The SME businesses which feel that they will weather the ill effects of the recession, are beginning to consider long term strategies for growing their businesses. With struggling competitors, suppliers and even customers, growth by acquisition currently offers a serious prospect of rapid expansion at attractive valuations. 

A cost effective due diligence service can add value to almost any transaction. There is little point in an SME undertaking a ‘full-blown’ due diligence exercise - which for bigger deals will cover not only financials, but specific work on operations, staff, pensions, properties, legals and many other issues. However a limited scope due diligence should provide the buyer with comfort in making their decision, and also a sound basis upon which to negotiate the price or other key terms.  

In the current financial environment, there are many examples of poor due diligence (when the economy is booming, due diligence failures will be less apparent). Failing to spot problems prior to signing the deal can have a devastating effect on the ability of a business to service its debt and ultimately survive. Don’t find out too late… 

If you are considering acquiring a company, please do get in contact with Julian Dobbin to discuss the potential due diligence services that may be of value.

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In my last posting I gave the first 5 tips, which covered the stage before an offer for a business had been made. My next tips pick up after the offer is accepted.

During Due Diligence :

This is the stage where you test the assumptions you made when you put together your offer.

6. Appoint a good accountant and lawyer. The potential long term costs of not taking appropriate advice should be considered very carefully!

7. Go back to your offer and the assumptions you made. Ensure the information provided by the vendor can be verified and corroborated by other data.

8. Consider the earnings figure you were presented with when you made your offer. Is it really sustainable? Will it be affected by exchange rate movements? Are contract terms due to change, will cost rises be matched by increases in revenue?

9. If you are acquiring shares, consider the potential for hidden liabilities. The most common are taxes – including corporation tax, VAT, PAYE, National Insurance etc. Also look at ongoing litigation, bonus arrangements, customer overpayments and any other matters appropriate to the business.

10. Spend a lot of time on your financial projections. Assess the impact of potential problems (reduced sales, lower margins etc) in a sensitivity analysis, paying particular attention to cashflow. Consider whether the budget complies with covenants set by the bank, and the amount of head room you have.

As I said in the last post, the priorities in an acquisition differ, dependent upon its nature – there are many other risks which should be considered in making an acquisition decision.

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The credit crunch is having an affect on all asset prices, and this is bringing some first time buyers/investors into the private SME market. With this in mind, I thought I would ‘blog’ some tips for SME acquisitions.

Prior to an offer being made :

1. Buy the trade / assets, and not the shares. With a company you inherit its problems and therefore potential liabilities. There are also tax advantages to buying the trade and assets. This is particularly important for ‘distressed’ acquisitions.
2. When reviewing profits for valuation purposes watch out for shareholders / directors remuneration. If the costs of their input to the business are not in the P&L, the valuation will be inflated.
3. Consider other missing costs. This is particularly relevant where a seller has more than one business - is rent correctly allocated? Which company does the accountant charge? etc
4. Customers. Reliance on a smaller number of large customers is a risk. The health of the customer base in the current economic climate is crucial. Ask the seller for outline details of clients – their size, sector etc and review the level of their own personal contact with customers. Consider what protection should be added into the offer – such as an ‘earn out’ for the seller.
5. In your offer be careful to clarify the assumptions you have made, and the conditions attached. This will make it easier to renegotiate the price should issues be identified during Due Diligence.

I will cover the 2^nd set of five tips in my next post.

Please note that the tips differ, dependent on the nature of the acquisition. I have been very general here and there are many other risks which should be considered in making an acquisition decision.

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Once you have made the decision to make an offer to invest in, or acquire, an SME you are probably past the point at which your accountant should be brought in to the process. Not only can the accountant provide sound advice on the ‘corporate finance’ aspects (for example the valuation, key terms etc), it is crucial to set an appropriate structure from a commercial and taxation perspective. 

This is particularly important in distressed situations. Mercer & Hole have recently advised on a distressed management buy out – under the initial terms, the acquirers were effectively taking on all old group liabilities (even though the majority did not relate to the division in question). This is clearly not an acceptable approach – and after several calls / emails the deal was very different. 

