Due Diligence When Selling A Business

Selling a business yourself?

Business Owners negotiate and agree deals on a daily basis, whether this be with suppliers, clients or even agreeing staff terms and contracts.  This means when it comes to selling a business, they already have an abundance of skills and experience to ensure they achieve the best deal for their Company.  Quite rightly, when it comes to selling or buying a business numerous clients I meet with advise me that this is an area that they are confident of conducting themselves, and do not see much value in instructing an agent for something they are more than capable of handling.  Whilst this may be the case for some business owners, when I explain to them that the sale or acquisition of a Company is not just about the negotiation of the deal and agreeing terms at the outset, but a lengthy on-going process for sometimes 3-4 months, they seem surprised.   So why can the sale of a Company potentially become so complicated?

The first critical part of the sale of any Company is confidentiality.  Sellers are wary of the details of them selling a business becoming common knowledge, whether it is being leaked to staff, clients or competitors.  Therefore the process of providing information in a ‘drip feed’ manner to interested parties is a must, helping to protect the Company’s identity and eliminate casual interests.  Even when a purchaser is identified as being serious and they meet with the seller, it is common that details regarding clients and contracts are limited until the terms of a deal are agreed.  At this point, when both parties agree a deal, some sellers believe that negotiations are over and as with the sale of a house they just need to sit back and wait for the solicitors to draw up the contract and the cash to hit their bank account.  The buyer, however, quite rightly sees this just as the start of negotiations.  They have made an offer without seeing all of the required information, and until they have fully assessed every aspect of the Company in their minds the price is not finalised.

What is Due Diligence?

Due Diligence is the terminology given to the stage whereby the buyer will be allowed access to all areas of the Company, to fully allow them to assess every aspect of it, to confirm the suggested areas of strength and growth, as well as view any potential issues which had not been disclosed.  Due Diligence consists of 4 main areas – Legal, Property, Financial and Operational.

Organising and prioritising these 4 areas is critical to ensure that momentum is maintained and the deal progresses.  The Legal aspects will relate to providing evidence of the Company’s incorporation, registration at Companies House, allocation of shares and stock transfer documents to name but a few.  Instructing a solicitor who specialises in mergers & acquisitions is critical for this stage, as this information will tie closely in with the Warranties & Indemnities and Disclosure Letter.  The Property aspects will concern the current lease and novation of this across to the purchaser removing any personal guarantees in place, or in the case of a freehold carrying out an independent valuation or creation of a new lease.

When selling a business, what difficulties might you encounter in Due Diligence?

The main area where deals fall apart with buyer and sellers dealing directly is in relation to Financial Due Diligence.  Typically a buyer will base their offer on historical accounts, or on as up to date management figures as are available.  Sellers tend to assume that this is the end of negotiations; however this is not the case.  Experienced buyers will instruct chartered accountants to carry out an in-depth analysis of the Company’s financial performance, typically over the last 12 weeks.  This review will reconstitute the profit & loss, recalculating the current turnover, gross profit and expenditure costs in order to provide the latest figures in line with the method used to agree the initial valuation.  I am sure you have all heard horror stories of colleagues in the business world who recall how they had deals agreed only for the buyer to ‘move the goalposts’ or change the deal at the last minute.  These stories relate to the Financial Due Diligence, and whilst there are some buyers out there who will use information to their advantage to get the best deal for them, more often or not it is because the buyer is locating funding from a bank or venture capitalist who will only value based on the information provided by the chartered accountant, and therefore the deal falls apart. 

So how can a broker help?

Understanding how buyers, and in some cases their backers, will operate throughout Due Diligence is critical to maintaining momentum and successfully selling a business.  Instructing brokers who are aware of what is standard, what is commonplace and more importantly what is not, allows you to plan for potential problematic circumstances, and will ensure that you are being guided accurately through this crucial time.  Brokers will negotiate every aspect of Financial Due Diligence, ensuring the price you had agreed is not ‘chipped away’ during the process, eliminating buyers looking to wear down the sellers by prolonging the sale in order to achieve the best price.

Ian Charlesworth, Senior Valuer
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How Does Your Sector Affect Valuing A Business?

Along with marriage, divorce, moving home and death, selling your business is something the majority of people will only ever do once in their lifetimes.

