BusinessBroker.ie

It’s March 2010 and we’re still in the depth of recession so why it is a great time to buy a business?

The answer is threefold:-

1.      Small businesses which have survived the last two years and are still trading profitably have come through the worst of the economic storm and will be well placed to grow sales and profits when the upturn eventually comes.

2.     None of the banks will finance a buyer looking to purchase a small business so owners who are motivated to sell have to be willing to accept some deferred or staged payments from the buyer in order to sell the business.

3.      Business valuations are at their lowest level for many years.

“You do things when the opportunities come along.” - Warren Buffett

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” - Warren Buffett

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Most business valuations are conducted on the basis of “Fair Market” value which is broadly defined as the value a willing buyer would pay a willing seller when neither is acting under compulsion i.e. the seller doesn’t have to sell and the buyer doesn’t have to buy.

Strategic buyers however do have a high degree of compulsion, they really want to acquire this particular business because it will give them access to a new product line, expand their geographic territory into an area they are weak in or they are afraid that if they don’t buy this particular business their competitor will and they will have a real battle on their hands.  Strong buyer compulsion amongst two or more potential buyers is exactly what a business broker is aiming for.   When that happens “Fair Market” value goes out the window and the strategic buyers motives rather than multiples of any kind drive the final selling price of the business.

Two key things to remember however:-

1. Only a small percentage of businesses have strategic value.  In general the smaller the business the less likely it is to have any strategic value.
2. Strategic buyers, like all business buyers, seek to pay the minimum possible for their acquisition.  The only practical way to force a strategic buyer to pay the maximum they can commercially justify is to have more than one buyer at the table.

When planning the sale of your business objectively evaluate whether or not it could have strategic value to another business in the same or similar sector, a regional competitor who has never been able to break into your geographic area because of the strength of your business or an international company who could use your business as a platform for breaking into the Irish market.  If it does then make sure you take full advantage.

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Most business owners don’t know the true market value of their business. Certain well established rules of thumb can be used to establish a very rough ball park value for a business providing the assumptions underlying the rule of thumb are clearly understood and the resulting estimate of value is validated against other valuation techniques and commercial reality.

There are many ways to calculate the fair market value of a business but in the end a business is worth the disposable value of its net assets or the present value of its future cashflow, whichever is greater, subject to there being willing and financially qualified buyers in the market for that type of business when the business is offered for sale.

When a buyer pays more than net asset value for a business they are agreeing to pay for goodwill and it’s important to understand that there are two types of goodwill, personal goodwill and business goodwill.  Personal goodwill vests in the owner of the business and walks out the door with the owner when the business is sold.  Examples are where the owner is responsible for all sales, has direct personal relationships with all customers and suppliers, manages the finance of the business and makes all the key decisions himself. Business goodwill is where the owner of the business has put systems, procedures and people in place who can continue running the business day to day without input from the owner.  Buyers are willing to pay for business goodwill but rarely pay for personal goodwill unless a detailed transition period is agreed where the outgoing owners personal goodwill is transferred to the incoming owner over an agreed and/or documented in a procedures manual.

If your business isn’t consistently producing a profit after you as the owner have taken home a market rate salary then your business is unlikely to sell for much more than the disposable value of its net assets.

If your business does produce a consistent profit over and above a market rate salary for you as the owner then one of the best ways to increase the value of your business is to understand the VCR formula i.e. V = C/R where V = business value, C = the sustainable annual cashflow your business will continue to produce and R = the internal and external risks to the business.  Once you understand the relationship between value, sustainable cashflow and business risk you can start to pro actively manage cashflow and risk to maximise value when the time comes to sell.

If you are planning to sell your business then I recommend you print out “V = C/R” and “↑C & ↓R” in big letters and put them somewhere where you’ll see and take notice of them every day because the value you get when you sell your business will depend significantly on sustainable cashflow and the amount of risk the buyer believes may affect the future success of the business.  The higher your sustainable cashflow and the lower the risks attaching to the business the greater the selling price will be.

Cashflow

For larger businesses cashflow is frequently expressed as Earnings Before Interest Depreciation and Amortisation (EBITDA) and for smaller owner managed business cashflow is usually expressed as EBITDA + the owners salary and all other benefits accruing to the owner annually such as pension contributions and any discretionary expenses paid for by the business which wouldn’t be continued after the owner has sold the business.  This is commonly known as Sellers Discretionary Earnings (SDE).

Increased cashflow can be achieved through increased sales but be careful not to chase low or no margin sales just to grow your sales figure as that will lower your overall margin and could actually damage the value of your business.  Increased cashflow can also be achieved by incrementally increasing gross margins, reducing operating costs and eliminating all non essential expenditure.

Business buyers frequently capitalise the sustainable cashflow of the business to calculate the value of the business to them and the capitalisation rate they use is heavily influenced by perceived risks to the business.  Every Euro increase you can generate in cashflow and every Euro decrease you can make in operating costs will yield a multiple in terms of the increased value of your business when you sell.

Risk

To decrease risk you should put yourself in the shoes of a potential buyer.  What would you want to see if you were looking to buy your own business?