Beware of sellers that say ‘we can do this without the accountants and lawyers’ – they are likely to have their own interests at heart…

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I have blogged in the past on the methods used to identify suitable SME businesses. I spoke last week about ways of identifying acquisition targets for companies, and now I will focus my attention on individuals who would prefer to invest in – rather than buy – a business. These individuals are generally referred to as ‘Business Angels’, a more sanguine term than ‘Dragons’. The general approach taken by such investors is somewhere between the two.

Investment in SME businesses

There are two main options for an investor – do you invest in a syndicated / pooled fund, or do you go it alone? 

A fund will make a series of regular investments, co-ordinating Due Diligence and other issues. The distinct advantage is that costs are pooled, and the syndicate will have well connected and experienced management. The latter carries more risks, but for the canny entrepreneur it can also generate greater rewards. The investor has increased autonomy, and can directly influence the day to day running of an investee company.

* Syndicated investment opportunities

There are several syndicates in the UK. The main private investment networks I am aware of are :

• Beer & Partners - www.investmentforgrowth.co.uk/opportunities.php. Network of around 1,700 private investors.
• Hot Bed –Slightly different model – see www.hotbed.uk.com
• CSS partners www.csspartners.co.uk/index.html Advisory firm – will align their interests with yours

There are many others – just enter something like ‘private investment network’ in Google or look at the British Business Angels Association www.bbaa.org.uk which covers some of the networks.

* Individual investments

The internet also provides many opportunities for private investors looking to go it alone. This takes a lot more effort by the investor, and as such opportunities are less ‘polished’ than those presented by the private networks mentioned above. 

Sites such as www.angelnews.co.uk any others through Google are a good starting point.

Before taking any investment decision, is important to take the appropriate advice, by an individual or body regulated by the FSA. It is also important that sufficient ‘Due Diligence’ is performed on prospective investments to ensure that representations made are factually correct.

Good luck!

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In my last blog, I talked about the confusion and concerns regarding traditional investment methods, and the (current) low rate of return from cash. This may lead to a rise in SME transactions.

People looking to buy SME businesses need to look at a variety of sources, as they are not listed in the Financial Times like stock exchange businesses! I will break it down into acquisitions and investments (my next blog):

Acquisition of businesses

In these purchases, the buyer will take a management role in the business (as opposed to an investment, where the involvement will range from ‘none’ to a sporadic / non-executive role). The current owner will hand over the reigns to the buyer, although he or she may be tied in via an earn out.

A Corporate Finance advisor can perform a search on your behalf, and this will be the most productive method of identifying suitable businesses. There is generally an upfront cost involved, and this reflects the advisors’ experience and ability to add value to the process.

For someone outside of corporate finance, one of the most common sources of such businesses are website directories – essentially databases of businesses. It is usually a case of entering parameters – location, size, amount etc, and the sites will then provide a list of suitable possibilities. 

Probably the best known site is Daltons  – the website of the well known Daltons Weekly publication. Daltons have over 30,000 businesses for sale. 

Businessesforsale.com, is an international site, with opportunities in a number of countries. It has a useful mid-market section, which includes businesses at the upper end of the SME market. There are many other sites, as you will find from entering ‘buy a business’ or a similar term in Google.

Another source of businesses for sale are professionals – speak to your lawyer and accountant – they may be able to consult their ‘black book’!

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I read a very interesting article in today’s FT regarding buyers compromising on the quality of Due Diligence. 

The article illustrates the short cuts taken in the Due Diligence process.  Large deals took only 80 days to complete in 2008, down from 142 in previous years (according to Towers Perrin).

Whilst the article focuses on the bigger M&A transactions, the principal is the same for buying any SME business. Reducing the level of scrutiny into a prospective purchase carries enormous risks – the article refers to the infamous ABN Amro acquisition as ‘one of the most value-destroying deals of all time’. 

Due Diligence is the unglamorous relative of corporate finance. It is a methodical process that starts with an assessment of the key risks on which the assumptions of a businesses value are based. It then runs through a series of checks, reviews and analysis. The outcome from Due Diligence should provide a buyer with comfort, and if not, should be a solid resource for renegotiating the price.

