Large businesses are collaborating with smaller ones for mutual benefit.
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The landscape of business is changing. While Apple’s recent $800bn valuation hints at the increasing monopolisation of international markets, with very few, very large companies dominating, all organisations are vulnerable to disruption.
An increasing number of deals between large businesses and start-ups in the UK, over 5,000 (5,447) since 2013, are indicative of one of the disruptive business models large companies are undertaking to retain the competitive advantage.
Totalling in excess of £102bn in the past four years, these deals include M&As, minority stakes and joint ventures and are having a transformative impact on the industry.
Partnerships of this kind can be mutually beneficial to the SME and large organisation. Smaller innovators can develop new smart technology from scratch, while larger firms can be held back by legacy systems.
Yet smaller innovators lack the scale, brand and infrastructure of the corporate giants to fully realise the value of their innovations. Bringing these two worlds together can help larger corporates achieve their economic goals through innovation, while startups get a shortcut to scaling up.
A successful collaboration depends on finding the right deal structure and partner, and every partnership comes with the potential for conflict. But with so much at stake, how can you mitigate the inherent risks and ensure an efficient and profitable union?
Motivation – on the same page
While alliances are usually driven by the same desire to drive innovation, each side will come at it from a different perspective. Large organisations need to generate return on investment (ROI) and SME shareholders seek to create maximum value from their proof of concept.
Negotiating a fair financial settlement at the start of the relationship is critical, but making sure your long-term view matches up is even more important. You don’t want to get a few months in and realise one party wants a fast turnaround and the other is interested in long-term value.
Brand and culture – keeping an original style
Having an entrepreneurial culture is currently a much feted trait, and SMEs in particular can take a great deal of pride in theirs – especially if they believe they do things differently. The extent to which an SME can retain its original culture, versus how much it is controlled by the larger party, cuts right to the heart of collaboration.
Equally, the larger party may be worried about risks to their brand – especially in an industry sensitive to consumer trust such as financial services. Finding the right balance between the autonomy of the SME and the need for central brand control can be hard work, but ultimately ensuring both sides feel fairly represented is a goal worth fighting for.
Tax – putting your pennies to work
Tax may not have the most exciting reputation, but it is in the best interests of both the SME and the larger business that they discuss their respective tax positions. Again, this is an area where both parties may have conflicting motivations.
On one side, the large organisation will want to maximise the tax efficiency of their investment by claiming Research and Development (R&D) relief, so may push for a larger stake. On the other side, the shareholders of the SME may want to retain enough equity interest for each individual to qualify for Entrepreneur’s Relief.
This is a scheme created to incentivise people to set up and grow businesses by providing a reduced level of Capital Gains Tax when you sell all or part of your business. This situation can be complicated if there are a number of individual shareholders, as there is less equity to go around.
Reconciling what may seem like conflicting objectives may be challenging, but maintaining an open and honest discussion, and setting out limitations, can help find a mutually beneficial solution.
The exit plan
Exit strategies have also undergone a shift in recent years. Where fast growth tech-powered startups were once built with the intention to float on the stock market, they are now geared towards a corporate sale – as seen in the decade's lowest global IPO rate in 2016.
However, this decline has been accompanied by a rise in the number of minority stake purchases by corporate organisations, rather than full acquisitions – suggesting they are aware of this tactic.
Wanting to buy continued development, rather than intellectual property alone, is understandable, but may not marry with the SME’s desire. One solution is to structure earn out (where the seller of the business receives payments based on future performance) around the sustainability of the company, rather than trying to tie individuals in for an unenforceable time period.
Robert Phillips is a corporate finance partner at national law firm Bond Dickinson.