Buyers typically want to see consistent financial performance over the last 3 years and up to date management accounts showing how the business is currently performing.  They will want to see a well trained and experienced workforce, a diversified customer base, a diversified supplier base, an opportunity for growth and clear evidence that the business can continue after you have departed.  Businesses which are too reliant on a small number of customers, a single supplier or the owner are very difficult to sell.

If you do a little each day to empower your staff, put systems and procedures in place, increase cash flow and decrease risk in your business you will significantly increase its value over time.

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You may believe that now isn’t a good time to sell your business and that you will have to put your retirement plans on hold.  While this rationale makes sense for some, waiting for better economic times does not necessarily equate to a higher value when the business is eventually sold.  There is no doubt that valuations are significantly lower than the heights of 2006 and 2007.  If you could have sold your business for €2m in 2007 and can only sell it for €1.2m now are you really out of pocket by €800,000?  If you’re retiring what would you have done with €2m in 2007?  Put it into an investment fund stuffed with blue chip bank shares?  Bought a rental property at the top of the market?  What would your €2m be worth now in October 2009 and how liquid would it be if you need to access it?  It would possibly be would be worth a lot less than the €1.2m you can get for your business right now and the funds you get now are not tied up in an unsaleable property.  

The reality is, in many instances, that the purchasing power of what you can sell your business for now will exceed what you could have purchased with the funds received from a sale in 2007.  Whether you believe that or not doesn’t actually matter.  The valuations of 2006 and 2007 are gone, that boat has sailed and won’t be returning to port for many a long year.  Your business, like every other asset in the market, is worth what someone will willingly pay for it today. 

If your motivation for selling is retirement then one of the worst things you can do is to ‘hang on’ for another few years hoping 2007 valuations will return.  Time and time again business owners do this and because you’re not as energetic and motivated as you were years ago the business can start retiring before you do.   The ‘hang on’ strategy often results in lower sales, lower profit and a less valuable business.  You can lose several years off your retirement and reduce your net worth at the same time.  A real lose lose scenario. 

Selling a profitable business during a recession is a viable strategy for owners who are ready to sell.  Value is dynamic not static.  Proper planning and preparation can make a big difference to the price a buyer will pay for your business.  Quality sells in any economic environment and profitable businesses that are correctly valued and confidentially presented to the market are still in demand. 

You might think there are fewer buyers in the market right now and you’d be correct as many struggle to get bank finance but paradoxically the ratio of financially qualified business buyers to active business sellers is actually quite high because many business owners are adopting a herd mentality and waiting for a ‘better time’ to sell. 

Your business will most likely account for a significant portion of your personal net worth and depending on your own circumstances and motivation the best strategy may be to sell when the time is personally right for you rather than put your life on hold for several more years hoping for the ‘good times’ to return.

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Most people assume selling a business is similar to selling a property but the reality is they are completely different processes.   A property’s value isn’t damaged by putting a “For Sale” sign over it and placing a picture of it in the estate agent’s window with an asking price of €500,000.  Do that with a business and see how quickly you lose your customers, how quickly your key staff are poached by your competitors, how quickly your suppliers will reduce or completely withdraw your credit facilities and how quickly there will be no business at all left to sell. 

Business Broking is a profession dedicated to the confidential sale of small to medium sized privately owned businesses which in practical terms means businesses with annual sales of between €500,000 and €10m.   It is not a widely known profession here in Ireland because traditionally most family owned businesses were passed down to the next generation or closed altogether when the owner decided to retire.  

As the education and career options available to younger generations have increased the number of businesses being passed down the family line has decreased.  This has resulted in more and more business owners deciding to extract the equity value built up in their business through a confidential sale of their business when the time comes to exit or retire.  That is where a professional business broker can add significant value by helping the business owner prepare the business for sale, set an asking price which the market will actually pay, confidentially market the business to financially qualified buyers and negotiate the best possible deal for the business owner by engineering a competitive bidding process. 

To give you an idea of whats typically involved when I confidentially sell a clients business I have outlined below the key steps undertaken to ensure a smooth and successful sale.

 Initial consultation

The purpose of the initial consultation with the business owner (seller) is to establish whether there is a basis for establishing a successful working relationship together.  Understanding the sellers motivations and objectives is a significant step.  We will be working very closely together so it is essential I understand the seller’s expectations and the seller understands exactly whats going to be involved in selling their business.  I clearly outline what I will be doing, what he/she needs to do and how we are going to get to the finishing line together.  To achieve the best outcome, we need to be on the same team working towards a common goal.

Formalising the relationship

If having established a basis for working together the seller wishes to move forward with a sale of their business we then sign an engagement agreement which outlines the terms and conditions of our working relationship for the duration of the business sale.

Consultation and communication

Selling a business is usually a once in a lifetime event.  If the seller doesn’t know what to expect they can become stressed or anxious.  To avoid this I use a jargon free consultative approach from the very beginning to keep the seller fully informed of the process we are following, the progress we are making, any issues or obstacles we encounter, what is required from the seller along the way and the role their solicitor and accountant will need to play.

