caused is presumably a small fraction of the whole term.’[13]

That the duration of the claimed interruption should be for a substantial period of the remaining lease in order to make out frustration seems to be wholly consistent with the doctrine of frustration itself. The general test for frustration as set out by Lord Radcliffe in Davis Contractors v Fareham Urban District Council[14] is whether a thing undertaken under the frustrating circumstances would be ‘a thing radically different from that which was undertaken by the contract.’ For a lease to be rendered ‘radically different’ by disruptions, it is common sense that the disruption suffered should last for a substantial period of the remaining lease.

As such, DHCJ Ho was surely correct for finding against the tenant due to its inability to demonstrate that the disruptions caused by social unrest and COVID-19 disruptions would remain extant for a ‘long period’ of the remaining tenancy.[15] It is of course trite law that the burden of proof is on the claimant, who was in this instance the tenant asserting that frustration had occurred.

Yet one cannot help but feel sympathy for the tenant (at least as far as this point is concerned), due to the practical impossibility of demonstrating the length of the disruptions caused by COVID-19 and social unrest. At the time of trial (before the results of several COVID-19 vaccine trials were announced), nobody, least of all an indebted tenant and its legal counsel, was in a position to even speculate how long the pandemic might last, or whether Hong Kong might again see mass political protests. The tenant can hardly be faulted for failing to adduce evidence that simply does not exist—the government monitors the pandemic and updates its policy on a day-to-day basis, so it is simply not possible to adduce evidence as to the duration (or even likely duration) of pandemic-related restrictions.

These observations raise an interesting general problem, which is perhaps the most germane aspect of the Center 76 judgment: any tenant trying to plead frustration under COVID-19 restrictions (or indeed, any restrictions of indeterminate duration) would face insuperable difficulty in fulfilling the burden of proof vis-à-vis the extent/duration of those restrictions. If the Center 76 case remains good law, it would be virtually impossible for any such claim to succeed.

The Second Ground: the Tenant’s Conduct

On the facts of the Center 76 case, the tenant failed to pay rent for several months, yet nonetheless refused to deliver possession of the premises when so demanded. In the subsequent action by the landlord, it then pleaded frustration, while still continuing to use and occupy the premises even as the case was being heard.[16] DHCJ Ho was understandably unimpressed by this conduct, and held that the tenant, to summarise with a colloquialism, could not have its cake and eat it too. There is nothing controversial about DHCJ Ho’s finding: surely, if the tenant believed that the lease had been frustrated, it would deliver possession and terminate the lease at the earliest opportunity; its failure to do this was evidence that the lease had not been frustrated, as the tenant still saw (and presumably in fact derived) value in retaining possession in an attempt to ‘generate income without paying rent to the prejudice of the [landlord]’.[17]

While the tenant’s conduct on the facts was certainly egregious, it is submitted that this finding should be confined to the facts of the present case. It may not be the case that every instance of a tenant refusing to deliver possession is evidence that the lease has not been frustrated, because there may be compelling reasons for not doing so. Take, for example, the lease of a showroom for the display of large chattels (e.g. furniture, or grand pianos, or luxury cars) that cannot practicably be moved in order to deliver up vacant possession, especially during a pandemic. The tenant in such a case may well still derive some value from the storage of the showpieces, but surely this value would be de minimis if the main purpose of the lease (to use the property as a showroom) is frustrated by the mandatory closure of non-essential shops. Therefore, the conduct of the tenant in failing to transfer possession when demanded should not be determinative in every case, although it is certainly conceded that a tenant that takes active steps to leave the premises would likely have the stronger factual claim for frustration compared to a tenant that does not do so.

The Way Forward

Despite the fact that the Center 76 case was heard in Hong Kong, both grounds of the judgment on frustration can easily apply to cases heard in English courts. If the judgment is indeed adopted, the implications for tenants seeking to frustrate their leases would be dire.

