The means of valuing your business are the same as ever, but the landscape has shifted. So how can a vendor achieve a good price today? Stuart Wilkin reports.
People trying to sell their homes are becoming pragmatists.
They realise they can’t get rid of their property if they have an unrealistic valuation. And with the spectre of deflation looming large many are cutting their losses and prices.
But when it comes to selling a business you have nurtured for years, over which you have sweated blood, and over which you have lost countless nights of sleep, the decision is even more emotive.
You could have achieved ten times earnings if you had sold 12 months ago, but just how much has your inability to bow out at the right time cost?
Prices have been driven down by the massive imbalance of supply and demand when it comes to accessing funds. And as the Chancellor threatened again to get tougher with the banks, who knows how many of them still have their fingers crossed behind their backs. They remain nervous of the wider picture and the domino effect of a collapsed business taking down one supplier, and so on.
So the cost of funds continues to rise, as the price of goods is driven down by a global perception that this is a buyer’s market.
Business owners who had an imminent retirement plan may have decided to continue operating, preoccupied by the task of working out whether the recession will be sharp and shallow, or deep and long. If they take the gloomier view that recovery is not within reach then it may be as well to sell now.
And timing is everything. There is little point in sweating what remaining blood you have to increase the value of your business by ten per cent over the next five years if the economy is spiralling down by 25 per cent.
Adrian Cutler, partner at Cobbetts law firm in Birmingham, believes most buyers are extremely wary of any business. He says: “We have no opportunity to rely on historical figures. You may have a business that’s outperformed the market for the past three or four years, but we’re in such uncertain times that nobody knows how it will perform over the next few years.
“Buyers are looking for stricter covenants in a business. They really want to know it can wash its face if you assume stagnant growth for the next couple of years.”
Cutler advises owners who are looking to sell to take the steps an impending recession has dictated. He says a professionally managed business that has undergone a redundancy programme, taken out overtime and refined stock will be a more attractive proposition: “If these processes are in place all the pain has been taken out.”
And Cutler says it is important when preparing a business for sale that an owner maintains dialogue with their suppliers and customers. “You need to talk to them and let them know if you’re doing well, and also let them know if you’re not,” he says. “Everyone is in the same boat and a surprising number of customers understand that pushing a business down the wrong road that ends with its death knell is not in anybody’s interest.
“You need to shore up your customer and supply network and your fixed overheads to project a stronger picture to any prospective buyer.”
But Cutler adds that extracting value is difficult. With limited access to funds a lot of offers reflect a realistic multiple of earnings, with the hope value attached to an earn-out or deferred consideration. And the chance of realising the hoped-for income is always at the mercy of the buyer’s ability to operate the business to benchmarks.
There are signs that private equity firms are getting ready to plug the gap left by the banks. Cutler says: “Venture capitalists are becoming involved on more than a 50/50 split with the banks. And the VCs we work with are talking about equity only deals, probably with a view to refinancing at some time, but it is very encouraging. The first equity only deal we see will send out a strong message.
“But we need the banks to get involved as well. Until they close 2008 and open their doors for 2009 with a fresh budget, and in some cases a cleaned-up balance sheet, we won’t see much movement.”
Paul Johnson, corporate finance partner at Baker Tilly in Birmingham, advises clients to look at their business with as much vigour as any prospective buyer would. He says: “Buyers are looking for strong management, a diverse customer base and maintainability and visibility of earnings.”
While some sectors have a degree of insulation in a downturn, with budget brands, takeaways, environmental and government-backed businesses leading the way, you don’t have to be Domino’s Pizza to present your business in a favourable light. And protecting the value of your business is reliant on the extent of your grooming it for sale.
Johnson says: “In more benign market conditions people will take a view in terms of due diligence investigations on a target business. But now buyers will look for any reason to renegotiate a price. There is an expectation there and the market will allow them to do that. If a skeleton comes out of the closet any buyer will immediately grasp the opportunity to renegotiate.”
So Johnson recommends that medium and bigger businesses seriously consider carrying out vendor due diligence as part of the grooming process. He says: “If a vendor knows what a problem is before he comes to the table, he has a chance to counter this problem before someone else finds it. He can then negate the possibility of renegotiation and insist that any offer made reflects all the facts available. And he must make sure the offer is properly funded, with no hidden doubts over accessibility of finance.”
John Farnsworth, corporate finance partner at Midlands accountancy firm Smith Cooper, agrees that with buyers’ due diligence going much deeper the vendors preparation must be thorough. He says: “To be attractive to a buyer your business needs to be clean of strange accounting practices, bad debts and complaints history. There can be no evidence of directing the business purely for the owner’s interest. You need to be squeaky clean to make the fundraising process more straight forward.”
And while this is not the best time to sell, it surely is a good time to plan and to get your house in order. Driving a business to generate profit and cash is more critical in the run-up to a sale, and an owner needs to protect it well. Make sure profits are maintained and cash is generated and not immediately absorbed by capital expenditure.
Farnsworth says: “A buyer will look for consistency of profit and cash holding, and they always like to see visibility of turnover. Contracted business is a great advantage as it gives stability of earnings. It’s okay to sell computer parts but there is no visibility of future earnings. If you sell them and then sign up maintenance contracts you have an ongoing contracted income and that will drive value.”
And Farnsworth advises selling businesses to clean up its balance sheet well in advance of sale: “There are often assets in a business that aren’t part of the company and these need to be removed. And if you’re sitting on a big pile of cash for heaven’s sake don’t take it out as director’s remuneration or dividends coming up to a sale.
“In terms of protecting the value of your business the same principles apply now as in any type of economy. But we have to acknowledge that the losses in the stock market have cascaded down through large companies to owner-managed businesses. Buyers’ willingness to pay a multiple of earnings is simply not where it was.”
It is getting more difficult to determine underlying profits and identify a profit multiple. And while benchmarks can be made by analysing historical transactions, they are affected by the quality of income and growth issues which are more prevalent in the current trading environment.
Heath Walker, corporate finance partner at Nottingham-based Cooper Parry, says: “Despite the existence of logical valuation methodologies, the reality is that a business is only worth what somebody is prepared to pay for it, and the best way to find that out is to conduct a controlled sales process.
“Unfortunately in a falling market price expectations will always be sticky. The emotional issue associated with owning a business is always at play and many owners have unrealistic expectations. To them their business is always better, stronger and worth more than a recently sold competitor.
“In an uncertain economy, with limited funding availability, business owners must accept that the world has changed. And many deals will only be concluded if valuations are put into context by asking ‘what economic and business risks does my business currently face?’”
Also in: January 2009
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A new deal
Kurt Jacobs and Sam Metcalf look at what hands dealmakers in the Midlands have been dealt for early 2009, and how they’ll play them.
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Pay up…or what?
Promises of payment are wearing thin, calls aren’t being returned – are you about to be left out of pocket by a failing customer? John Duckers speaks to companies caught out by administration to find out how to spot the signs.