Selling a Business: An Advisor’s Tale

A friend of mine who runs a small, but successful business (let’s call it ABC Co… might save him being bombarded with requests!) asked me ‘Glen, you’ve sold a load of businesses, I’m thinking of selling mine, what’s important, what do I need to know, how much is my business worth, I’ve been approached by someone recently… what should I do?’

Ok… selling a business is not exactly a small subject matter, so I took the opportunity to reflect on what I’ve been doing for the last 17 years, in the hope of distilling some useful information for my friend. In doing this, I thought it might also be helpful to share my thoughts and experiences with others, so here goes. I have condensed this into several points which I have numbered in the hope of making it a little more readable, but let’s start with the party that approached him…

What is critical, is that anyone thinking of selling their business, doesn’t simply drift into a tide of interest and process from any one party. Selling a business reactively in this way, means that the price will only ever go down. Irrespective of whether you have been approached or not, planning and preparation are fundamental to the success of any process and will ensure that you are more likely to achieve the result you are aiming for. Any process therefore should be robust, timely and one which all advisors should be familiar with.

1. Have you been approached? - The company that approached my friend… probably isn’t the right/final acquirer (illusion shattered!)… and I could provide many examples from my ‘back catalogue’ to illustrate this. Why not? This is a golden opportunity for a buyer to have a good chance at picking up his business cheaply. Why? How does he know what his business is really worth? I guess he could try to identify some comparisons with similar companies or maybe have a bit of a punt and say it’s worth ’N’ x this plus a lump of that. After all, at the end of the day many buyers may do similar… ‘So what is the solution?’. It is really important that you’re able to identify (and possibly approach) as many suitable potential acquirers as you can and have some inkling of where the ‘fit’ is. Also consider carefully that your acquirer may well be outside of the UK – this will mean casting a wider net! That said, look closely at the motives of the acquirer that is sat overseas vs. your nearest and dearest competitor down the road in Basingstoke… who do you think an acquisition of ABC Co would mean more to?

The golden rule here is that introducing a level of competition will help by :-

• Keeping a potential acquirer ‘honest’. They are less likely to play games if they know there is another equally qualified acquirer in the wings.

• Not only maintaining the value of any offer, it may also help by driving the value up. I have many examples of this from my past.

• Proceeding with one acquirer leaves you with little contingency in the event that a buyer withdraws. Not having a ‘Plan B’ and possibly C can prove both time-consuming and expensive.

‘So if I sell my business for a price, do they get the property, stock and cash in the price?’… Ok, so this really is getting a bit more complex. My friend then said that someone he knew sold his business on a ‘Cash and Debt Free basis’ – what did that mean? The short answer is that it can mean more than one thing depending on who you are asking. I think the point here is that if anyone was to make me an offer

on a ‘cash & debt free basis’, the first question I have is ‘what specifically do you mean by this?’ and ‘can you provide me with a worked example for clarity’s sake?’ Never assume!

The last point in this section (and maybe it should have been the first!), be clear on what it is that you want from a sale. Whilst its always flattering when someone approaches you in this way, this is not a reason! What is it that’s driving the interest in selling? A. Money B. Good home for the business C. Protecting or rewarding employees D. Timing – now or in future E. Other F. Mixture of all previous.

2. ‘How much is my business worth?’ Sellers think it’s worth twice as much as it probably is and buyers will probably want to offer you half as much as it’s probably worth! Cynical? - Perhaps, but I’ve seen all sorts over the years. I think what is clear, is that the more interest you’re able to generate in your business (born out of sector and deal research), the better the price you’re likely to command. However, this needs to be genuine interest or at least there needs to be a visibly good potential fit.

In addition to the above, any broker should be able to provide an indicative ‘valuation range’ born out of previous experience from in-sector transactions of a similar scale. Whilst this is not an exact science, it will enable any seller to gain a realistic understanding of what their business is potentially worth prior to embarking on what might amount to a time-consuming and expensive sales process.

‘So, if I sell my business for £8m, what do I actually see in my hand?’ Really good question! The true answer is that it depends on quite a few different variables and too much to put in this one paper. Consideration, taxes (and when they are paid), costs and net receipts all depend on your individual circumstances but should form part of the planning cycle with advisors. It is so important that you enter into any process knowing how much you need to comfortably exit your business. This will only result from adequate planning and preparation.