It could be to realise funds to start a new business venture or to allow the continuing trading of a business that is finding itself in troubled times. It could be due to the business finding itself in a stage of stagnation, or perhaps it’s just because you have worked hard and it’s time to cash in on your efforts and enjoy that early retirement. You must, must, get it right, as you won’t be able to get back either your hard earned cash or your company once it’s gone.

For me, the whole “What is my business worth?” and “How has it been valued” question is probably the most important part of this journey you are considering to undertake. For if we get this part wrong from the start, the whole process or journey could be doomed to fail.

Therefore I will now discuss one of the most important things you must consider when valuing a business:

Well meaning business brokerages that do not have experience in the various sectors of business sales will often employ a “smokes and mirrors” attack on naive sellers, promising them huge multipliers (also forgetting to mention “deal structure” throughout the initial discussions) just to get their instructions to sell their business. This normally culminates with them handing the seller a hefty instruction fee for their “expertise” with no promise of success and being tied into a contract of exclusivity that could end in either a lengthy battle to escape from such a clause or a business not selling, which ultimately could be detrimental to the business, your nerves or personal life.

We have found that understanding your sector and how potential buyers value their targets can often lead to sale values of over 400 percent higher the results gained by inexperienced brokers. A great broker will also utilise a number of methods of valuing businesses to not only achieve you a higher return for your hard work, but more importantly to realistically justify this to a potential buyer. Ultimately it doesn’t matter how you package the valuation, it all comes down to one question: “How much cash is going to end up in my pocket?.”

A Senior Broker here at Axis recently had a conversation with a person considering the sale of their business that had just had another meeting with a potential corporate company that specialised in selling SME businesses. They had been told to “never accept any offer that was based on a multiplier of anything less than at least 7 times”. 7 times filed profit? 7 times adjusted profit or EBITDA?

Quickly, we reassured the vendor that this indeed could be right, but as previously stated, before we either confirmed or rejected whether his prior advisor was indeed correct, we probed a bit deeper into his business and sector of trade.

As previously stated, the first point of call made by a good business broker is the sector of work that the potential vendors company trades in. Once we understand this, and a whole raft of other information I shall discuss later, we at Axis would then consider what method to value such a business first. As I will show you, if any business broker is being genuine then they must fully consider this information first before offering any REALISTIC goodwill value, full share value or deal structure to any vendor.

The company my Broker was talking to traded in the Lettings & Estate Agency sector, which we all know since the start of the recession has been affected greatly, with a large number of company owners having to either down size, sell at a reduced sale value or even, I am afraid, fall by the way side.

So let’s assume some figures for the client. Say, a £1 million turnover with £50k filed profits. (Based on a national average of 10% management fee)

So based on his previous advice by the inexperienced corporate broker, they suggested, “Never sell for anything less that at least 6 or 7 times your profits and we would be aiming for nearer 9 times!”

So a bit of quick maths suggests that his “goodwill” value would be in the region of circa £300k to £450k for the sale of his business. Up to 9 years worth of profits, and surely a sign of serious intent from a purchaser as it would mean a return on investment of 9 years!! That’s a long time for a buyer, especially if it’s a venture capitalist backed group pulling the purchasing strings.

Quite rightly, compared to the multipliers of 2, 3 or 4 he had been told from other brokers or his accountant, he was eager to accept such a promise from his potential advisers. But quickly my Broker stepped in a saved him from such an almighty potential error.

Calmly and logically, my Broker explained to the vendor, that this indeed sounded a very good offer, but let’s study the suggestions made by the other corporate broker in a little more detail.

“6 to 9 times”. This consideration for goodwill is based on 6 to 9 times the companies filed profit of £50k, hence a “goodwill” value of £300k to £450k.

So lets consider a common method of how Axis, other Brokers and the vast majority of the accounting and financial world are valuing a business, IE. On the “EBITDA” method. This basically means putting back into the company’s accounts any costs associated with the current owners accessing their cash in the most tax efficient way possible, and also any costs incurred by the current owners due to the way they manage the business etc. This inflates the filed profit figure before Tax and Depreciation up to what we refer to as an “adjusted net profit”.

