UK: WALK OUT START UP.

UK: WALK OUT START UP. - Why pay the owners of a business for skills that belong to individuals? Why not start your own company taking that expertise with you? Enterprising managers are doing just that.

by Anita van de Vliet.
Last Updated: 31 Aug 2010

Why pay the owners of a business for skills that belong to individuals? Why not start your own company taking that expertise with you? Enterprising managers are doing just that.

If your image of the typical business start-up is of a whiz kid in a garage or a boffin with a brilliant idea, think again. It is more likely - certainly with a successful start-up - that it will take shape through the exodus of a team of managers, who set up in a similar business, often in direct or indirect competition with their former employers.

For self-evident reasons, this process has been graphically christened the 'management walkout'. It is also known as a 'management start-up' or, slightly more technically, as a 'rolling start-up' - so-called, according to Marc Gordon, who last year left investment managers John Govett with his team to set up the Close Fund Management for merchant bank Close Brothers, because 'Since you're starting with a number of people with expertise, you can start to build up the business from day one.' Roll up and roll on, as it were.

Whatever the terminology, the key feature is that it is started by a team of managers who have experience in their chosen sector and of working together. It is precisely because of this experience that these are really the only sort of start-ups likely to win venture capital backing. Comments Chris Tennant of Phildrew Ventures: 'People remain nervous of innovative start-ups: they're harder to judge.' With the management walkout, he points out, 'You don't have the risk that the product and the marketplace are unproven'.

This timorousness on the part of UK venture capitalists is often contrasted with the bolder backing for innovative start-ups in the US. According to Tennant, however, 'In the US many inventors deliberately see it as worth their while to spend their first 10 years in a big corporation in order to learn the ground rules. In the UK inventors think that's beneath them.' It is 'genuinely the truth', he says, 'that we have looked at a large number of innovative start-ups, but we could not be comfortable with them.' His colleague Frank Neale puts matters equally bluntly. 'The only start-ups that have made us money are those started by a team that has done something fairly similar before, and has done it organically.' The last point is important: backing will go to those who can claim to have built up a business from scratch organically, even if this has been achieved under the wing of a larger corporation, but not to those who have been running a business division they have inherited, where the infrastructure, customer base and supplier network came ready-made. Phildrew Ventures is relatively unusual in investing in business start-ups at all, most UK funds preferring to back the safer prospects of the management buyout or, as second choice, a management team buying into an existing business. So why and how does the management walkout take place?

Andrew Joy, managing director of CINVen (also a backer of what it prefers to call management start-ups), suggests that many large corporations find it difficult to respond to the contemporary rapid evolution of markets, leaving middle management frustrated: any company has only finite capital for investment, and managers whose business area has been passed over may be left fretting at market opportunities they are unable to exploit. Against the wider background of changing and more positive attitudes to risk and wealth-making, on the one hand, and of lessening secure lifetime employment, on the other, the more enterprising among them may think of starting up their own company rather than leaving to join another corporation as would have happened in the old days. 'The key motivation is the belief that, given a free rein, they could really build something,' says Joy. This 'determination to prove they were right' could of course be fulfilled by a management buyout; but this is not always possible (because the owners refuse to sell), or practicable (why buy a business which in essence consists of your own skills and experience, as in publishing, for example?).

Take the case of David Gallagher, founder of Prime Time recruitment agency. Gallagher had built up the HMS recruitment agency as part of the Hestair Group, but became 'disillusioned' after the business was taken over by BET in 1990, feeling that his new bosses did not fully understand his business. 'We were strong in our beliefs and what we wanted to do - focusing on sales recruitment, engineering and industrial,' he says. 'We wanted to be able to look at acquisitions, and we wanted more investment.' But the recession had by then set in, and BET directors rejected these proposals. So Gallagher, clearly a forceful and energetic personality who had been used to acting as 'bell-cow' in Hestair, along with another 'dissatisfied' colleague, started putting together plans for their new venture. Gallagher had told BET of his intention to leave, and 'they knew I'd be doing something similar', he says. He resisted attempts to persuade him to stay on and eventually, having served out his contract, out he walked, followed by 20 other HMS employees who would join in his new venture.

Prime Time has since proved its worth, growing to 37 branches and a turnover of £18 million in its fourth year, achieving profitability in its second year, ahead of schedule, and 'good profits' now. Gallagher is hoping for a flotation in a couple of years, to pay back Phildrew and other backers, and to invest for the future. The early days of the company, however, were a hair-raising reminder of why management walkouts are not for the faint-hearted. The company opened the doors to its six branches on 17 February 1992. The next morning brought the arrival of 36 solicitors, armed with the draconian search powers granted under an Anton Piller order (the equivalent of an injunction). In the weeks that followed, claims Gallagher, the searching of offices, houses and even cars for evidence of theft of sensitive information from BET continued. 'It was extremely worrying,' he says. 'People had given up good jobs to join us.' In the event, it emerged that despite instructions to the contrary somebody in the new team had taken what could be construed as client information - canvas cards, applicants' cards and diaries - and the case was eventually settled out of court. The episode cost some £500,000 - a huge sum in the first year of a company's operation.

