Why investors always need to watch out for related party transactions
This first appeared in Aimzine, an online publication for the AIM community www.aimzine.co.uk
This month I had the pleasure of speaking at an event run by Cityzone which is a network for entrepreneurs, SMEs, investors and advisers. The event was part of their IPO Club which seeks to assist companies in considering their options and preparing for IPO. Introduced by the silky-tongued, boy-band sound-a-like, founder of Cityzone, Ronan Bryan, I gave a presentation which I’ve often given before at PLUS Markets seminars and also to entrepreneurs looking to raise Angel and VC funding; it’s a fairly versatile presentation because the issues it raises are common for companies seeking funding from whatever type of investor.
It seemed a good time to raise these issues because with the credit crunch firmly behind us companies are again looking at their options for growth funding and need to be aware of common gripes that potential investors raise. It is also a good time because one of the key issues the presentation raises is the matter of related-party transactions (RPTs) which have been in the news again (more on that later).
RPTs and shareholders
In private owner-managed companies it is not unusual for there to be RPTs. Of course, if there are no other shareholders it really doesn’t matter to anyone if the owner is running the business out of a property that he himself owns and is paying rent out of the company to himself. If there are other shareholders, then quite rightly they would expect to be told of such an arrangement to ensure that it is a normal commercial transaction at normal commercial rates and also to ensure that the owner cannot hold the company hostage at any time.
IFRS defines a related party as one which is related to the company preparing financial statements by way of joint control, management, ownership or significant influence.
When giving examples in my presentation I always presage the RPT section by saying that obviously these are old examples and of course no one would dream of having any such transactions in their company these days. It’s interesting at that point to see the looks on the faces of entrepreneurs. My co-presenters from the accounting firm BDO and the lawyers, Fasken Martineau, gave me wry smiles reiterating that infact such transactions are still commonplace in companies coming to IPO and even in many companies post-IPO. The point, of course, is that shareholders will put up with RPTs whilst things are good and the founder or CEO or director is critical to the business but soon become unforgiving about them when the business falters.
Clarity example
Such was the case a few years ago when Clarity Commerce Solutions, an AIM-quoted software company, was headed up by its founder Graham York. Amongst the various dubious activities going on in the company at the time was an expense of over £270,000 which had been incurred for the hire of an executive jet. Now we all know the hubris of CEOs having corporate jets, but this seems all the more bizarre for the fact that Clarity at that time only had revenues of around £20m. In this incident though, the facts were even more bizarre because the company which was providing the jet had as a director and principal shareholder none other than Graham York.
This was clearly an extreme and rather gratuitous example but this month a more subtle example of related party transactions was in the news again.
Recent example
A company called Eco City Vehicles plc (“ECV”) gave an update at the beginning of November about some litigation involving Cabvision, an associate company in which ECV holds a 29% stake. ECV is not a party to the Cabvision litigation but it came to the attention of the non executive directors that KPM, a wholly-owned subsidiary of ECV had been making payments, totalling over £500,000, as loans to Cabvision in order to, amongst other things, fund Cabvision’s litigation. Whilst these payments were recorded correctly in ECV’s books they were not disclosed separately in the management accounts circulated to the board, and clearly hadn’t been approved by the board or any assessment undertaken as to whether they are reasonable.
The commercial logic of those loans would be questionable under normal circumstances but in this case, the picture was muddied by the fact that Cabvision is majority owned by relations of three directors of ECV. Fortunately, any loss to ECV’s shareholders would be covered by indemnities given by the directors of ECV when they undertook the reverse takeover that gave rise to ECV. However, that should not reduce the significance of these events and infact the lesson is that the facts behind related party transactions should never be overlooked.
Following a period when corporate governance has generally been improving, we should not lose sight of the fact that companies both on AIM and coming to AIM may have related party transactions. Many of these will be in the normal course of business and of no concern but you should always turn to note 93 (or wherever they’re tucked away) in annual reports to see if there are any related party transactions, and if the description doesn’t tell you all you need to know then it’s worth calling the company to find out more. The chances are that there may well be more to the transaction than meets the eye.
Showing posts with label fasken martineau. Show all posts
Showing posts with label fasken martineau. Show all posts
Tuesday, 16 November 2010
Wednesday, 20 October 2010
Presenting at Cass Business School...
...and why an IPO is a bit like getting married.
Off to Cass Business School yesterday to present at the Cityzone IPO Club sponsored by law firm Fasken Martineau and accountancy firm BDO.
