May 15, 2014 (Vol. 34, No. 10)
J. Leslie Glick Ph.D. Independent Corporate Management Advisor
A Poorly Planned “Purchase of Choice” May Lead to Less-Than-Choice Outcomes
In this column, in the December 1, 2012 and August 1, 2013 issues, I provided evidence that growth of the biotech industry has been enhanced by creative acquisition—the acquisition of successful firms by larger firms at premium market valuations. Creative acquisition, however, has a dark side that could be called destructive acquisition. This kind of acquisition has nothing to do with distressed sales, that is, sales of companies that are bound to fail, and soon.
Destructive acquisition exists in a variety of forms:
- More of the same—acquiring a competitor, consolidating operations, and reducing expenses mostly by reducing the acquired firm’s staff.
- Pick and discard—acquiring a company for a specific product line or technology of potential strategic importance to the acquirer and jettisoning the rest of the business (even if it has real potential, just not for the acquirer).
Loss of focus—acquiring a company primarily to diversify into a business space new to the acquirer, which the latter eventually abandons because of the excessive demands of diversification.
When a promising firm is up for sale, particularly when it appears that the sale may follow the scenario of a destructive acquisition, major stakeholder classes—management, employees, and investors—may well differ as to whether the company should be sold or remain independent. The incentives driving management, employees, and investors are not necessarily in synch.
Such concerns certainly apply to early and mid-stage biotech companies, as I have gleaned from my consulting practice over the past 21 years. Examples are discussed below. None of them was a distressed sale.
More of the Same
Two companies, Firm A and Firm B, commercialized products used in biomedical research. They sold competing products as well as products that one company or the other lacked. The majority investor of Firm A decided to sell it, and Firm B agreed to buy it. As a result, Firm A was fully integrated into Firm B.
The CEO of Firm A was offered a senior management position at Firm B, which he accepted, but his real preference would have been to continue as CEO of an independent Firm A. Most of Firm A’s employees correctly figured it was just a matter of time before they would be laid off. Moreover, Firm A’s CEO was ineffective in his new position at Firm B and was shortly terminated.
As it turned out, unforeseen problems in integrating the product lines were never fully resolved, and there being no internal champions to remedy this mess, many of Firm A’s products that had previously not been commercialized by Firm B dropped by the wayside.
Pick and Discard
Firm C and Firm D were engaged in various biotechnology development projects for strategic partners as well as for themselves. The major investors of Firm C decided to put the company up for sale, and Firm D agreed to purchase it. Firm D was interested in continuing the development of certain projects of Firm C that would fit with Firm D’s overall strategy.
Following completion of the acquisition, Firm D laid off a number of Firm C’s employees—those who had been involved with the projects that Firm D decided to discontinue.
The corporate culture of Firm C was such that scientists working on different projects were used to providing each other with feedback. Unfortunately, after Firm C had been acquired by Firm D, the morale of those scientists from Firm C that remained with Firm D plunged due to the loss of support from knowledgeable colleagues no longer there.
The scientists from Firm C who had been selected to remain with Firm D gradually left to take positions elsewhere. Consequently, the projects that Firm D was interested in continuing simply languished.
Loss of Focus
The majority investor of Firm E, which manufactured biomedical research equipment, decided to sell the company. Firm F, a supplier of biomedical research reagents, agreed to purchase it, even though the equipment was used in applications having no relationship to the reagents that Firm F manufactured and was sold to a completely different customer base. Firm F relocated the operations of Firm E to Firm F’s facility, which was a significant distance from Firm E’s facility.
Certain key personnel of Firm E decided not to relocate but seek employment relatively near to where they were living, thereby resulting in Firm F having to hire replacements for those personnel. Moreover, the consolidation of the two businesses required Firm F to seek additional working capital. However, Firm F was unable to attract investors to fund operations for a totally different business from the one in which it had a track record.
As a result, problems both in manufacturing and sales of Firm E’s product line developed. Eventually, the problems became so severe that the product line was discontinued.
Key Personnel Motivations
Management and key employees owning stock in their company have a financial incentive to grow the company, but that incentive tends be secondary until these stakeholders achieve their individual goals. Collectively, the pursuit of individual goals results in a flourishing enterprise.
Entrepreneurs managing early and mid-stage biotech firms are driven by the desire to create a company that satisfies important customer needs, leading to attractive growth in sales and net income. Scientists are driven by the desire to create the products that fulfill important customer needs.
These stakeholders will not be satisfied until they have completed their roles and have seen the products reach the marketplace and perform as anticipated. Selling a company before this mission is achieved would not be the first choice of many scientists and entrepreneurs, regardless of what they would be paid for their shares in the company.
My clients have included 73 small companies, of which 37 were biotech firms. Thirteen of the 73 companies were either approached by potential buyers and/or had investors who favored selling the company. All 13 companies, of which 6 were from the biotech sector, had sufficient working capital and did not need to be acquired in order to meet their technological and commercial objectives.
Of the 13 companies, 10 were majority owned by management and key personnel; the remaining 3 were majority owned by outside investors. In every case, management and key personnel wanted to fulfill their mission—the successful development and meaningful commercialization of their product lines, before considering the sale of the company. All of the management and key personnel in these 13 companies thought they were years away from fulfilling their mission.
As expected, the 10 companies majority owned by management and key personnel turned down the offers to buy them. At the time this article was written, one of the three companies majority owned by outside investors was acquired, and one was in the process of being acquired. Management of the third was trying to persuade the outside investors to postpone selling the company.
If a majority of the shares held in a company are owned by stockholders desiring to sell the company, regardless of whether management and key employees want the company to remain independent, the sale will proceed if the buyer is convinced that the acquisition makes sense and is able to agree on a price that is acceptable to the seller. But unless the buyer can be assured that the people in the company being acquired are in favor of such an acquisition, buyer beware.
J. Leslie Glick, Ph.D. (email@example.com), is an independent corporate management advisor.