Typically your accountant would afford you multipliers when valuing with this method of anywhere between 3 to 5 times EBITDA. So in this case, when considering the vendors accounts, it gave an EBITDA of £100k which would suggest goodwill values of between £300k to £500k.

Can you see where this is heading? The vendor could quickly see that by using a “smokes and mirrors” approach, the crafty broker had flashed large multipliers about which on the face of it looked too good to be true, when in fact, they were not too good to be true, but were really in a way, not different than the norm!

But we are not finished here. Again my Broker, using testimony and examples of recent deals completed, explained further still how understanding your company was even more important than this potentially fishy subject of “Multipliers”. You see Axis has been one of the major players in the sale of companies in the corporate sector for over 16 years now, and this is something we pride ourselves in. We have facilitated deals with many of the major “Blue Chip” company’s right down to one man band businesses and from Scotland to Lands End and feel we have the proverbial “finger on the pulse” of such sectors in the current SME market. So did we agree on this method? NO!

You see, understanding the sectors like we do, we explained that in fact the majority of the UK market that specialises in the Lettings & Estate Agency actually values on a method where goodwill is calculated on a multiple of its “Fee income” or to less experienced brokers, “Turnover”.

Both recently and historically, Axis has negotiated sales values for goodwill based on multipliers of up to and over 2 times a company’s fee income. In this case, suggesting our client’s value for goodwill would actually be in the region of circa £2 million pounds and not the previously suggested value of only £300k to £450k! This, on their method, should have equated to multipliers for goodwill of around 40!

After allowing for the client to put his chair right and pick the phone up again, the Broker forwarded over both previous testimonies and current marketing information of similar companies to his that we had recently sold and were currently marketing. Not only to justify our valuation and methods, but to also reassure him of our good intentions to look after him as a client and not just to gain his instruction and hefty consultancy fee, as unlike other corporate business brokers the majority of our fees are performance related, and not upon instruction.

So to summarise, I am not stating that the other methods suggested by other Brokers are wrong or flawed, as saying “ours is the only way!” is not only wrong but arrogant. Being honest, depending on your sector of trade this will and can be a method we use when valuing a business. But I must strongly reiterate the importance of finding a broker that understands your sector or work, your business, and more importantly how the market values and buys businesses in your sector. Any competent brokerage will be able to sell your business, it’s just they will potentially sell if for a sum far, far less that it is potentially worth and that you deserve.

Ian Charlesworth, Senior Valuer

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How To Sell A Business And Get Up To 40% Extra Cash In Your Pocket

Being the Senior Valuer here at Axis, I am normally the first point of call for clients considering selling their businesses, and therefore first in line to answer a whole raft of questions relating to how to sell a business and the business sales and marketing process.

Selling businesses can realistically be a very straightforward process, and when the two parties involved are in agreement, it can be quick, pain-free and completed with very little stress for either party. Being realistic though, this is not normally the case, with buyers playing on the naivety of a seller. This is why vendors will often call in the help and guidance of business brokers such as Axis to take the stress and hassle out of selling a company. This then allows them to carry on with the day to day tasks of being a business owner, a point which is often forgotten, and can be hugely detrimental to a company’s future for both the seller and the buyer.

Part of our service offered to clients, which is often grossly overlooked by Vendors when selling a business off their own backs, is to look at the bigger picture. Not only should consider the obvious details when negotiating a sale, like “how much are they going to pay me for my business, and when”, but a main point which is regularly overlooked is the Vendor’s Tax standpoint, and their Asset or Balance sheet value.

The buzz words here for people to consider are “Entrepreneurial Tax Relief”. In layman’s terms for people like myself  it basically means that if you have owned a trading company for more than 12 months, then you potentially only have to pay 10% Tax on up to £10m of your lifetime gains through company disposal (I always suggest seeking professional Tax Advice).

