Does your Buyer have the funds to acquire you?

Simon Gregory

Considering the size of your buyer is more important than you think

Over the last 15 years I have met and consulted with over 4,000 shareholders, owners of Small to Medium sized enterprises. I have looked at the accounts of those companies and discussed the way in which these shareholders might find a buyer for their business once they are ready to sell. One thing that is extremely clear to me is that to achieve a good price, these shareholders need to be talking to companies that are far larger than they are. It sounds obvious, but it is something that is seriously overlooked when sellers are discussing selling to an interested party.

For example I remember meeting with the owner of a long held family business that had average revenue over the last few years of around Euro 12 million. The company was making a Profit After Tax, including what the shareholder was taking out of the business of Euro 1 million. 

Although traditional thinking says that value is all about multiples of profit, my view is that value is more about the motive of the purchaser and what the buyer can do with the acquired company. Value is always improved when you have a competitive situation i.e. lots of buyers interested in acquiring your business all at the same time. However for purposes of illustration, let’s consider a traditional approach to valuation. The average multiple used across industry, where a competitive situation is absent is 5. We won’t go into why that is the case right now, but leave it for another time.

If we were to value the company mentioned above using the traditional approach, then the value would be Euro 5 million. This simply means that anyone that invests Euro 5 million in acquiring this company would get a year on year return on investment of Euro 1 million per annum, and therefore a complete return within 5 years. To my mind that sort of price makes buying a company one of the best ways of getting a return on your money. Where else could you invest Euro 5 million and get that sort of return on your money every year, and a complete return within 5 years. That’s not my point.

The point is that even on a traditional multiplier the buyer would need to have access to Euro 5 million in cash within its own business.

So let’s consider that here we have a Euro 12 million turnover company making a Euro 1 million profit. In order to have Euro 5 million to buy this business the buyer might need to have 5 times the seller's company’s turnover, arguably.

In other words to have Euro 5 million to acquire the company on a similar turnover to profit ratio as the selling company the buyer would need to have a turnover of around 60 million.

I am generalising here, but for purposes of illustration it helps us to consider that if a 12 million turnover company has a profit of 1 million, a company with 60 million turnover (5 times the turnover of the seller) might arguably be making a profit of 5 times that of the seller (i.e. 5 million). Albeit the 60 million turnover company might have accumulated cash within its business, the point I am trying to make is that to afford a price of 5 million. The buyers needs to be substantially larger than the seller.

As we think about this it becomes abundantly clear that in reality in order to have Euro 5 million to buy a company we must consider that to pay this price, realistically most buyers would need to have a turnover greater than perhaps Euro 100 million.

The important thing to consider though is that no seller wants to have 1 buyer. If you have 1 buyer that buyer will base his valuation on a traditional Return on Investment calculation a 5 times multiple. Most seller would prefer to have a choice of buyers in the hope that a competitive environment will drive the price higher.

In order to get a higher price than the Euro 5 million on the table from the one company, the seller would need to be in contact with players that are much larger than the Euro 100 million company.

Some people would say, no you are wrong Mr. Gregory. Companies that are smaller than Euro 100 million might not have the cash in their business, but they will have some of it.

Okay let’s say they have Euro 2 million in cash in their business. Well, they need to keep a million in the business as working capital. They can't expend it all on an acquisition.

This smaller company is prepared to spend Euro 1 million of its own money, and is prepared to borrow the rest in order to make the acquisition. This is when the seller runs into a major problem.

If the buyer has to borrow heavily, and borrow from a bank or financial institution, the bank will always think Return on Investment - they will always base their valuation on traditional methods.

The bank will want a quick return on their investment, because they are a bank, and of course they are not prepared to take long-term risks with their money.

The buyer will then be limited in terms of what he can borrow. The bank might want a return within 2 or 3 years.

So now we have a situation where the company has been traditionally valued at 5 times. The buyer is prepared to use Euro 1 million of its own money, and to borrow the rest in order to make the acquisition. The bank though will not take a big risk, and won’t approve of the buyer taking a big risk with the bank’s money. The buyer can only borrow 2 or 3 million at the most.

