Following on from our features on whether to use equity or debt to grow your business and how you can replace friends and family shareholders with alternative investment, the next and fourth component of our Build Back Better Series looks at the considerations when selling a business. Ian Dawson, corporate finance director at Seneca Partners, takes a closer look.
A life-changing event
Despite the challenges many businesses and sectors have faced over the past year, the business sale or M&A market is strong, with many corporates looking to acquire and private equity firms looking to invest too. For many entrepreneurs, the sale of their business is both a once in a lifetime and a life-changing event, so it’s important to get it right. Selling a business is complex with a lot of moving parts and even the simplest of deals will often involve multiple unforeseen twists and turns. Many stages of a business sale involve an element of “deal craft” and getting it right requires preparation and planning, hard work and good advice.
Whether a formal auction or a rifle-shot approach to one strategic buyer, most business sales can be broken down into four main stages 1) preparation 2) marketing 3) diligence and closing, and 4) post-closing. It typically takes six to nine months to complete a deal, sometimes much longer if you start preparing well in advance, but rarely shorter.
Planning and preparation
It is rarely too early to start preparing an exit strategy. The decision to sell can be driven by both business or personal factors but whatever the reason, anyone considering a sale should first establish their objectives and the value required from the sale. A good IFA can help you with the valuation you require whilst a good corporate finance advisor will tell you whether the valuation is realistic and achievable.
We’ll discuss the art and science of business valuation in a later article, but most businesses are valued using a multiple of earnings, typically reported EBIT or EBITDA (earnings before interest, taxes, depreciation, and amortisation) results adjusted for any exceptional or non-recurring items (resulting in an enterprise value). The enterprise value is then adjusted by adding net cash or subtracting net debt and adjusting for a normalised level of working capital, resulting in an equity valuation, or the pre-tax value received by shareholders. Although a theoretical valuation exercise can be carried out pre-sale, value is ultimately determined by the market and what purchasers are willing to pay. It can however be improved by thorough preparation, good marketing and a professional sales process.
Many business owners are not aware of the range of exit options available to them such as trade sale, management buy-out or buy-in (either equity and/or debt funded) or a full or partial sale to private equity. An early conversation with an advisor will help you to understand your options and the “art of the possible”.
Preparation can start several years before the formal sale process begins. Consider which buyers will pay a premium price and position the business to make it attractive to them. Bring the senior management team forward to make yourself dispensable, ensure contracts are in place, tidy up the balance sheet, maximise profit and cash generation and pay down debt. Timing the approach to the market can be difficult and whilst M&A often involves an element of serendipity, planning will ensure you give yourself the best chance of a successful outcome. Also, consider that you are likely to get a better deal if you sell when results are on an upward trajectory, continued growth is forecast and the M&A market is buoyant.
Other steps in preparation include drafting documents such as a one-page confidential teaser and an information memorandum (“IM”), designed to present the business in the best possible light. The buyer and/or investor pools will be mapped and qualified buyers likely to pay a premium price will be identified. Should you anticipate strong buyer interest you may consider vendor due diligence (“VDD”) which significantly reduces the risk that the deal will collapse during diligence as any issues will be out in the open before approaching potential buyers. Solid preparation ensures you can maintain momentum and ultimately run a slick sale process that maximises value.
So, the IM’s prepared and the list of potential buyers is finalised – what next? Your advisor will discuss the opportunity with potential buyers, the confidential teaser is issued and confidentiality agreements are signed ahead of issuing the IM, and often management meetings are offered to qualified parties. Offers are invited and, depending on the strength of interest and your negotiating position, there may be multiple rounds of bids. Ultimately there will be one preferred party with which you will negotiate and agree heads of terms and exclusivity. Exclusivity should never be granted lightly as, once granted, the seller loses an element of control. Throughout the marketing process, it is important to generate and maintain competitive tension in order to achieve the best possible deal and do not forget that this is also your opportunity to quiz the buyer – what are their intentions? How are they funding the deal?
When negotiating, note that the highest headline price is not always the best deal. Offers can be structured in several ways. A lower headline valuation offering more cash upfront may be more attractive than a higher offer heavily structured towards shares or other forms of deferred consideration (deferred cash, loan notes or contingent earn-out adding time and risk). Also consider what transition period is expected and qualitative factors such as what the buyer will bring to the table, their intentions for employees and their impact on the company culture.
Negotiation is about striking a mutually beneficial deal. You don’t need to be over-zealous and win every point of detail to get a great deal, but you do need to know which terms are important to you, those important to the buyer and those you may be willing to concede. Think win-win and avoid overly protracted negotiations.
Once heads of terms are agreed, the buyer or investor will instruct diligence and legal advisors. Diligence can range from a light touch, in-house review if a trade buyer knows the sector well, but in most cases, it will at least involve external financial and legal diligence whilst in many others it will involve areas such as commercial, pension funding and compliance, management, technology, insurance and environmental.
It’s at the diligence stage that a lot of hard work, stress and deal fatigue occurs and being prepared well in advance, including having a populated data room, will ensure it runs smoothly. Your advisor will help protect value, assist with final negotiations and project manage the transaction through to completion, whilst your lawyer will be heavily involved in drafting the sale and purchase agreement and other legal documents. A good lawyer will always add value so ensure they are M&A specialists and suitably experienced in the type of transaction you’re contemplating.
You’ve completed the deal, what now? A handover or earn-out period is typical along with post deal marketing and multiple conversations with staff, customers, suppliers and other important stakeholders. Again, preparation is key.
It’s never too early to understand your options for one of the most important events in your life and a good advisor will help you navigate through these stages towards a successful outcome.
Next time, we take the opposite perspective and examine the key considerations when buying a business.
Ian Dawson is corporate finance director at Seneca Partners.