‘What is an earnout?’ Put simply, an earnout is where part of the consideration is contingent on hitting a target (typically profit or revenue though it could equally be based on a different target e.g. maintaining key clients or staff) and is not paid automatically.

If an earnout is included and agreed by both parties, it is vital they are based on SMART targets ie they are Specific, Measurable and most of all Achievable! Control and any rules during the earnout period are key! Who controls pricing and costs post completion – buyer or seller? If you have an earnout based on profit, without adequate controls to prevent an acquirer adding additional cost to the P&L, could leave the seller exposed.

Never get tempted to over-egg projections for a buyer, as this is where it can come back and bite you. That said, I’ve experienced several transactions where earnouts have been successful, and my clients have benefited from them forming part of a transaction. It really does depend though, as quite often there is no substitute for ‘cash in the bank’. Equally, from a buyer’s perspective, this will help them mitigate the risk of a business declining post completion, whilst entertaining this option may just make your business more attractive and saleable.

Selling the future. Buyers will gain significant comfort from what you have achieved with the business so far. However, they are mostly interested in the business for its future potential under their ownership. Given this is the case, if the future potential under their ownership looks buoyant, it is important that this is highlighted and drawn to their attention. There is however a real balance to be struck in my opinion. If you over-sell this potential, you are likely to encourage a greater amount of earnout or at best, deferred consideration. Once again, balance is key!

‘Ok, so what would happen if I only reached 75% of my target in Year 1, but overachieved in Year 2?’ This is a good question, and really comes down to the art of deal-making. At the point of accepting any offer ‘in principle’, it is important to assess the achievability of any targets, and if possible, replace ‘all or nothing’ targets with some form of tiered or pro-rata payment plan. This means that, in the event that you fail to meet a target (typically financial), you achieve some percentage of your agreed earnout. Equally, if you overachieve against a target, there should also be consideration given to additional recompense.

3. Property & Cash – If the property is owned, is it on or off the books? If it’s off the books, one assumes you’re charging back the company a market rate rental/lease. In my experience, it’s no better than 50/50 as to whether buyers are interested in acquiring the property and many, if not most, simply prefer buying the business with a market rate lease in place. ‘Ok, so what happens if it’s on the books, but the buyer doesn’t want to buy it?’ Good question, with several answers… I think if I was advising people from scratch, I’d think carefully about buying the property and whether or not to hold it privately (maybe in a pension fund, separate company shell etc.). It can certainly be advantageous to have a commercial property in, or as part of a pension fund, so worth exploring further with your accountant or tax advisor.

‘So I’ve managed to build up quite a bit of cash on the balance sheet, should I take it out, or leave it in?’ Another good question.. with a few potential answers. Of course you are always able to withdraw ‘free/surplus’ cash, via the usual mechanisms (dividends, PAYE etc.), but I think what you’re asking is whether it is more advantageous to leave it in the business, and for a buyer to ‘buy’ it £ for £? The answer is almost certainly ‘yes’ depending on a number of factors (inc. total amount of consideration being paid, amount of surplus cash…and others). Either way, this is definitely one to be considered carefully, with the correct tax advice in advance of any transaction, and preferably as part of any planning and preparation. What is essential is that both seller and advisors all have an early common view about working capital, surplus cash, property etc. An early understanding of these will enable us to drive any process and also enable contingency planning, particularly with regard to property.

In summary, get clear tax advice on the property and cash as early as possible in any process!

‘Sounds complex… so who do I need to get involved? Do I get my accountant to sell the business?’ Again, probably not a short answer.

4. Advisors: Broker, Lawyer, Accountant? Let’s start with choosing a broker…there are loads! They range from the big players like Grant Thornton, EY (probably more used to working with much larger companies though), to smaller more boutique companies. Choose carefully and look very closely at any contract you are offered. Why? Well, it’s got to do with the way many earn their fees, which are usually split in 2 components:-

1. Some form of retainer – can be as much as £50k+ or as little as £3k in my experience

2. A sale fee or commission - 3-5%+ of ‘Sale/Gross Transaction Value’ (Sale Price) is not uncommon

If you think about it, none of this is a problem if you sell the business for a reasonable value. However, what happens if you don’t sell the business? Some of the contracts you will undoubtedly be offered will have a ‘tail’ on them, which can effectively mean that you are liable for a commission if you sell your business within a set period – maybe as long as 3-5 years after the termination of any agreement with the broker – assuming they were unsuccessful in selling your company.