The buyer's offer now reduces from 5 times (Euro 5 million) to Euro 3 million or at the most Euro 4 million, and now sits below the seller aspirational value.

The closer a buyer is to you in terms of size the more they will need to borrow. The more they have to borrow the more likely that the bank will want an even quicker return on its investment. Smaller companies might express an interest in you, but they will not be able to afford to buy you.  

In a survey I carried out once looking at the size of the acquirers of 250 sellers, where there was a competitive environment i.e. lots of companies competing to buy each of these 250 companies I discovered that 88% of the buyers had a turnover greater than Euro 10 million, but more interestingly just over 50% in total had a turnover greater than Euro 100 million. These larger companies were buying many companies with turnovers greater than Euro 1 million and in some cases companies with turnover in the hundreds of thousands. The vast majority of these companies had multiple offers where the difference between highest and lowest offers was significant.

Having seen thousand of accounts over the years, of companies of differing shapes and sizes, I know that many companies below Euro 100 million do not have the cash to acquire at the sorts of prices that make selling worthwhile for the seller. Occasionally they do, but it is very rare. In a later article though, I am going to talk about why there are exceptions to the rule, and why there are sometimes good reasons to contact companies that on the surface might not look like they have the money.

Generally as a rule of thumb, when you are selling a company you need to be talking to lots of companies that are significantly larger than you. If they are of similar size, they will not have the money. You will usually have to sell to them for a low price.

The buyer will want to pay a low price because not only does he have to borrow the money to buy your business, but in order to grow it he will have to invest in it in the very same way you would have to do if your were retaining the business and going to grow it yourself. He will therefore try to pay a low a price as possible, considering he has this extra investment in growth to make once he has bought it.

A buyer that is larger than you (lets stick with our example of the Euro 12 million company), let’s say a Euro 300 million turnover company, will already have in place a much larger infrastructure. In other words he does not have to invest in this infrastructure to grow your business. You can tap into that infrastructure straight away. The buyer will already have multiple channels of distribution already in place to effect greater and faster growth for your business. They will have a much larger field sales force than you have, significantly more customers than you have to whom they can introduce your products. They will have a greater geographic footprint than you have, they may also be able to open up new market sectors to your products, where you might have had some inroads, but where they already have significant presence. This larger buyer also has complementary products or services of their own which they can now sell to your existing customer base.

Here is the key. You buyer should be much larger than you are. They should have most or if not at least the majority of cash within their business available to acquire you.

If they have to borrow heavily you are on the slippery slide to a low price. They should already have in place a significantly larger infrastructure than yours, be able to introduce you to many more customers, increase your geographic footprint, and all the other things I have described above.

If they do not have these things in place already then the likelihood is, no matter how interested in your business they appear to be, they will not be able to pay you (in some cases the minimum you might accept) and they certainly wont be able to pay you the maximum or premium price.

There is nothing worse than expending, time, finance and energy, on buyers who can ‘talk the talk’, but when it comes down to it, do not have the finance or the synergies, to even consider paying you anything more than a traditional valuation based on them getting a quick return on their investment, because they couldn’t borrow enough to pay you a decent price. Size really does matter.

The next article will consider research strategies and how to identify the sorts of buyers that will pay a premium price for your business.              

Simon Gregory

Simon Gregory

BCMS Corporate Limited, Link 665 Business Centre, Todd Hall Road, Haslingden, Rossendale, Lancashire, BB4 5HU

Telephone: + 44 1706 833 900

E-mail: simon.gregory@bcmscorporate.com

www.bcmscorporate.com

Simon Gregory is a Corporate Consultant with Mergers & Acquisition specialist BCMS Corporate Limited based in the company’s northern division, located near to Manchester. Simon specialises in advising shareholders of commercial companies in how to sell and achieve maximum value. He advises small, and medium sized businesses as well as mid market entities looking to sell or to divest subsidiaries. He has worked with BCMS since 1991, initially setting up a Customer Service programme to strengthen client relationships and then relatively quickly developing as a seminar presenter within the company’s international trade division. Simon had a supporting role in the development of this division in the United States speaking at the seminar programmes during a 5 year period from 1993 to 1998 across North America. Simon has advised and presented to shareholders and boards of commercial enterprises for over 20 years. He relocated from the head office in 1998 to the UK’s north and opened a small office which has now grown to 25 staff based on the work he carried out as part of the company’s continual expansion programme. Today this office handles around 60 M&A projects every year. Simon presents at between 20 to 30 UK seminars every year working alongside the Group Managing Director, David Rebbettes and Group Director, Malcolm Murray. In addition he continues to secure clients from one to one consultations with 28 company sales mandates secured during the financial year 2010-2011.  