Leaving aside the (not entirely clear) facts of this particular case, the wider point is that managers have to be scrupulously careful over what information they take with them. 'Unfortunately, people sometimes concentrate on their contracts of employment (which may stipulate a period of 'gardening leave', to weaken contacts with clients), and forget their common law or fiduciary responsibilities,' observes Neale. But even when all is done with utter correctness, some employers do all in their power to thwart the new venture and stop it from trading successfully, as the four founders of Safeline discovered when they came up against their former boss, the ever-litigious Robert Maxwell, in court in 1990 (they won, with costs). And except in the rare cases where the present employer happily agrees to the departure of a top team, the management walkout process is likely to be contentious.

The real problem, comments Tennant, is the perception that the reason why the team and its backers are not buying out the business is that the value of the business lies only in the skills and experience of the managers themselves. Why pay the owners for skills that belong to individuals? 'The manager of a subsidiary of a big public company has a responsibility towards his employers, but it is difficult to say where this ends and his responsibility towards himself begins,' he comments. Offering a talented, experienced manager another job in another company would be regarded as perfectly normal; his acceptance of the job would be seen as a good career move. From the employer's point of view, however, matters obviously appear differently. 'They think, "You're grabbing my guys, you ought to be paying me",' says Tennant.

The problems of walkouts are therefore both legal and ethical, and managers contemplating this course need to consult both a good corporate lawyer and their own conscience. But if the risks are greater than for a MBO, so are the potential returns. Comments Jim Martin, who deals with 'emerging businesses' at 3i: 'The returns of a start-up can be higher, because you're not carrying extra costs.' And to 'quality management teams' he says in encouragement: 'You will be able to raise funding if you know your sector well, and if you have worked together.' Sectors that are not capital-intensive will find it easier to get backing, says Tennant, pointing out that you 'can have a substantial business with low investment'. The first debt/equity investment in Prime Time, for example, was £2 million.

Whatever the business, the successful start-up will have a clear idea of its market, and there will be a real need for its products and services. Take Close Fund Management. Marc Gordon and his team are launching 'lifestyle' investment products which they reckon are clearly tailored to the needs of the 1990s. Known as defined pay-off products, because they have a known performance characteristic, they are designed to 'turn savings into investments', which can be for pensions, mortgages, attaching to life insurance or school fees. 'Through the 1980s, the equity market just went up and up; over the last five or six years, it has been very volatile; and if you're trying to save, you need certainty,' explains Gordon. In addition, both government and employers are shifting away from the provision of pensions, moving from a system of defined benefit to defined contribution, as in the US.

Gallagher has some advice for others contemplating a start-up. First, he says, look at your abilities self-critically, examine what you're good at and what you're not: 'I could have left to run a branch up here in Yorkshire, but I'm best at actually building a business. That's what I get a buzz from. You have to look at what gives you a buzz.' Next, remember that not only will the business be difficult to get going, but your energies and commitment will be demanded for five, 10, 15 years: 'If you think that you could just about survive for a couple of years, don't do it.' Third, he says, 'Don't take all your senior people with you. Take the ones you can train up, and promote: they'll appreciate it.' Sitting in his office 'surrounded by safety shoes and trolleys', he points out that there are 'no ivory towers' at Prime Time: 'Everybody in the company gets the business.' Prime Time provides a 24-hour service on the industrial recruitment side; offices are open from 7.00am. 'Our success is due to the work-rate and determination and enthusiasm of our people,' he says.

Over at Close Fund Management, meanwhile, Gordon looks to his parent company as an encouraging example of what rolling start-ups can achieve. Although hardly a household name, Close Brothers is the second largest independent merchant bank on the stock market (after Schroders), with a market capitalisation of £350 million. Back in 1978, its young management team under Rod Kent undertook the first MBO of a British merchant bank when they bought it from Consolidated Gold Fields. Since then they have expanded their coverage of financial services through bringing in teams with expertise from larger companies to set up subsidiaries (some seven, so far). These are run as if they were autonomous businesses, but can seek the support of the main holding company, which also monitors their activities. In each case, Close Brothers holds the majority holding, but all the executive directors 'have - and pay for - stakes in the business'. 'This helps incentivisation, and is important for commitment,' says Gordon, who himself put in 'relatively big money'. 'I have tried to back my own confidence.' And that confidence is boosted by the Close Brothers record - 20 years of unbroken profit growth, which is more than most merchant banks could claim.

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