Perhaps the days of limited access online data rooms – with terms dictated by the seller – are nearing an end? It is safe to say that 2009 is a buyers market, and the basis on which deals are struck will change.

Those with capital, and the guts, will come across some bargains in the current climate. However a short term saving on Due Diligence costs, can lead to many years of problems for a buyer. As Lina Saigol’s article states ‘the due diligence process … is critical to mergers and acquisitions and one that should be intensified, not diminished, during times of crisis.’

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With depressed asset prices, across all classes, traditional investment policies are being questioned. Cash? Interest rates are at an all time low, and are expected to decrease. The stock market? Not exactly a safe haven – too volatile and prone to the irrational movements caused by agitated city investors. Property? Possibly, but who knows where that will end up…? 

A number of people are now looking at investment in private companies. Why? In my experience people traditionally invest in small businesses for one or more of the following reasons:

• Many investors are entrepreneurs, who have run their own successful companies. This makes you aware of the issues – financial, commercial and otherwise that businesses face in this sector.
• Small companies are transparent. They can be ‘touched and felt’ and are not a ‘black box’ like their stock market relatives. Even a minority investor in an SME company can help manage and influence the future of the business.
• Investment in private companies has distinct tax advantages – some will qualify for the Enterprise Investment Scheme, in which HMRC will reduce the income tax liability of the individual for 20% of the investment value, offer capital gains tax / other advantages (subject to conditions). There are also Inheritance Tax reliefs for shares in private companies. 
• Involvement at these private rounds of financing often offers the highest risk/return on investment

I have been asked by clients on a number of occasions where to look for investment / acquisition opportunities in small companies. I will return to this in a blog, later this week or early next week.

It is important to obtain proper investment advice, by an individual or body regulated by the FSA – please speak to one our colleagues at Nightingale Associates if you would like any such advice. It is also important that sufficient ‘Due Diligence’ is performed on prospective investments to ensure that representations made are factually correct.

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As the uncertainty in our economy continues, there are still many who perceive that asset prices (in a number of classes) are undervalued. There are many SME businesses which fall into this category – but to the naïve, or badly advised, buyer, the process is fraught with danger which can erode the value of an acquisition. I have frequently mentioned M&H’s previous acquisition successes, and very few advisors are in the unique position of having risked their money and accomplished their growth goals.

In the final part of this trail of blogs, our hypothetical acquisition had just got through a rigorous due diligence process. If a deal is still on the table at this point - you should be able to move quickly to completion.

You should have been planning how to integrate the business months ago. Hopefully your plans are now finalised and they can soon be put into action. Even if the acquisition will run as a stand alone unit, time still needs to be dedicated by senior management, otherwise the company could lack sufficient control in the future.

The completion meeting may be a reason to celebrate, but watch out – the real work is about to start…..

 

Please see our website (http://www.mercerhole.co.uk/services/overview/C24) for more details on the acquisition process.

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I have blogged in the past on Mercer & Hole's achievements in making acquisitions. We have acquired whole departments from international accounting firms, and have successfully integrated these staff and their clients into our ethos of ‘Big firm expertise with a personal service’. There are many risks involved in buying a company, and the likelihood of failure is surprisingly high.

In my last blog a week or so ago, I had taken our hypothetical acquisition to an offer being accepted. At this point, the action intensifies. Accountants are appointed to undertake Financial Due Diligence and Lawyers for the Legal Due Diligence. In some deals you may also need commercial, pensions, environmental and IT Diligence. 

I always recommend that a key member(s) of the acquirers internal management are heavily involved in commercial and operational issues with the vendor - external advisers should not be trusted with everything, and the more involved you are, the easier it is for decisions to be made quickly as the deal progresses.

 

Once the results of Due Diligence are collated, another round of negotiations / horse trading commences. There is still a ‘not in-significant’ likelihood that a deal will fail at this point, particularly if unexpected problems have been found - the seller could have been given unrealistic expectations and may not compromise on the price.