This is an example of how a simple piece of advice and professional brokering from someone like Axis can make you that huge potential gain in your overall return on your life’s work. It is not only the “Goodwill” value that benefits from this tax relief, but also potentially your Balance Sheet / Assets. Let me give you an example of how Axis managed to help a client realise a higher return from their company disposal:

We had been brokering a sale for a client in the recruitment sector recently that had a “Goodwill” value of circa £1 million, but also had Cash and Assets within the company of around £1 million. The client’s first instinct was to draw down this cash; as they quite rightly stated, “It was my cash”. This is something hundreds of company owners are saying and doing all around the country as we speak but unknowingly to their huge loss. Our Senior Broker who handled the sale quickly stated that this was not the best course of action to take at present, as Axis often has great success in selling this cash for its clients. If this is achievable, then the Tax saving for the client is potentially huge. Ultimately, if we could not sell the cash then, quite rightly, it was yours to “Draw Down”. Luckily for our client, the purchaser was happy to work with them as part of the negotiating process and helped them secure their hard earned money at this far more advantageous Tax rate, and in this case, securing them nearly an extra £200,000 worth of cash! This money would originally have been written off through having both no prior knowledge of this Tax break, and no professional advice.

Summing up then, most business owners out there are perfectly capable of finding out how to sell a business and doing it themselves, and require no help at any stage of the process. But for the majority of Vendors out in the market that are considering this process, asking for a little help is not a bad thing. Is it? And it could be potentially the best business decision they will ever make. Axis will always act with our clients best interests and if offering advice such as turning your Partnership or Sole Trader into a Limited Company or LLP would enable the client to achieve better sale value, then this is something we will do, as ultimately the more money we secure for our client, the more money Axis earn...even if it takes us more than a year to earn it!

Ian Charlesworth, Senior Valuer

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Selling Your Business Is More Than Just A Great Bottom Line

I wan't to know how to value my business. Aren't profit margins the most important aspect?

The past few months, and more importantly, the past few deals we have had completed have highlighted that selling your business, and achieving either the highest value or best deal structure, does not always depend on a great bottom line. I am definitely not saying that strong profit margins are not essential, in effect they are. But I always inform clients that the primary factor which drives a purchaser’s mindset when buying a company, and therefore the price they could be willing to pay, is why they are buying you in the first place.

Whether you have taken advice from your accountant, a financial advisor, Google or even a business transfer agent, the main emphasis is always on, “what profit are we working with?” And, “what are they multiplying it by?” If you have had that conversation, (and you may have done with me) then you were absolutely right to do so.  Every sale has to start somewhere, so why not start with a good idea of what you may be worth on traditional methods.  However where that number ends up at realistically, always falls back on why someone wants to take your company off your hands in the first place.

To what degree does this affect how to value my business?

When you come to market, a purchaser may make you an offer on purely a market share purchase, or just because you’re in the next town down from them, and therefore they may not always the best person to offer you the greatest return on your investment, or the best deal structure moving forward.

From my point of view, I want a buyer for my client that NEEDS their business for a multiple of reasons. Geographically, market share, complimentary service or sector, staff knowledge, brand goodwill, I could go on. The more of these I can tick off, the better, and can only help make THAT buyer spend more money than the next.

Therefore when you start to think about selling your business, not only do you need to get specialist advice on the realistic sale price, but it can also be a worthwhile exercise to sit and think, “Why would someone want to buy me, and why would they pay me a premium price?”

My colleague Adam Croft always says the same thing, “Two companies with the same turnovers and profits, are not always worth the same money”, and he is absolutely right. Now sometimes there is not a great deal you can do to increase significantly a value of a business other than increasing your profits. But understanding your business, and what makes it special or stand out, will help you understand how far that sale value could go, or, at least realistically get you to understand how far it may not.

So how can I best gain control of this process?

TIME. Time to understand your business and realistically how much it’s worth, and from my perspective, time for me to find you that buyer that just NEEDS your business rather than just wanting it.

Two deals we have completed recently have over achieved on “the norm” due to this sort of thing happening. One was valued at around four times its adjusted profits or EBITDA, but completed at nearer to eight! Yes eight! But both have also received large amounts of cash on day one and with deferred payments rather than performance related deals. The buyers in both cases NEEDED that purchase to go through, and boy did we make them maximise this need.

Other deals look like they could be heading this way, and time, like I said is key for me. The longer you can let me have to find that buyer, the more chance I have of finding them for you.

Therefore while the year has started off well, premiums are starting to rise and deals more favourable, why not drop me an email or give me a call to discuss how I can proactively and confidentially afford you a bespoke brokering service?

Ian Charlesworth, Senior Valuer

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