Career to date:

1980’s – UK Sales Manager within an international business to business publisher    

1991 to present - one to one consultancy and seminar presentation with international M&A firm BCMS Corporate.

Languages:

English, Private French lessons over the last two years

Additional Information:

Simon is also an exhibiting fine artist

http://www.howarth-gallery.co.uk/product_search.php?q=simon+gregory

Things to avoid when looking for a buyer for your business

Simon Gregory

Understand why acquirers buy and don’t adopt a passive approach to selling the largest asset you will ever own

Most companies are bought rather than sold. In other words the acquirer will approach a number of targets, and seek to keep these targets away from other buyers. Their interest is to get you in as tight a corner as possible. There are definite tactics in place to ensure you don’t talk to others.

It works a little bit like this:

A company decides to grow their business via acquisition and will often approach one or more targets. Often the company making the approach is of such stature, that the seller is both flattered and drawn in by their interest. The buyer will try to put the seller fairly quickly under some sort of exclusive arrangement as early as possible in the relationship. Of course the buyer will then want to place consultants in the acquisition target to look at the company with a view to acquiring it.

If this acquirer is looking at lots of other targets (playing the field), then the possible deal seems to drag out over a long period of time, because they have limited personnel and a lot of potential deals to consider.

Every time you meet the acquirer and its representatives you feel more and more flattered, but as time passes by, you begin to wonder if anything is really happening. Then at last you receive the phone call ‘we have decided to proceed and buy the company, however as we have been looking at the company we have uncovered a number of things that gives us cause for concern. Your credit control is poor, there are a number of vulnerability issues with your clients, your sales director is getting older and we are wondering whether he might leave and we will lose business in the long term. For those reasons although we initially hinted at a sale price of Euro 6 million, we are taking a much higher risk than we thought initially, we are therefore reducing our offer from Euro 6 million to 4 million. Because we are taking a big risk, we are also only prepared to give you 50% of the sale price up front. The remainder will be based on future performance, and if the company meets its targets we are prepared to pay the rest.’

All along the tactic has been to secure your interest with the hint at a high price, drag the process out until you reach the stage where you might almost be prepared to give the company away, drop the price at the last minute, and then place terms and conditions on the deal that mean that you might not get the remaining 50% of the sale price. Once you have sold the business to them, you will no longer have control of the performance of the business and they may well do things to make sure you don't receive all that you thought you would receive.

What started out with great enthusiasm on your part, flattered by the approach of this larger company looking to acquire you, now turns to disappointment. Nevertheless you decide to sell to this buyer because it has taken you 18 months to get to the deal with only buyer you have. What’s to say if you tried to find another buyer, if you find one, what is to prevent them from putting you in exact the same position as this current buyer? Most company owners concede and sell to the buyer they have now.

The statement I made above ‘most companies are bought not sold’ is true and this is why when you talk to an accountant about selling your company, or even a lawyer, because they are used to getting involved when you have a buyer already, their experience flows along the lines of accepting terms and conditions being dictated to you. Everything seems to work in favour of the buyer rather than the seller and your advisers who are making good money out of the deal may well persuade you to sell because this is the only deal on the table. The reality is, that no one has done any work to secure other buyers. so you have no idea whether what they are offering you is a good price or whether in fact there are other willing buyers out there.

There is a very real sense that the balance needs to be redressed. The answer to this lies in understanding that although acquirers try to pay for the past (a multiple of profits based on past performance) in reality they are actually ‘buying the future’. That future has a value.

