Exits

Deals made in heaven

Nov 07 issue
 

It’s going to be a buyer’s market over the coming 18 months, so if you’re looking to sell you have to be at the top of your game to negotiate the best price. Marc Barber reports

The proposal by Chancellor Alistair Darling to axe taper relief and create a new capital gains tax of 18 per cent has focused the minds of entrepreneurs considering selling their business.

Since the announcement, corporate finance advisers have seen a rise in enquiries about sales from owner-managers who fear paying 80 per cent extra tax if a sale goes through after April 2008.

Trying to get the best price for your concern in this environment won’t be easy, especially as Spring draws closer and canny buyers pick up on a vendor’s desperation to sell before the laws change.

For Paul Yates, this is of no concern as his three-year old online venture Just Search is – at the time of writing – on the point of being acquired by Swedish company Getupdated Internet Marketing. He’s about to go on holiday and celebrate his success, evidently on cloud nine.

‘From a young age, I always thought I was going to be a millionaire, but I never expected it to happen as soon as it has,’ says the 31-year-old.

The initial consideration is £8.8 million, rising to £13.4 million post earn-out in 2009. He will take a position on the board and act as the UK CEO for an organisation that has a presence in the US, Germany, Norway and, of course, Sweden.

‘I wanted us to be a global organisation but it would’ve taken four to five years for us to get into another country. Now we can do it overnight,’ he says.

The company was started three years ago after he and a partner failed to establish a paid web search business. ‘I took about £5,000 as an exit from him and then maxed out one of my credit cards. I set up the business for about £13,000,’ he says.

For this financial year, Yates claims the company will generate net profit of £3 million on turnover of £5.5 million. He attributes this, in part, to targeting the right customers, then concentrating on retention, as opposed to fresh sales.

‘A lot of other agencies target the biggest clients, whereas I have set the foundations by going for smaller ones,’ he says. ‘Then I have the next tier, which consists of small-to medium-sized enterprises, and then I have the corporates on top.

‘It wouldn’t make such a difference if I lost a corporate, as the business will still generate revenue and run.’

Long-term contracts
Yates observes that clients are on 12-month contracts, creating a stream of sustainable revenue. He notes that 18 months ago a decision was made to switch the business model by not asking for total fees to be paid upfront by a client: ‘We just took 50 per cent and put the remainder on standing order to be paid throughout the remaining 11 months of the contract. Our sales quadrupled as a result; people felt more relaxed about using us.’

The future prospects of Just Search made it particularly attractive: ‘Obviously, our turnover going into 2008 and the profits we’re going to make has put a different spin on things. So the acquirer came along thinking: “We need to get them now as we won’t be able to afford them in 12 months.”’

A great deal

There are five elements to Yates’ success that are universally applicable if a sale is going to be achieved:

• Reliable recurring revenues
• A spread of loyal customers
• Operating in a hot sector
• A good management team
• The potential for growth

For entrepreneurs considering an exit, there are a number of steps you can take to be fit for sale. First and foremost, you’ll need to master the various players involved: the buyer, investors, employees, the corporate finance team, accountants and lawyers.
Jon Breach, a corporate finance partner at professional services firm BDO Stoy Hayward, says: ‘Handle issues upfront so they don’t hinder the sales process. You need to address tax affairs, like the ownership of the business or investigations from the revenue.

‘Anything that is complex and has to be explained will make things more difficult. As with anything, when people are buying they like it to be as straightforward as possible.’
A fatal error is to over-promise on financial projections. Says Breach: ‘A sale can take three to six months. If you stated that you’re going to make profits of £2 million and you only make £1 million, that will lead to a significant discount on price.’

Researching who the potential buyers are in your sector can give you an advantage too. Manish Madhvani, co-founder of GP Bullhound, an investment bank specialising in the technology sector, says it’s not unusual for this research to last a couple of months.
‘The key is to talk to all the relevant players and try to learn what their plans are. From this, we can go back to the company and position it in the best way for a sale. Ideally, a great sale involves finding a buyer who regards your business as a transformational acquisition.’

Courting potential suitors
Ashley Ward, who is currently chair of the European Leadership Programme, a mentoring organisation for CEOs, takes a similar line: ‘The preparation and landscaping can’t be done soon enough. Get advisers to do a reconnaissance on the market properly, doing a thorough job to identify who might buy you.’

Ward is a battle-scarred exit veteran, having gone through no less than seven tours of duty via trade sales, buy-outs and initial public offerings. ‘The success of these things is always variable,’ he remarks. ‘Sometimes it can be an orderly walkout but naturally the best exit is the fruition of some sort of a plan.’

Back in 1997, Ward was the MD of IT company Anite Networks when it was bought by Cable & Wireless for £60 million. He observes that pleasant surprises from the balance sheet helped push up the price of an ailing company he’d managed to turn around.

