Date 5 July 2010
How can owners guarantee the best price for their business when it comes to selling? Exit strategy specialists Ian Gibbon from chartered accountants and business advisors Alliotts, and Chris Wilks from law firm SA Law outline the required mindsets.
Fantasy success stories such as the Seattle Coffee Company and YouTube fuel our business sale dreams. At some point, all owners will have fantasised about being offered an astronomic sum for their operation. Starbucks paid $83 million for all 60 outlets of the UK’s Seattle Coffee Company. And the three founders of YouTube received a tidy $1.65 billion from Google. Not bad for a business that was operating from above a pizza restaurant.
On the whole, we know that these ‘Mary Poppins’ cash-rich buyers appearing out of the blue are few and far between. The more likely scenario is a proactive strategy of targeting and courting a likely purchaser. And the most likely purchaser is what we call a predator – an established business or entrepreneur that is looking to expand operations or reap the rewards of a perceived lucrative investment.
Naturally, that predator wants to take control of your business for the least amount of capital outlay possible, and it doesn’t take much for them to drop the offer price. Therefore, the challenge for a seller is to groom their business in such a way that it gives the predator no cause to negotiate a price reduction.
The Road to Sale
There are four what we could call ‘foundation mindsets’ for business owners with an intention to sell. The first is to be prepared for a marathon and not a sprint. An effective exit that achieves the optimum price for your business is usually at least an 18 months to two-year strategic project.
Second, the fundamental distinction between running a business and grooming it for sale must be understood. Grooming is a set of specific strategies to maximise the equity value of the business, and these extend much further than simply having a great balance sheet. It covers aspects such as perception of your brand, market penetration, degree of innovation, security of the intellectual property and its physical infrastructure. Some of our venture start-up clients even state their intention to sell before they begin trading – enabling us to immediately instigate the right structure, management and tax strategies that allow the business to work towards equity value maximisation.
Third, remember that predators are looking forward, not back. Typically, they’re not after a ‘ready to wear’ business. More likely, the predator wants a suitable investment that they can apply their own commercial ‘x factor’ to in the areas of management, brand and innovation/creativity. Predators will tend to believe that they can take a business operating at around 15% profit up to around 25% to 30%. Therefore, it’s not so much about your company’s track record – it’s about how that track record projects a valuable and opportunity-rich future.
Finally, be objective and open-minded. Selling something that has been ‘your baby’ for a long time can be more traumatic than people realise. The seller may not respect your business as much as, or in the same way that you do. But if they’re talking to you, they almost certainly see its potential.
The Sales Process
Maximising equity value is best explored from the perspective of what actually occurs in a business sale. Naturally, the process is slightly weighted in favour of the purchaser, who will commission a rigorous due diligence review in order to achieve a complete picture of your business as it operates today. Nine times out of ten, this will expose an issue that prickles the purchaser’s fear factor.
Therefore, sellers must spot the issues and eradicate them ahead of the sale, or openly declare them as a part of the business. And the ideal strategy for achieving this position is for the seller to undertake their own due diligence ahead of presenting the company for sale. This allows you to determine what the buyer is likely to look at, and expose any problems before they become an issue. Selling a business is very much like a beauty parade, and this will ensure you look your best before you step onto the catwalk.
Owners are often surprised about the areas in which due diligence exposes issues, with the most common being employees and intellectual property. Employment law is such a complex animal nowadays that contracts, policies and PAYE frequently present irregularities. Intellectual property can be equally problematic – often because the full extent of the business’s intangible assets aren’t adequately protected against exploitation. If a purchaser is specifically buying a brand, then ownership and security of the intellectual property must be unquestionable.
Aside from the obvious assessment of the financial health of the business, other areas covered by the review include studying its working capital structure; IT systems; supplier and sub-contractor agreements; shareholder status; and tax/VAT position and projections. All client contracts must also be valid after the business is sold. And remember that more complex businesses will naturally take longer to assess as the review process will extend to all subsidiary and associated companies as well.
The valuation itself is a complex calculation based on the financial value of the business, its equity value and the perceived risk it carries. The valuation also takes into account growth projections based on the quality of the management team; market perception of the brand; competitiveness within its markets; and the innovation and creativity displayed by all facets of the business.
Once the price has been agreed, the legal stages kick off in earnest, starting with the ‘heads of terms’ – a document that summarises the key points of the deal for both seller and purchaser. These provide a target to work towards for the remainder of the process.
The choice of selling assets or shares dictates much of what happens next, as do myriad other factors such as whether the owners will stay on after the sale, and the form and structure of the purchaser’s payments. Other documentation that you can expect to see in a business sale includes non-disclosure agreements; the share or asset purchase agreement; warranties; tax covenants; and any other restrictive covenants such as those that prevent the seller undertaking certain competitive commercial actions within a set period of time.
Throughout the deal, both the seller’s legal team and buyer’s legal team work to protect the interests of their respective clients, whilst completing the deal as quickly as possible to keep costs to a minimum. This in itself is impetus for the seller to be open and clear about the status of the business. Every time the buyer exposes a problem, it inevitably results in more legal work that eats further and further into the seller’s exit pot.
Possible in this Market?
2010 is almost universally predicted to be a slow economic haul, which prompts the question of whether predators will be active over the coming months. Whilst funding and borrowing difficulties have certainly caused a drop in the number of purchasers compared to 2007 and early 2008, the next 12 months will still present opportunities for a profitable exit if handled correctly. This is because all businesses face the problem of a limited scope for natural economic growth. Acquisition is therefore one of the primary options for those that wish to expand. Cash-rich predators have also used the recession to change the face of their traditional market ahead of the recovery, or used it to enter new markets. Which brings us onto the real issue of selling now – price.
A downturn can of course equate to a lower business valuation. Many owners looking to sell in 2010 have been unrealistically considering their business in terms of its 2007, pre-recession value. This has meant a certain amount of expectation reengineering in light of the current market. That said, the true value of any business is always what the purchaser is prepared to pay for it. Some of those fantasy business success stories have certainly occurred during recessions – one reason being that cash buyers look for investments that will yield a better rate of return than bank interest. So if you’re lucky enough to identify a predator with a niche commercial objective that you can fulfil, and have fully identified all the potential skeletons in your closet, then there’s no reason why a sale in the next 12 months can’t be extremely lucrative.
Ian Gibbon is a Corporate Finance Partner at Alliotts chartered accountants and business advisors. Contact him on 020 7759 9393 or at iang@alliotts.com. Chris Wilks is Head of Corporate at law firm SA Law. Contact him on 01727 798083 or at chris.wilks@salaw.com.