Look closely at what is included in any commissions i.e. you may be asked to pay a commission on surplus cash, property, salaries or other benefits – the list can be exhaustive! Quite a few brokers will attempt to wrap these all in. Similarly, what happens if you don’t get paid all of your consideration at the point of completion and there is some form of deferred consideration or earnout involved? You may be asked to pay this at the point of completion, even though you might not see any of the funds yourself for several years.

Brokers may well spend a fortune on trying to sell to you, but once you are signed up, that same level attention tends to evaporate. Over the years I’ve heard horror stories about a number of brokers bending over backwards to sign you up as a new client, but in reality, only sell about 1 in 10 of the companies they take on. This is where the tail on the contract really becomes a problem. You’ve been warned! Check the agreement closely or involve someone who has experience in such matters.

Irrespective of what you are going to be charged, it’s important to understand your brokers credentials and pedigree. Do they have any previous experience/success within your sector? Perhaps ask for recommendation or reference.

Lawyers – you will almost certainly need a lawyer to assist with the legal aspects of any transaction. I’m fortunate, I have worked with some really good ones over the years. I’ve also met ‘some others’. My advice here is make sure you use a lawyer that has the appropriate corporate experience, and preferably one that is able to offer tax/property/HR related advice as part of their service. They also need to have the end goal of selling the business in mind. Whilst a lawyer’s role is to protect their clients from risk, there is a position of balance to be struck between ‘willing buyer and seller’.

The lawyer’s responsibility in the process is to ‘own’ all of the legal aspects, including:-

• The disclosure process – any relevant information that is shared with an acquirer including that for which you may subsequently need to provide a warranties or indemnities.

• Any Legal agreements, contracts or deeds including the SPA (Share Purchase Agreement or Sale & Purchase Agreement) utilised during the sale process.

A good idea here is to take some advice from your appointed broker or accountant before choosing a lawyer to represent you and then go and meet with a few of them for a cup of tea. I have always found that choosing a lawyer is a personal matter, so it’s really important that you can get on with them. Most lawyers will be prepared to meet with you for an hour free of charge, if they know there is a chance of winning your business. If your broker or accountant recommend a lawyer, there is automatically another level of comfort. Selling a business is very much a team game – it’s vital that you, your lawyer, broker and accountant can all work together efficiently and without borders or obstacles.

Each part of the process, (be it legal, commercial or financial) is interwoven, therefore each team member needs to be dovetailed seamlessly into the process.

Accountant – your accountant will certainly have some involvement throughout the process with demands for information and supporting opinion. The demands of preparing for a sale and particularly due diligence are quite specialised and very time consuming. As the transaction process gets up and running, due diligence will require a lot of attention with quick response turnaround times. If your existing accountant is not familiar with a sale process or does not have capacity to take on the additional workload and deal with the type of information requests that will come up in due diligence, while at the same time keeping the normal demands of day to-day business serviced, then it may be advisable to employ additional experienced accounting help to assist during the preparation and due diligence phases. This resource would sit alongside your own accountant to use their knowledge and experience but also feed back to them information from the process.

My final point on advisors is this. Irrespective of whether you are speaking about brokers, lawyers or accountants, don’t be driven purely by fees. You’ll always be able to save £10k on advisors, however, this could be the most costly £10k decision you have ever made for this ‘once in a lifetime’ transaction if you get this wrong! Look closely at who you are dealing with, their relative experience, their recommendations, their contracts and their fee structure.

5. The process - ‘How long does it take to sell a business?’ Personally, I’ve sold one in 3 months, and one in particular took me over 3 years and several attempts. A typical timescale is somewhere between 6-12 months depending on what kind of process you are engaged in. The due diligence process alone, where a buyer is validating what they are offering from the business, can take 2-3 months. Momentum in this process is key. Time delays can be the biggest killers of transactions… there are others though.

The process can be divided into several components:-

• Preparation & Planning – Is your business in the right shape to sell? What is the risk profile? Are there any skeletons in the closet? Is there any over-reliance on management, staff, client(s) or supplier? Collating documentation. As a team, we already know what types of questions will be asked (on and offline), which means we can be well-prepared with data and model answers.

