Some of the CP Deals team have put their heads together to come up with a useful guide on selling your business. Based on their experience of working with business owners over many years we’re sure it’ll be invaluable if you’re looking to put in place your own exit strategy.
It’s not just about having a business exit strategy in place. There are a whole range of considerations you need to take into account – from working out the business value through to succession planning which could help with your business exit. Identifying potential buyers for your business along with navigating the whole deal process from start to finish.
CURRENT MARKET THEMES
Let’s start with an overview of M&A trends. Focussing on UK Deals and what you can expect from the market.
2023 proved to be another slow year for M&A as UK deal volume dropped 18% from 2022. Those market conditions continued to be unfavourable due to the economic headwinds and the effects of geopolitical conditions. Including interest rate and inflationary pressures that we’re seeing in the market at the moment – all driving up the cost of debt.
As these settle, we expect to see both Private Equity (PE) and trade acquirers returning to the table. Though of course an imminent UK general election is likely to cause a temporary blip in the market.
With market conditions stabilising and interest rates gradually coming down we expect to see more platform deals from PE. Due largely to debt becoming cheaper and the need to deploy dry powder intensifies.
PE investors will also look to create value through the transformation of their portfolio companies. Particularly with strategic bolt-on deals to create rapid growth.
ESG (Environmental Social Governance) continues to be a key consideration within the acquisition criteria when PE houses are looking at businesses to buy. New regulations and standards, which are still continuing to evolve, are making ESG and Sustainability consulting businesses particularly attractive to PE investors.
As Niall Chantrill our Corporate Finance Partner says:
“It’s been an interesting ride the last three years in terms of the M&A market. Post COVID we’ve seen a high in terms of transaction volumes & valuations coming into 2021 and the first half of 2022. But the last 18 months had a different feel to it in terms of the market and how buyers and sellers are starting to behave.
A lot of that’s been borne out of geopolitical interest rate & inflationary pressures that we’re seeing in the market at the moment – all driving up the cost of debt. Transactions are becoming a lot more prolonged in terms of duration, deals that maybe was taking six months previously might be taking up to 12 months to get to get over the line When you’re looking at buyers, there’s definitely more risk aversion. But another key aspect that we’re seeing is that maybe sellers aren’t as prepared as they should be heading into a potential sale process. And we often say when working with businesses that pre-sale planning should start 18-24 months ahead of a potential transaction because there’s plenty of things that you should be thinking about as early as possible ahead of a potential deal.”
MAXIMISING VALUE
As a business owner, you may feel like you are ready to cash out completely through a sale. Or maybe you want to realise some of the value you’ve created through taking on investment from private equity. That way you can retain some of the business and help drive future growth.
BUSINESS VALUATIONS
Commonly, businesses are valued by a multiple of earnings (EBITDA). This metric gives an insight into the company’s cash generation ability and operational efficiency, as it doesn’t account for non-cash expenses. In some cases (e.g. Tech), businesses are valued by a multiple of their revenue.
FACTORS AFFECTING THE MULTIPLE
The multiple your business ultimately achieves will depend on numerous factors. At a high level, the nature of your business and the sector you operate in will have the greatest effect on the multiple. However, there are factors which can increase the multiple. This emphasises the importance of preparing for your business exit well in advance of a sale. You need to position your business carefully to achieve the best valuation possible.
Here are some things to consider:
- Quality of Earnings (QoE) – Is your revenue highly recurring in nature or one-off? Do you have a strong, secured pipeline? This will allow investors to gauge the predictability of future earnings and revenue volatility.
- Barriers to Entry – How difficult would it be to replicate what you do? What intellectual property do you have to protect the business and its products/services?
- Employees – Are there gaps in your team which the next investor will have to address? Or is there a succession plan already in place?
- Business Functions – Do you have existing primary and support functions to meet the business’ needs? For example, adequate financial reporting and management accounting? This could make the process much smoother when you eventually sell the business and go through due diligence
- Customers – What is your customer concentration and retention? This will allow investors to understand the quality of your revenue
Another factor affecting the valuation of your business is the growth potential. If you are interested in a sale to private equity, you should consider the following:
- Is the market you operate in growing?
- Have you got a strategic plan in place to gain more market share?
- Are there opportunities for acquisitions?
- Is your business model scalable?