They are not buying the future under your ownership, they are actually buying the future under their ownership. Because different buyers will open up the future for your business in different ways, because they each have different resources to help your business grow, this should mean that you have a different price to different purchasers, however this will only be revealed in a competitive environment. It will not be revealed if you only have one buyer.

True Value

The value of your business will be driven by the strategic considerations or the opportunity you represent to the buyer as well as the opportunity the buyers presents to you.

Simply put, the real reason companies are bought is to do with future opportunity rather than multiples of past profit. However this will not be drawn out of the buyer, outside of having a competitive environment, i.e. you need to have a number of financially strong, strategically motivated buyers interested in buying, and they need to be interested in buying you at the same time as each other.

This is a real key to achieving maximum value.  

When a competitive environment is missing, it is very difficult to persuade a buyer to attach value to the opportunity based on future performance under the buyer’s ownership. Without competition the buyer will want to convince you it is all about a multiple of profits routed in past performance.

Whilst past performance is important, no company was every acquired for its past. Every company is bought because of the future open to it within the structure of a larger player. However buyers will always try to convince you it is about past performance and a multiple of profits.

I will state this again, you need to have a number of strategically, motivated, financially strong acquirers all interested in your business sat the same time as each other.

To achieve this you need to be proactive in your search for a buyer.

Advertising the company for sale, in a newspaper, business or trade magazine, or on a web site, will not work!

If you advertise your company in any of the ways suggested above, you actually have no control over who is looking at that advert, whether they have any money, or when buyers might respond. You also have no control over whether all of the right companies that could buy you know about the opportunity. Each of these things creates its own problems.

No control over who is looking

Unfortunately in the M&A world there are lots of bargain hunters out there. People looking to make themselves a success by acquiring a company at as low a price as possible and later selling it on at a high price.

Databases, newspaper adverts and trade journal advertisements are the places where they hope to pick up a company for a bargain price.

What you should be looking for in a buyer, is another company that is significantly more successful than you are, not someone looking to make themselves a success by buying your business.

No control over whether they have any money

Often these individuals and even company owners do not have the finances to acquire your business for the price you are looking for. You can spend a lot of wasted time with individuals that come across as if they are well financed only to find out frustratingly that they do not have the cash to buy your business. They need to go to the bank to raise the finance. The bank will think Return on Investment, and want their money back within 2 or 3 years. This will result in a low multiple

No control over when they will respond

This is more critical than people think. When you advertise a company on a web site or in a newspaper advertisement, the problem is that you have no control over when people respond. You are simply sitting around waiting for a response. When you do get a response you have no control over when another interested party might respond. The first company will put you under a lot of pressure to sign some sort of exclusive agreement with them. You want to wait for others to respond, but the first prospect will play the card of ‘pulling out’ if you don’t deal with them, now. Nervous that you might lose this potential buyer, you agree and therefore fail to generate competition.

The opportunity remains hidden from many of the companies that could buy your business.

No matter where you advertise the company, newspaper, or database, it is very likely that most of the companies that could buy your company won’t even know the company is for sale. Many of the potential buyers of your business may be based in a different country, or be selling complementary rather than competitive products, and therefore will not know about the opportunity unless you make a direct approach to inform them of the opportunity. Many of the decision makers, particularly in the larger companies will need to be identified and approached directly, because they will not be reading the advert, or looking at the web site where you have advertised your company.

Sales - The Missing Element

Simon Gregory

The average age at which company owners sell their business is 55.

Often succession is lacking, sons and daughters have other interests and if you have been running the business for 20 years, knowing the ups and downs, the good times and the bad, you might not want to pass on those same struggles to the next generation. 

Selling the business becomes a big consideration, but company owners really don't know where to turn. You have staff that have worked with you loyally, for many years, and it is important that the business goes to a good home. At the same time its right to think about making sure that when you sell it, you do so for the best price possible. 

A sale could take a year. Once the deal is done it may 6 months to 12 months to make a final exit as you transition out of the business to ensure that you effect a smooth handover of the business to its new owners. 

