We’re often asked this by recruitment business owners who are contemplating an exit and more often than not it’s a very difficult question to answer because there are quite a few variables that are outside of an owner’s sphere of influence. Take the most recent economic history for example – the prices being paid for businesses between 2005 & 2007 where purchaser appetite was being fuelled by cheap and easily available debt facilities were considerably higher (as a rule) than those being paid after the collapse of Lehmann Brothers and it’s doubtful that the peak reached back then will be seen again. That said, there’s plenty that is within a business owner’s sphere of influence and as with so much else in life, it’s all in the planning.
A well-executed exit plan will, ideally, contemplate a period of 4 to 5 years leading up to an exit. Clearly, that timeframe won’t always be realistic as the timing may be influenced by the position of the business owner – ill-health or a decision simply to stop for example, or by rapidly changing industry conditions that an owner may be concerned by. For the purposes of this document though, let’s assume relative stability in the economy and the sector, and let’s assume we have a business owner who has identified the end of 2020 as their desired retirement date.
What can a business owner in these circumstances do to maximise the value he gets on an exit?
Firstly, put yourself in the position of a potential purchaser – what would you want to examine were you to take a detailed look at a potential target? You might call this phase “vendor due diligence”, and the sorts of things we’d recommend looking at are:
- Management Team – one of the biggest drivers in value will be the second tier of management that’s left behind when the owner exits the business. You need the normal bases covered here, so finance, HR, IT, sales & marketing, etc. If you, as a business owner, haven’t empowered the people in these positions yet, ask yourself why and develop a plan to do that. For top quality people also consider an incentive plan that will retain them through to, and beyond, your exit.
- Strategy – what is the current strategic plan for the business, we’re talking SWOT analysis and competitor analysis here. This is a great opportunity to set out exactly why there is a strategic rationale for buying your business. There needs to be some honesty though as you must be prepared to be challenged on the assertions made. The work done in this area may also be extremely useful when it comes to arriving at a list of potential purchasers.
- Where is the Value? – depending on your activities there may be divisions or sites that are significantly out-performing other parts of the business. Could spinning those high performing parts out into a separate vehicle (or vehicles) help create additional value?
- Budgets and Cash Flow Forecasts – these should take a lead from your strategic document and should make it clear to any potential buyer how the successful execution of your strategy will manifest itself in earnings and cash flow. It will add credibility to these forecasts if the main assumptions are robust and some sensitivity analysis is capable of being performed within the financial model.
- Revenue – the method with which companies recognise revenue may look uncontroversial on the face of it but several high profile deals have gone sour because of a failure to understand differences in methods between the buyer company and the target company. Whilst accounting rules provide some guidance in this area, there can be a number of different interpretations between companies who, ostensibly, are making the same sorts of sales. The key thing here is to ensure that your policy is one that is common in the industry, and ensure that your auditor/accountant is confident that it is well within the bounds of normality.
- Intellectual Property – if your revenue and profitability is driven by a strong brand image, you might consider whether you should protect the IP by applying to register a trade mark. Also ensure that your company has good title to any IP generated by its employees (LinkedIn contacts are of particular concern to recruiters in this area) – this can normally be covered by well drafted contracts of employment.
- Contracts – purchasers are most interested in high quality (that is to say enduring and profitable) revenue streams so if there is any scope for establishing contractual relationships with customers or perhaps framework agreements, then really push to get those tied up as it will give purchasers far more confidence over the company’s future earnings.
- Working Capital – most purchasers have a preference for cash generative businesses, and whilst that might not be realistic for some sectors you can, nevertheless, look to work on reducing your working capital cycle, as a strong and stable cash position will attract more buyers and assist you when it comes to a determination of what “free cash” there is in the business when it comes to price negotiations. So, whilst bearing in mind the wider business context, stay on top of debtor balances and don’t, for example, rely on the comfort of an invoice discounting facility. Sounds simple, doesn’t it!
- Contingent Liabilities – issues surrounding litigation can often be deal breakers as buyers have to make significant judgements as to the final outcome. In the vast majority of cases any legal action is settled before it reaches Court so the advice here is to be pragmatic and commercial, and don’t give a buyer a reason to take flight.
- Property – if for whatever reason your company owns any investment property you may consider whether a buyer is likely to want to take that property on (the same may apply to trading premises). It’s possible to split the property from the trade without significant tax consequences well in advance of a sale, and that gives the buyer the option to either take the property or not. This is preferable to having to sell the property from within the company as there could be tax payable on any capital gain by the company and more tax payable by you on taking the net proceeds out of the company. If the trading premises are leased then it might be sensible to negotiate additional break clauses (even if it means slightly higher rents) to give potential buyers the flexibility to quickly gain overhead synergies.
- Systems – buyers will expect all of your key business processes, whether that’s sales, accounting, treasury or IT, to be documented and to be verifiable so some internal auditing of your own processes will be time well spent.
- Tax – a health check of recent compliance on VAT and employment taxes is a sensible step as any issues that arise can either be dealt with or else a plan can be formulated to deal with questions that are likely to come from the advisers of any potential purchasers. If there has been any aggressive tax avoidance subject to actual or potential HMRC scrutiny, then carefully consider how to move forward, some buyers will be put off because of the potential cash flow impact and/or the reputational damage.
- Tax Planning – it’s a good time to think about the taxation of any deal that you do further down the line as there’s quite a bit at stake. Entrepreneur’s Relief (ER) currently creates a 10% tax rate for the first £10m of lifetime gains – this compares to a mainstream tax rate for CGT of 20%. So, for example, is it worth transferring some shares to your spouse as part of the exit plan? There are some pitfalls to avoid with ER though, as there are qualifying tests for both the company and the shareholder – in the example above the spouse would have to have been working in the business and would have had to have held the shares for at least 12 months.
- Minority Interests – it’s not unusual for there to be minority shareholders in companies, they may be employees, family members or legacy investors, what’s less usual is for there to be a shareholders agreement that governs the relationship between the shareholders, including amongst other things what is to happen if a majority of shareholders wish to sell to an external party (generally known as drag & tag clauses). You can’t ignore minority shareholders as they will need to be parties to any transaction assuming that a buyer is expecting to acquire 100% of the company, and consequently have the capacity to cause some problems. Some sensible housekeeping, therefore, might be either to buy out (possibly through a company purchase of own shares) minority shareholders or ask them to enter into a shareholders agreement.
Clearly, the above isn’t an exhaustive list but it’s a useful starting point to help you to achieve the value that you probably attach to your business, and to help you stay in control of a business sale process.
If you would like to discuss your exit planning strategy with an expert please get in touch with James Price or Marie Pegram.