The presentation I gave was one I use frequently as it talks about what companies need to do from a finance perspective to prepare not just for IPO but for any fundraising, and what they need to do to make a success of their IPO.
This includes not having related party transactions. Crudely put this means not siphoning money out of the company. Many entrepreneurs run their businesses from property they own in their own right rather than it being owned by the business. That’s all very well if you don’t have external investors but if you do they will want to see that it’s at a market rent and not a ruse by which the entrepreneur can take shareholders cash out of the business. The property example is a common and simple one but there are many other more exotic arrangements (like company jets) which I’ll describe another time. Other areas companies usually have to clean up their act is in ownership of key assets. Again, many entrepreneurs will try to keep the key assets, eg patents, trademarks etc. out of the company so as not to jeopardise them but also because they feel the assets are personal to them. And finally, these days we have to have a few slides on corporate governance, and the importance of good control, reporting, non executive directors etc..
I went to a rather average university and never got round to going to business school. I would have liked to but could never fit it amongst work and life, in so I’m always a little overawed by any good academic institution like Cass Business school. A friend of mine recently became a professor and whilst I’m not one for titles, if I had a title other than Mr then it would have to be Prof. It sounds so like you didn’t really want it; that it was foist upon you for your greatness, unlike say Sir or Lord which most people who receive it were probably very desperate for it. Alas, to get the Prof title you need to need to follow the academic route, which frankly was never my cup of tea, or should I say as in academia, my glass of port.
The Cityzone IPO Club is run by the silky-tongued, boy-band sound-a-like, founder of Cityzone, Ronan Bryan, who manages the room deftly and with quiet confidence and the usual Celtic charm. He makes a group of professional advisers and entrepreneurs feel like it’s just a get together of friends, and the interaction amongst the group is quite stimulating.
I go on to talk about how to get the most out of going through the costly, and time-consuming process of an IPO. Many companies see it as an end point, in the same way as some men see marriage as an end point, but looking optimistically it’s actually the start of something potentially beautiful, and like marriage it doesn’t just create happiness by itself. Being a quoted company, like being in a successful marriage, requires hard work, and getting through the tough times. A lesson that many entreprenuers often forget.
Off to Cass Business School yesterday to present at the Cityzone IPO Club sponsored by law firm Fasken Martineau and accountancy firm BDO.
The presentation I gave was one I use frequently as it talks about what companies need to do from a finance perspective to prepare not just for IPO but for any fundraising, and what they need to do to make a success of their IPO.
This includes not having related party transactions. Crudely put this means not siphoning money out of the company. Many entrepreneurs run their businesses from property they own in their own right rather than it being owned by the business. That’s all very well if you don’t have external investors but if you do they will want to see that it’s at a market rent and not a ruse by which the entrepreneur can take shareholders cash out of the business. The property example is a common and simple one but there are many other more exotic arrangements (like company jets) which I’ll describe another time. Other areas companies usually have to clean up their act is in ownership of key assets. Again, many entrepreneurs will try to keep the key assets, eg patents, trademarks etc. out of the company so as not to jeopardise them but also because they feel the assets are personal to them. And finally, these days we have to have a few slides on corporate governance, and the importance of good control, reporting, non executive directors etc..
I went to a rather average university and never got round to going to business school. I would have liked to but could never fit it amongst work and life, in so I’m always a little overawed by any good academic institution like Cass Business school. A friend of mine recently became a professor and whilst I’m not one for titles, if I had a title other than Mr then it would have to be Prof. It sounds so like you didn’t really want it; that it was foist upon you for your greatness, unlike say Sir or Lord which most people who receive it were probably very desperate for it. Alas, to get the Prof title you need to need to follow the academic route, which frankly was never my cup of tea, or should I say as in academia, my glass of port.
The Cityzone IPO Club is run by the silky-tongued, boy-band sound-a-like, founder of Cityzone, Ronan Bryan, who manages the room deftly and with quiet confidence and the usual Celtic charm. He makes a group of professional advisers and entrepreneurs feel like it’s just a get together of friends, and the interaction amongst the group is quite stimulating.
I go on to talk about how to get the most out of going through the costly, and time-consuming process of an IPO. Many companies see it as an end point, in the same way as some men see marriage as an end point, but looking optimistically it’s actually the start of something potentially beautiful, and like marriage it doesn’t just create happiness by itself. Being a quoted company, like being in a successful marriage, requires hard work, and getting through the tough times. A lesson that many entreprenuers often forget.
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