 

Good Due Diligence is crucial to protect your interests - in simple terms it tests the assumptions the buyer has made regarding the acquisition. I have yet to be involved in a deal where it does not identify an issue of relevance. A good accountant and lawyer are worth their weight in gold!

Please see our website (http://www.mercerhole.co.uk/services/overview/C24) for more details on the acquisition process.

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In my recent posts, I have been talking about how an acquirer can maximise their return on investment by avoiding the standard pitfalls in a deal. I have mentioned the experiences of Mercer & Hole in making acquisitions, and how we have ultimately succeeded by aiming at niche businesses, realistic negotiating and by integrating into the existing M&H ethos. 

We had reached the point in our hypothetical deal where the seller had provided enough information to make an offer.

It is important to invest significant time in the offer itself. The key issue is obviously the valuation - there are a number of ways to approach this - profit multiples, discounted cash flows etc (far too much for this blog). 

It is almost as important to ensure the other terms are in your favour - earn out agreements, working capital levels, vendor service agreements and warranties. A crucial issue I come across time and time again are the conditions attached to the offer - if sufficient conditions are not included with the offer, it may hinder price negotiations after due diligence. It is not easy to predict what the diligence will identify, but with a bit of thought the key risks can be covered. 

Most sellers will attempt to renegotiate the terms of the offer - most good business people should be well used to bartering / haggling at this point. In the words of the father of modern economics: 

"The propensity to truck, barter and exchange one thing for another is common to all men, and to be found in no other race of animals."

Adam Smith (Scottish philosopher and economist) 

I will cover the final stages shortly. 

Please see our website (http://www.mercerhole.co.uk/services/overview/C24) for more details on the acquisition process.

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In my previous blog I mentioned the failure of the majority of acquisitions to generate a return for the buyer. Buying a company is a different process to anything else you have experienced. The wrong move at the wrong time will cost the deal – even the right move at the wrong time could cost ‘hundreds-of-thousands’ of lost value.  

I finished the last posting at the point where a search for acquisition targets had commenced. The typical acquisition targets are competitors, suppliers and even customers. Businesses in parallel markets should also be considered - for example an accounting practice could acquire a financial advisor. 

If we are offered a business at what is ostensibly a bargain price - we will not need to perform a wide search, but we should still test the market. Are business within the sector being sold at similar prices, is this really a bargain?

Lets now presume that a suitable business has been found. What information do we now request? At this stage the seller will be reluctant to provide too much detail - some recent P&L's, with details of any exceptional revenue / costs and the remuneration extracted by the sellers should suffice. 

In order to make a serious offer for the business - it is standard practice to hold detailed discussions with the sellers, and extend this to key management if appropriate. The seller is still likely to be reticent about certain sensitive information, but some level of detail can be provided including customers, suppliers, contracts and management. 

At this stage we are still a way off Due Diligence – only then will full disclosures be made – as illustrated by the recent transfer saga of Kaka / Man City reported in two our national papers – The Independent and The Guardian.  

I will return to the Diligence stage soon. 

Please see our website (http://www.mercerhole.co.uk/services/overview/C24) for more details on the acquisition process.

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Mercer & Hole have an inside track on making acquisitions work - our partners have the direct experience of spending their own hard earned money. We have acquired several businesses including smaller practices and whole departments from one of the international accounting firms. We have made this a success by applying our long standing philosophy – ‘Big firm expertise, with a personal service’. 

Many experienced and successful entrepreneurs can find the acquisition process difficult – quick judgements need to be made throughout the process and for the inexperienced it is easy to make well meaning but poor decisions. There is a frequently quoted statistic that 80% of acquisitions fail to add value. My experience is that this figure does not reflect the SME sector – the vast majority of deals I have seen are beneficial for the buyer. Despite the reduced relevance for SME’s, the statistic does make us aware that caution should be exercised. 