This may be less important for trade acquirers, as their reasons for acquiring will be different to private equity. Trade acquirers may be looking at your businesses for:
- Vertical integration
- Improving operational efficiency
- Entering new markets or geographies
- Obtaining intellectual property
Simon Nichols our Transaction Service Partner advises:
“It’s never too early to start thinking about your business and looking at it through the lens of an aggressive buyer to identify areas of concern which may lead to difficulties realising the maximum value for the business. We have an ‘Exit Readiness Diagnostic’ where we work with clients to quickly review all key areas of the business – quality of financials, control environment, tax & legal, customers & suppliers etc. This flags any concerns early and so gives time for these areas to be improved in advance of a transaction”
SALES OPTIONS AND PROCESS
When it comes to selling your business, there are several options available to you which could all change the landscape of your business moving forward. It’s important that you consider them all and go ahead with the one that best fits you, your company and its future prospect.
SALE TO PRIVATE EQUITY
One of the options available is a majority or minority sale to private equity. A majority sale would be a great option if you wanted to completely step away from the business or realise most of the value you have created. A minority sale is best suited if you are looking to realise a portion of your personal wealth in the business but are still eager to retain majority equity. In majority deals, PE investors will often offer to roll some of the proceeds over to align leadership and private equity funding with future growth plans.
PE investors may look to acquire your business as a platform deal which will go onto their portfolio. Or they may potentially acquire your business as a bolt-on to an existing portfolio company. The type of deal PE will look to do will be based on a number of factors. The size of your business. Whether they are looking for entry into your sector, and if they have existing portfolio businesses that your company complements.
SALE TO TRADE
In this case, a company usually in the same or adjacent sector, will look to acquire your business. As an owner, a sale to trade will maximise the money you see on day one. It’s likely a trade business would acquire all of the equity in your business, taking full control after the handover period. If you’re looking to sell to trade, it’s also important to consider cultural integration as this acquiring business will be the new home for your people.
Preparing your business for a sale to trade early is vitally important. These transactions can take longer than PE investment. This is because PE execute deals regularly so often have processes and advisors in place to speed up timeframes.
INITIAL PUBLIC OFFERING (IPO)
An IPO is the process of taking your company from Private to Public. Your company’s shares will be sold to general public via a stock exchange. Whilst IPOs do typically raise more capital, business owners looking to perform an IPO should be aware of the strict regulatory rules you will need to adhere to, the more onerous ongoing financial reporting requirements and scrutiny from the public and investors.
Niall goes on to suggest:
“You need to consider your options for sale in the light of things such as cash conversion rates, sustainability of earnings and potential synergy opportunities.
Once that is decided then the next step is to ensure you have a robust value proposition. Taking into account anything you can do to improve that further. For example, renegotiating key contracts, winning new customers, ensuring ESG is built into your plan etc.
Then consider the buyer population – understand what they will be focussing on and ensure you run a competitive process.
Once into the deal process itself make sure you control the information – both in terms of what you release and when. Use Vendor Due Diligence where relevant to ensure bidders can rely on an independent assessment of the financials. This’ll also minimise the disruption to you and your team allowing for business as usual as much as possible. You don’t want to get distracted from running the business to its maximum potential during a process”
TAX CONSIDERATIONS
To be exit ready from a tax perspective there are a number of questions you should consider. The answers will help shape the best approach when it comes to the tax implications:
WHAT ARE YOU SELLING?
What exactly do you want to sell? It may not be the whole business. Is there any pre-transaction structuring required to get the company or group exit ready? Are there assets which are to excluded from the deal (for example that you want to retain or that the buyer may not want) and therefore need to be extracted? It is key to ensure any pre-sale structuring is undertaken tax efficiently, as well as appropriately to prevent unnecessary diligence scrutiny.
There are also Capital Gains Tax considerations, to find out more check out our article on the potential changes to CGT.
WHO NEEDS TO BE INCENTIVISED?
Very often people are at the heart of any business success. If your existing team is going to remain in place post sale, how do you know they will remain committed to the business? Who are the key people in the business you want to incentivise and how? Ensuring any share incentives / share option plans are implemented in as far in advance as possible for tax effectiveness is recommended.
TAX RISKS
Have you identified all the potential tax risks in your business? It’s helpful to be on the front foot discussing these with any potential purchaser. If a purchaser identifies tax risk this destroys value, adds complexity and time to any process. Without any lead time to rectify any issues there may be demand for a price reduction. We would always recommend a tax review well in advance of any sale process.
SUCCESSION AND INHERITANCE TAX
Pre-sale it’s also important to think about what it means for you personally from a wealth, succession and inheritance tax perspective. Selling your business will be one of the biggest events of your life. You’ll be crystallising value by turning shares into cash. Making sure you secure the value that is crystallised at capital gains tax rates (as opposed to income tax rates) is key. It is also crucial to get the inheritance tax planning right to avoid the risk of losing 40% of value later. Having the right conversations about what the transaction means for you and your long-term objectives early is therefore strongly recommended.