Selling is usually a once in a lifetime experience for most company owners and because of this lack of experience, there is often an inclination to approach our professional advisers, our auditors (accountants) or a corporate finance firm in the hope that they might be able to help us in the sale process.

In approaching our accountants we anticipate that because they deal with numbers and financial matters, they might be able to help us discover the value of the business.

Our accountants will usually base their valuation on the profit of the company. The profit (which will include the shareholders costs added back), will be multiplied by a ratio to come up with a value. If a ratio of 5 times is used and the profit is Euro 300,000, then the value would be Euro 1.5 million, which simply means if the buyer pays Euro 1.5 million for the business the buyer will get a return on investment (make his money back) within 5 years, if he uses a multiple of 6, then it's 6 years, if 7 then 7 years. In other words the accountant’s valuation is mostly based on a Return on Investment calculation.  It does not consider that the value of your company might be different to different buyers. Some might be prepared to pay significantly more than this, others will want to pay less. This type of valuation ceilings (or puts a cap on the price)

Here is the problem with this type of valuation. Let's say that you had two Printing Companies, for sale and one was showing a profit of Euro 500,000, whilst the other was showing a profit of Euro 200,000. According to the accountant’s way of valuing a company, the one showing the higher profit would be worth more than the one showing lower profits if you used a multiplier of 5.

However, is this the correct way to value the business? What if we were to say that the company that was showing the lower profit, had recently invested in 4 new sales people, recruited from within the industry, bringing many new contacts and orders from customers they had dealt with over the years, and what if the company showing the lower profit had recently invested in the latest state-or-the-art digital technology to take it into the next decade, and this was the reason it was showing a lower profit.

On the other hand, the company showing the higher profit, had not and did not have a sales team, and much of its machinery was life's end. Are we saying that the first company is worth less than the second, because it was showing a lower profit?

Surely this cannot be! Traditional valuation methods based on a multiple on profits actually fail to consider the value of the company based on the future. They simply reduce value to a calculation based on a multiple of profits. They fail to consider that your business might be worth more to one company than another!

In addition, something else must be considered when it comes to valuation.

Let's say that I have a number of companies interested in buying my company, and let’s say that I currently have a customer base of 600 clients. Each of the companies interested might be able to do different things with my business going forward. One for example might have a further 2,000 customers that it could introduce to me, another might be able to open up a larger geographic territory for me, another might enable me to diversify, or internationalise, because they are a significantly larger player than I am.

Different sized buyers may be able to open up the future to my business in different ways. One potential buyer might have a turnover of Euro 100 million; another might have a turnover of Euro 600 million. Each could do different things with my business in terms of generating growth. Shouldn't it be true therefore that I potentially have a different value to different companies dependent on what they are going to do with my business? Absolutely. 

Unfortunately this is not how most advisers in Mergers and Acquisitions work. They tend to value the company first, and never really consider that it could be worth different things to different buyers dependent on what they are going to do with your business.

To make the situation worse, not only do accountants, and corporate finance specialists value the company upfront, they often then take the company to market with a price tag attached. As soon as the price tag becomes public information, the seller has effectively sealed the price. In fact it is worse than that. Once you make a price public, the buyer will only try to negotiate one way from that price, and that is usually down. 

The thing to consider here, is that of course accountants are very important to most people's businesses, however we would never consider giving our accountants our products and services to sell, but that is exactly what we do when it comes to selling our businesses, we give it to an accountant to sell, and yet the accountants skill is not in the area of sales.

Selling a business is first and foremost a selling issue.

Every day business owners employ sales skills and techniques to sell their own products and services. The process of selling a company differs only slightly from selling products and services, and yet sadly what often happens is that because of lack of experience in selling companies, shareholders often give their business to an accountant to market.

This Blog is here to help you identify, how to sell your company and achieve maximum value and how to ensure that you have a number of potential buyers interested in acquiring your business, and most importantly how to secure the best price.

As part of BCMS Corporate, one of the largest Mergers and Acquisitions Groups by volume of deals completed, and with a 20 year history presenting at hundreds of business seminars over the years I hope that you will find the articles contained within this blog helpful and interesting in considering how best to maximise the value of your business.