The first questions to consider is whether an acquisition strategy is appropriate in the first place. The buyer must keep asking “why am I doing this?”. Would it be more cost effective to pursue organic growth? Even if a company you are familiar with, is offered at a bargain price, you should consider what value it will add. Look at yourself and inside your business - do you have the necessary capabilities - management time, systems / accounting capacity and (of course) funding? If an acquisition can not be controlled after completion, it will be a huge drain on time, resources and profits. It also crucial to consider the state of the sector and the wider economy. Is the sector growing / contracting? What economic / political / cultural policies will have an affect?  

Once a decision has been made to adopt an acquisition strategy, the second key area is where to search. I will return to this at a later date - and will answer the frequently asked question "how do I buy a company" 

Please see our website (http://www.mercerhole.co.uk/services/overview/C24) for more details on the acquisition process.

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I have spoken in the past about the ongoing importance of a financial due diligence process, even when buying/investing in a business for what is ostensibly a ‘bargain’ price. The contraction of the credit markets, and the inevitable trading recession which will follow, will create a number of distressed transactions in the SME sector. These transactions are vital to ensure continuity of employment for a large number of people across the UK.

The focus in such circumstances differs from typical financial due diligence investigations. In my experience the major risk areas are:

•  If you are buying a company, you inherit its assets and its liabilities. Distressed companies inevitably have substantial liabilities, not all of which appear on the balance sheet. It is very important to be aware of the extent of these liabilities, and also to understand the agreed terms of payment.
• In many cases a company will sell one (or more) divisions separately, rather than offloading its entire business. In these situations the business being sold will be ‘carved out’ from the existing company. As part of the process, a separate P&L is usually prepared for the division, and ensuring that the extracted P&L is accurate & maintainable is fundamental in distressed sales. This will not only prevent over-paying for the business, it will also allow more accurate projections to be prepared by the acquirer / investor.  The treatment of shared costs is always an ambiguous area, and can lead to the overstatement of profits.
• In the current climate it is particularly important to focus on working capital requirements. The traditionally used method of looking at old balance sheets and payment terms will need to evolve to cover the affects of a post credit crunch environment.
• Customer health. A feature of the post credit crunch economy is the precarious circumstances all customers find themselves in. It is crucial that an acquirer / investor understands how profitable different customers are. The financial health of the key customers should be undertaken, and this can be extended to the fundamental suppliers of the business.

Financial Due Diligence is still as important as it has ever been. The only difference is a change in emphasis, and with ‘distressed transactions’ the need for all advisors to move quickly is paramount to successful completion.

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Given the current state of our national finances, there will be a number of businesses in distress which will either raise funds via the sale of a proportion of equity or even be forced to sell entirely. Avoiding business failure and successfully completing a ‘distressed transaction’ is important for the economy - by maintaining employment directly for the business and its supply chain.

2009 will see standard SME valuation methods abandoned. Not only will earnings multiples reduce – as buyers become wary of uncertainty – but the profits used to value businesses will be slashed. In the midst of falling asset prices, astute investors will identify ‘needy’ SME businesses that are significantly undervalued. We will see companies buying competitors, customers and suppliers as the liquidity problems bite.

If businesses can be acquired using comparatively low valuations, is it still worthwhile undertaking a formal Financial Due Diligence process? 

There are three principal reasons why I believe it is still a fundamental part of the investment process:

• Whilst an acquisition may be at a comparatively low valuation - if the underlying business is defective, then the investor will still lose money (even if it is less than would have been lost in 2007!)
• The acquisition process uses the most valuable resource of all – time. If potential problems are identified early on it prevents the acquirer wasting time chasing a deal which will never complete.
• Deal structure is still crucial – particularly from a tax perspective – and professional advice on this is necessary to maximise long term shareholder value. For corporate acquisitions it is important that the structure is organised so that the financial health of the acquired business does not threaten existing operations.

I will write another blog in the near future on the areas of financial due diligence to focus on for distressed acquisitions.

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I have mentioned before that the key to a smooth transaction and therefore maximising the value you will receive is preparation. 

When selling your business you may receive several visits from advisors dealing with financial, legal, commercial, environmental, property and pensions due diligence. It may seem that you are asked for the same paperwork thousands of times.

To keep you sane, I have a few tips :

Continue Reading...