Calculate a market valuation for the business

Correctly pricing the business is absolutely essential.  Placing too low an asking price on a business can leave money on the table whilst over valuing a business is the single biggest reason so many businesses fail to sell.  With fifteen years business valuation experience to draw on and access to an international database of 30,000 previous business sales across all industry sectors I will calculate a target selling price for the business. 

Prepare the documentation

After carrying out comprehensive analysis of the business two key documents are prepared:-

1. A one page Confidential Business Summary which contains a brief description of the business. This document is used to market the business but does not identify the business name or location in any way.  
2. A detailed Business Information Memorandum.  This document contains detailed financial and operational information about the business and the market it operates in and is only issued to financially qualified buyers who have signed a confidentiality agreement and demonstrated their bone fide interest in acquiring the business.  It is compiled and submitted to the seller for their approval prior to being finalised.  This gives the seller control over the information disclosed to prospective buyers. 

Prepare for due diligence

Due diligence is the process whereby a buyer who has had an offer accepted (usually “subject to contract and satisfactory due diligence”) is given an opportunity to examine the financial, legal, operational and other records of the business.  This exercise is usually carried out by the buyers’ accountant and solicitor and whilst they are entitled to ask whatever questions they want most questions can be anticipated and prepared for in advance.  I therefore provide the seller with a typical due diligence list and advise them to gather the requested information into a file so that when the buyers’ advisors ask for it we have it ready to hand.  There are two advantages to preparing for due diligence in advance:-

1. If there are any issues relating to the documents required in due diligence they are flagged early and the seller will have an opportunity to address them before actual due diligence starts.
2. It creates confidence in the mindset of the buyer when documents asked for in due diligence are readily available.  Delays getting copies of leases, employment contracts and financial information etc creates doubt in the mind of the buyer and can scupper what would otherwise be a successful sale.

Establish and implement the marketing strategy

The marketing strategy I adopt will depend on the business I am selling and the types of buyer most likely to be interested in acquiring that type of business.  It is crucial that the strategy implemented is appropriate to the business and that it captures the interest of all possible buyers. 

Identify and qualify buyers

Selling a business is a pro active process.  Some buyers will respond to marketing and advertising but others have to be more actively targeted.  It takes a focused effort and tenacity to ensure the business is exposed to all potential buyers.  My role is to find a buyer who has a commercial motivation to purchase the business and the financial ability to complete an acquisition.

Advising buyers

Like the seller, the buyer may not have been through this process before so I frequently spend time with potential buyers discussing the steps involved in acquiring a business.  All potential buyers must sign a confidentiality agreement and confirm they have the financial ability to acquire the business before they are given any confidential information about the business. Once a buyer has reviewed the information memorandum and met with the seller to review and discuss the business I invite them to make a conditional offer for the business subject to contract and satisfactory due diligence.

Negotiating the terms of sale

It is rare that a buyer will make an offer which is immediately acceptable to the seller.  It may take several offers and counter offers to hammer out a price and terms which are acceptable to both the seller and the buyer.  Once a deal is agreed the principle terms and a timeline to completion are summarised in a heads of agreement which is signed by both the buyer and seller.  The heads of agreement forms the basis of a binding purchase and sale agreement to be signed once due diligence is complete. This can be a particularly stressful stage for both buyer and seller so it is critical to keep good lines of communication open and things moving along in accordance with the agreed schedule.

Iron out problems during due diligence

Due diligence usually starts straight after the heads of agreement is signed and will typically take two to four weeks to complete.  The purpose of due diligence is to give the buyers’ advisors an opportunity to examine the records and operation of the business to ensure that the business their client is acquiring has no legal, financial, operational or other issues of concern which have not already been declared to them. 

I have yet to see a business which didn’t have some sort of skeleton in the cupboard or some issue which the seller believes is trivial but the buyers’ advisors believe is a deal breaker.  My role at this point in the process is to act as an intermediary between both sets of advisors and help iron out any issues that arise.  Solicitors and accountants are retained to protect their client’s interest and reduce the amount of risk their client is exposed to which frequently leads to a Mexican standoff.  My objective is to seek commercially sensible compromise between the buyer and seller so the buyer achieves his/her goal of acquiring the business and the seller achieves his/her goal of selling the business.

Completion and payment

Once due diligence is complete to the buyers satisfaction the final step in the process is to for the seller and buyer to sign a binding sale and purchase agreement which reflects the terms agreed in the heads of agreement and any amendments agreed as a result of issues arising from the due diligence process.  Once the sale and purchase agreement is completed the seller receives the agreed consideration and the buyer becomes the new owner of the business.  There can frequently be a transition period where the seller works with the buyer after the sale has completed to help the buyer take over the running of the business and there will likely be some deferred payments due to the seller contingent on a successful handover and/or the business hitting certain pre agreed targets after the handover. 

Follow-up

My role finishes once the sale has completed and ownership of the business has transferred from the seller to the buyer but I remain available to the seller if any post sale issues arise which I can help resolve.

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