Louise Meldrum, Senior Manger Transaction Tax, advises:
“From a tax perspective, it’s really important to be on the front foot to be prepared and invest the time to identify any potential tax risks so they can be mitigated or resolved before going into a sale process. There are a couple of hot topics that we’re seeing at the moment on tax due diligence.
One area where we are seeing particularly aggressive stances is employee share incentives which can result in significant employment tax risk. Undertaking a review to ensure the tax effectiveness of any share plans is as expected is recommended. If there are any potential issues identified, it’s really important that they are rectified as far in advance of a sale process as possible to make sure the tax efficiency of the plans is retained.
Another area of challenge we are seeing is the use of off-payroll workers, therefore having a review of those arrangements to see if there are any potential tax risks is really key”
LEGAL CONSIDERATIONS
By focusing on these key legal areas companies can significantly enhance their readiness for an exit. A well organised data room and thoroughly vetted contracts not only streamline the due diligence process but also build confidence among potential buyers or investors.
A few key steps to get a company exit-ready from a legal perspective:
ESTABLISHING A COMPREHENSIVE DATA ROOM
A comprehensive virtual data room is a critical tool for potential buyers or investors to conduct due diligence. It should include all relevant contracts and documents, systemically organised for ease and access.
The key components of a data room typically include:
- Corporate Documents – Incorporation documents, statutory books, articles of association, any shareholders agreement, board minutes and resolution.
- Financial Records – Financial statements, tax returns and forecasts.
- Contracts and Agreements – Customer and supplier contracts.
- Intellectual Property – Trademarks, patents, copyrights and related documentation
- Employment – Employment contracts, employee handbook, benefit plans, pension documentation and incentive plans.
- Litigation – any documentation in connection with current, pending or settled legal dispute, judgements or settlement agreements.
CONTRACT ENFORCEABILITY
Review each contract to confirm it complies with applicable laws and includes all necessary elements to be enforceable before and after the exit. In particular look at any change of control provisions that might be triggered by a sale or merger.
RETENTION OF YOUR KEY ASSETS
When there is an exit occurring, there’s a delicate balance to be had between incentivising your employees to maximise the company value whilst ensuring their retention post-exit. A well-structured incentive programme is critical to achieve this balance. The key to incentivising staff lies in offering immediate financial rewards whilst also providing them with reasons to continue with the new company, therefore a company could structure their plan that allows employees to sell a portion of their shares at an exit whilst requiring the employees to roll over a portion of their shares in the new company. This creates an ongoing financial stake in the success of the new company.
BE REALISTIC
Selling a company is a complex and time-consuming process that requires significant effort from you as a business owner, it is likely to include preparation for the sale, marketing to find the right buyers, negotiations, and dealing with completion. Not to forget there is also an emotional and operational strain on the business. However, the burden can be greatly alleviated with the help of professional advisors and getting them on board as early as possible.
Emily Waterhouse, Head of Cooper Parry Law explains a bit more about how we can help:
“At Cooper Parry Law, we specialise in M&A legal advice, which allows us to work with both buyers and sellers. This is beneficial because when we’re acting for a seller, we know what our buyers are looking for.
We’d always advise to get a very good, electronic data room up and ready as early as possible to then store all the necessary information.
Key pre-sale work involves us really digging deep into the company, looking at the contracts that you have, making sure that if you can sell, they’re still legitimate and legal (e.g. change of control provisions). Also, considering any litigation issues that should be resolved prior to exit.
And don’t forget the basics. For example, ensuring that you’ve got employment contracts for each employee, you’d be surprised how many companies don’t.”
SUMMARY
- It’s never too early to start thinking about an Exit. 18-24 months beforehand you should be considering the exit options, what is the value proposition and giving initial consideration to the financial, tax & legal roadblocks. Give yourself time to fix these
- Maximising Value – Give early consideration to how you can maximise the value of your business. Focus on sustainability of earnings, cash conversion, quality of management team, quality & security of customer and supplier base, synergy opportunities, ESG
- Stay in control of the process – Appoint your advisors in good time. Consider an early stage ‘Exit Readiness’ assessment. Use vendor due diligence to ensure you can present buyers with consistent, independent information which will allow you to maximise value, minimise disruption and accelerate the process
- Consider the personal angles – How will management be incentivised to help drive the business forward post deal? What are the personal tax considerations and how can these be dealt with in the most efficient way?
WANT TO KNOW MORE?
Do get in touch if anything in this article has sparked a thought that you’d like to discuss further. You can find out more about the CP approach to deals here. We work as one team supporting business owners, management teams and private equity investors. Our broad experience means you can draw on a range of skills to provide the services you’ll need for a successful deal.
You can watch the above videos and more of the team sharing exit planning advice, here.