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It is typical for businesses to sell for a multiple of profits. At the early stages of a deal a buyer will rely on the seller to provide a profit figure. It is up to the seller to decide on a multiple and I will talk about how to approach this decision in another posting.

A large amount of judgement will go into the identification of the profit figure by the seller. The most important factor is

Continue Reading...

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Due Diligence is an involving task, where the old idiom ‘…can’t see the wood for the trees’ is true.

It is very easy to get immersed in the detail of a transaction – checking that balance sheets balance, existence of assets, invoices are not shredded etc etc. However most value from the DD process is derived from standing back and pondering – is my client getting a good deal?

Before you embark on detailed financial due diligence, I wholeheartedly recommend you spend half a day with your accountant and your offer letter (or heads of agreement). Not only will your accountant be able to independently appraise the all important headline figures associated with the transaction, but this will also allow you to identify risk areas together – ensuring a more focused DD process.

Oh and by the way, it is useful to review the ‘wood’ element before a not insignificant fee has been agreed with your accountants and lawyers.

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I have and I am pleased to say the new Companies Act will take away this requirement for private companies.

However I do have concerns over complex deals where the protection of the creditors will be lost. How are they going to feel if the transaction leaves them with a shortfall in the amount they get back ? No doubt the lawyers will end up getting involved.

At least an amended form of Section 151 of Companies Act 1985 still applies to public companies.

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Is it just me or are transactions becoming more and more leveraged? Lenders appear to be have a better appetite for lending compared to when I started in the profession. I think this is a positive change, as very few transactions I have been involved in have gone awry (it must be the excellent Due Diligence advice…..).

However could it be that lenders are misinterpreting the profit calculations? The shift in profit measures from EBT (Earnings Before Tax), EBIT (Earnings Before Interest & Tax) and EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) have meant that the basis for earnings has increased. Could it be that the increase in the profit measure has meant that lenders continue to use the same multiple, while simultaneously providing more finance??

PS to all the bankers I deal with – only joking.

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Finance raising – part of the tax planning for growing businesses series

When raising funds, essentially you have two main choices:

· Loans
· Equity

Loans
The position on loan finance is relatively clear – there is no tax relief on capital repayments but tax relief is available on interest costs.

One point to bear in mind is that tax relief is also available on the costs of raising loan finance (e.g. the bank arrangement fee) even if these are capitalised in your accounts.

Equity
The commercial implications of issuing new equity can be significant but, looking just at the tax impact, can you structure your business to make it more attractive to new investors?

There are essentially three classes of investor and potential reliefs to benefit them:

• Individuals Enterprise Investment Relief (EIS)
• Companies Corporate Venturing Relief (CVS)
• Venture Capital Trusts (VCT's) Need to invest in qualifying company

The reliefs apply provided certain conditions are met:

· EIS provides income tax relief at 20% on the amount subscribed up to £400,000, the ability to defer capital gains on the total amount subscribed and provides for exemption from capital gains tax on sale.
· CVS provides corporation tax relief on the amount subscribed and the ability to defer the gain on any disposal of the CVS shares into the next CVS investment.

The qualifying conditions for all three investors are broadly similar and mainly relate to the trade carried on; the quantum of non-trading activity (capped at 20%) and gross assets being less than £8 million after the issue of new shares.

Continue Reading...

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Your focus is to grow your business profitably, so are you sometimes tempted to ignore the tax issues and leave them to your accountant to sort out at the end of the year? In the scheme of things is tax really that important?

Well, yes it is. Tax will impact on virtually every decision you make. For example:

What can I give my manager to make him stay for the long-term?

 

How can I find the extra cash to develop my product?

 

Where can I find some extra working capital?

 

It could make sense commercially to set up a manufacturing/service centre abroad – pros/cons?

 

I have found a great business to bolt on to mine that would really add value – how do I structure the acquisition?

It is not possible to cover everything you may ever need to know, so I propose to look at five key areas:

Raising additional finance

Capital spend

Product Development

Staff retention and incentives

Acquisitions

Interested? Subscribe today and keep in touch

 

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