As regards the first ground, English tenants seeking to plead frustration would, logically, also find it impossible to fulfil the burden of proof as regards the expected duration of disruption while the pandemic is still ongoing. This would have the unjust effect of causing claims to fail that would have otherwise succeeded if the actual duration of disruption is known beforehand: suppose that the current COVID restrictions last until the end of 2021, but no longer. If the government announced this in January 2021, a retail tenant that entered into a one-year lease at the end of 2020 would certainly have a strong case for frustration; but if the government refuses to commit to a long-term strategy and instead intermittently reviews the restrictions (as it is now doing), the tenant would not be able to succeed in its claim until most of the lease is already elapsed—a financially ruinous outcome.

The second ground of DHCJ Ho’s judgment, while more confined to the facts of the Center 76 case, nonetheless suggest that tenants must be mindful of their conduct, as it could well form the evidential basis of the court’s finding on frustration. In particular, a retail tenant facing a demand to deliver up vacant possession may be in a difficult dilemma, since doing so might be financially ruinous (due to the added expense of transporting and storing stock), but not doing so may impede a subsequent claim of frustration.

If English courts decide to adopt the ratio of the Center 76 case, tenants intending to plead frustration in respect of COVID-19 restrictions would certainly face an uphill battle, with the broader implication that the doctrine of frustration as applied to leases would be robbed of a great part of its practical significance. Beyond implausible scenarios such as where ‘some vast convulsion of nature swallow[s] up the property altogether’,[18] the status quo under stringent COVID restrictions seems to be the quintessential situation where frustration should rescue a tenant from a lease that has been rendered commercially ruinous; however, most claimants would have little prospect of success if faced with an impossible burden of proof as regards the duration of disruption.

It is therefore submitted that English courts should decline to follow DHCJ Ho’s judgment in the Hong Kong Court of First Instance, and should instead take this opportunity to re-examine the law on frustration as applied to leases. It is accepted that frustration is an exceptional and residual doctrine designed to cure injustice where no other remedy can operate, and as such should not be applied liberally.[19] Notwithstanding, its extension to leases would be largely devoid of purpose if the bar remains insuperably high. Adopting a lower standard of proof as regards the duration of disruption than that applied in the Center 76 case would not only result in greater legal coherence insofar as it allows the doctrine to be successfully applied in practice, but may also provide a lifeline to countless tenants in dire financial straits. A careful balance must be struck, and time is of the essence.


[1] I am a final year law student at the University of Oxford (Exeter College). All errors remain my own. I welcome any comments or criticisms, and can be reached at alexander.yean@exeter.ox.ac.uk.

[2] Law Reform (Frustrated Contracts) Act 1943, s 1.

[3] [2020] HKCFI 2881

[4] National Carriers Ltd v Panalpina (Northern) Ltd [1981] AC 675

[5] Accepted 4-1, with Lord Russell dissenting in part.

[6] Perhaps the closest that the proposition has come to being directly applied as law was in Hussein v Mehlman [1992] 2 EGLR 87, 89, wherein Sedley QC (then sitting as an Assistant Recorder in the County Court) accepted the proposition as a matter of law, but only applied it as part of his reasoning that leases were susceptible to repudiation (a concept that he reasoned to be similar to frustration, insofar as both are contractual doctrines that operated to determine a lease and its demise in land).

[7] See e.g. the Blundell Lecture of 2020 (wherein Anthony Tanney from Falcon Chambers assumed the proposition when giving a lecture entitled “From Panalpina to the Pandemic: Leases and the Doctrine of Frustration”); the Blundell Lecture of 2000 (wherein both Lord Millett and Neuberger J (as he then was) accepted the proposition in the context of an extrajudicial debate on the applicability of the doctrine of contractual repudiation to leases); Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch), [23] (where the proposition is accepted in the context of a failed claim for the frustration of a 25-year lease); and Center 76, [38] (wherein DHCJ Ho and both sides’ counsel accept the proposition).

[8] [2019] EWHC 335 (Ch)

[9] Center 76 [50].

[10] Center 76 [39].

[11] Considered at Center 76 [39].

[12] Cricklewood Property and Investment Trust Ltd v Leighton’s Investment Trust Ltd [1945] AC 221

[13] Cricklewood 231-32.

[14] [1956] AC 696, 729

[15] Center 76 [39].

[16] Center 76 [49].

[17] Center 76 [39].

[18] Cricklewood 229.

[19] National Carriers 701.