• The marketing approach – Have you already been approached by a prospective acquirer or not? This will undoubtedly influence the strategy adopted to market the business. Confidentiality/NDAs – how much information do you share, and how is this controlled?

• Meetings – Who attends? What is the format? Dos and Don’ts…

• Offer Management – Inviting offers. What is the process for dealing with an offer(s)? One point to mention is that it’s important to disclose as much as possible to a serious acquirer prior to them making an offer. This way there should be little variation in that offer during/post the due diligence process as their offer has been made predicated on a level of information being disclosed. This will also have an impact on the number and kind of warranties and indemnities you will be asked to give as part of any final agreement. All part of the negotiations, but certainly one for the lawyers!!

• Due Diligence – What is this, how long does it last, who does what and how is information flow managed? Can buyers revise their offer throughout any process? It’s rare that an offer goes up!

• Completion. Is this a physical meeting? I always advise that we only meet when we’re good and ready. Don’t be tempted into a meeting when there are unresolved material items to be negotiated as you will undoubtedly be compelled into conceding points. Physical completion meetings are preferred from my perspective as everyone is in the same room. This way completion will happen more efficiently with funds usually being transferred on the same day.

6. Alternative options - MBOs and Employee Ownership Trusts (EOT). My friend pointed out to me that he was also approached by a couple of his managers a few years ago. They asked whether the business was for sale as they’d ‘heard a rumour’. My friend replied that it wasn’t.

A couple of points here, businesses are always for sale – it’s largely dependent on timing and price. That said, there are ways to manage these types of enquiries from staff, in order to halt the rumour mill, which could otherwise prove potentially damaging. That said, this specific interest arose from the fact that my friend’s managers were potentially interested in buying the business were it for sale.

This brings in the subject of MBOs and Employee Ownership Trusts, both of which warrant consideration depending on the drivers for wanting to sell. ‘What are they? What’s the difference? What are the Pros and Cons?’ Ok, so this is where we start entering into the requirement for greater detail than I can provide in a summary document. At a high level, if you’d ultimately like to sell to your managers/staff and are less concerned about taking your money out in one go, but would like a tax efficient deal and a speedier transaction, an EOT might very well be an option. An MBO might also serve a similar purpose by facilitating a sale to your management team whilst enabling you to take a larger proportion of the consideration sooner.

I’m afraid these are big subject matters, that require a great deal of consideration before deciding. Ultimately, if you want to maximise the value you receive for your business on Day 1, then an EOT is unlikely to deliver on this.

Some other facts – You will not sell your business to someone you do not like and trust – Fact! Your buyer will have a similar view on this and are unlikely to buy your business if there is little rapport or empathy between buyer and seller. What’s key is that something that should be all about the P&L and Balance Sheet, isn’t! Soft issues like trust, empathy and culture are vital in any successful transaction.

How long will I have to stay on after selling?’ That depends - how much of this business is you? i.e. Is it owner reliant? It’s quite common that owner managers are highly active and influential in small businesses. They may even ‘own’ some of the key customer or supplier relationships. Clearly from a buyer’s perspective there is a perceived risk when they acquire a business if the owner was to exit the business on day 1. That said, buyers do realise that post-completion, entrepreneurs don’t necessarily make the best employees. As always, there are 2 sides to this coin and a balance to be struck.

‘Am I guaranteed to sell’ – Nope! But buyers are always looking for good businesses. ‘What makes my business attractive?’ Quality, People, Pedigree and Profitability. Whilst a clean and profitable business is always attractive, do not try and build the perfect company and squeeze every ounce of profitability out of the business. There has to be some upside for the acquirer.

Summary

Selling a business takes time! You may be fortunate to get all of the consideration for your business at the point of completion but assume that it will take you 2-3 years if you really want to physically exit from your business. Given this is the case, if you want to maximise the value you receive for selling your most treasured asset, start the planning and preparation early. It is also really import to open up an early dialog with advisors. It costs nothing to meet with them, but it will enable you to make an informed decision on who to appoint at the appropriate time.

Look carefully at the advisors you select and at the contracts you are offered. All that glitters isn’t gold!

I do hope that this is of use. I have written it at a pretty high level and there is a great deal more depth to be considered I’m afraid. If anyone does have any questions, do feel free to message me directly or email me at gmallaby@pinpointba.com