I know of a small entrepreneurial team who met at university, discovered they shared a passion for the tourism industry, graduated later and went to work in tourism as employees of the dominant company at the time. After a few years valuable experience they decided they could do better than the incumbent and left, joined forces and set up their company. They kept costs down for many years.
In any industry it takes time to build up trust and part of this trust is simply being around over time, so keeping costs way low meant that conservative international distributors who met them at a travel show one year, would see them still alive a year later, and would start to trust them with some business only a year or two after that. Inbound tourism has fairly low barriers to entry but long sales cycles, where products are often finalised and marketed 1-2 years in advance, so the experienced distributors know to wait it out and see which of their suppliers survive. Only then can they trust them with their business 2 years from now.
What typically happens with new entrants is that they buy expensive new vehicles in which to carry clients around Africa, and equip them well. They put fewer seats in their trucks so that customers have more comfort, but then make the mistake of pricing their trips the same as the lower cost operators in an effort to win business. The result is that each trip is marginal, if not loss making and within a year or two they are out of business and all capital is destroyed. The experienced distributors have seen this all before, so they hold back on giving business to new operators. This means that new operators must have a differentiated offering, a lot of luck, and very low costs to start with. They have to get around the 2-4 year phase of building trust with their distributors.
This is what the team I know did, almost too well. Pretty soon they had the number 1 distributor in a large foreign market signed up and were in all their brochures and getting all their local business. Then the number 2 supplier in that market approached them also wanting to sell their trips. The problem was that they couldn’t supply both. So after some thinking they set up a separate company, which they owned, and gave some equity to their chief lieutenant who was then tasked with driving the new business. Through the two businesses they could now service both distributors and grow things well. Indeed for the first year or two this is what happened.
Then the Lieutenant’s girl (whom he met on one of their trips) became his wife and this led to pressure from her for him to get his ‘fair share’ of the business. So there were lots of negotiations and eventually he was made the majority owner of the business. I asked at the time what would happen if he didn’t meet targets or how he could be replaced and they response I got was that he was fine and knew his stuff and there wasn’t any need to put these kinds of clauses into the deal. You know what is coming next of course: the Lieutenant’s wife moves back to the foreign country where she came from, pregnant, and he goes with her. Suddenly the local business is being ‘run’ from a distant foreign land from a ‘stay at home dad’ and things don’t go well.
Its been nearly a decade since this happened. The original business is now big enough that it employs nearly 100 people. The spin-off business is still only 5 people, some of whom are seasonal. The original shareholders can’t change the shareholding in the spin-off and haven’t been impressed with the returns, so they have simply stopped supplying the business with managerial expertise or further capital. They’ve considered selling it too, but it’s not easy given the low growth rate, foreign owner and other issues. So they’ve rightly focussed their efforts where they can influence returns.
When they setup the spin-off, they never planned around what could go wrong. They didn’t anticipate the people’s lives change and that someone so committed to the early success of the business could meet someone who would effectively force him to move country and neglect things to such a degree. They screwed up the legal side of things and its cost them some money, but mainly its cost them all the growth that could have been.
The lesson here is around legal homework – any shareholding-level agreement needs a lot of thought not just in terms of what each person gets, but also in terms of what happens when things go wrong. How do you revert? How do you claw back? How do you measure performance and strip away any free gifts of shares before it’s too late. Get an attorney on your side before you sign the deal.