‘During the sale, we played conservative with our accounting, so when we sold we could, during the due diligence, release provisions that made the figures better than they first seemed. That oiled the wheels of the sale as it meant the buyers were getting something that was at least as good as they thought it was.’

Quality control
Whatever the exit under consideration, certain principles always apply. Ward says: ‘You must establish higher quality standards in everything you do. It’s useful to have quality control manuals and be compliant with the appropriate standards set out by the International Organization for Standardisation. In every business I’ve ever sold, it’s been a priority to hire a quality manager to do that.’

In 2000, Ward led the IPO of the dotcom darling Orchestream, which saw its market value of £214 million soar to over £900 million. He warns that an IPO should never be regarded as a way out, saying: ‘Listing on the public markets is a transition, not an exit. It’s a means to raise funds, nothing else. As a founder, for instance, you can’t sell shares as that hits confidence in the business.’

When it comes to how to value a business, it’s easy for a listed entity as the price to earnings ratio is an adequate measure. For private companies, it’s more ambiguous. ‘If you ask five people to value something, invariably they’ll come up with five different answers; there’ll always be a range,’ comments BDO’s Breach.

The most commonly used valuation is EBITDA (earnings before interest, tax, depreciation and amortisation). However, operating in a hot sector can throw the science of valuations out the window.

Hugo Haddon-Grant, managing director of corporate finance firm Cavendish, says: ‘There’ll always be flavours of the month, sectors where buyers take a longer-term view. At the moment, the hot sector is internet-related information providers, which are frequently quite small but command good multiples and valuations.’

The exit specialists are venture capital and private equity firms operating in the small to mid-market arena. Philip Newborough, CEO of Bridges Ventures, which aims to provide a return to investors while sticking to a socially aware agenda, notes that when evaluating a company’s value, he sticks to the basics: ‘I’m old fashioned. The goal is to produce current or future cash flows.’

Clean up the numbers
Ian Cameron, investment director at The Capital Fund, which backs early stage ventures in London, agrees, stating that good numbers matched with proper financial reporting are essential if a company is to be an attractive prospect. ‘We require our portfolio companies to give us monthly financial reports, which are measured
against set key performance indicators,’ he says.

In short, if private equity firms are on board, a company’s systems and processes will be professionalised. There’ll be formal board meetings, non-executive directors with appropriate sector experience will be appointed, and performance will be linked to the management accounts.

Newborough notes that when deciding on investing in a company, two points need considering: deciding on the potential of the addressable market, and whether the management team is right.

Quite often, a company will be overly reliant on the entrepreneur who’s grown the concern and is seeking an exit, meaning that a second tier of management will either need to be groomed or brought in to guarantee continuity.

Beyond the founding father
In 2002, Bridges invested £345,000 in a call-centre start-up called SimplySwitch, a price comparison site for consumers seeking the best offers in the utility and financial services sectors.

After the initial outlay, Newborough became the executive chairman. He explains: ‘We had two founders and we brought in a financial director, plus a sales and a marketing director. From simply being a telephone cost comparison service, we developed the online side and introduced other services, such as credit cards and insurance.’
He adds that while the online presence undoubtedly boosted sales, 50 per cent of revenue continued to come through the call centre. This strengthened the company’s position as it appealed to both a younger and older demographic.

Similar to Just Search, SimplySwitch had arranged long-term contracts with clients that, in this instance, were with national newspapers. The newspapers used the utility services to provide special offers for readers.

Newborough notes that while all this was good, lady luck shined when SimplySwitch’s main UK rival, Uswitch, was sold to US media company EW Scripps for £210 million.
That prompted a visit from SimplySwitch to corporate finance firm Longacre Partners, which had handled the sale for Uswitch and an auction was launched. The Daily Mail bought the company for £22 million in 2006. ‘From our initial investment, the sale did happen quickly but it was a high-growth business,’ Newborough says.

Beauty parades

Perhaps it’s inevitable that advisers will suggest that an auction process should generate the best price as companies bid for your venture, rather than accept an informal approach.

Breach insists that ‘it allows you to maintain the upper hand in negotiations and gives you a fallback if the buyer you’ve chosen to run with doesn’t deliver on what they’ve promised’.

However, as Yates demonstrates, an informal approach can be equally attractive. The trick is to keep in control of the sale and not feel bullied or harried into an uncomfortable decision.

Ward states a figure early in proceedings and has a fixed idea of what the limit is going to be: ‘I’ve had several sales fall through. What often happens is that a buyer becomes greedy and chips away at the price during due diligence.

‘Often buyers offer the world and, when the deal is close to being done and they think the vendor is desperate, they reduce the offer by five or ten per cent. What I like to do is establish the terms of the deal at the beginning, agreeing pound for pound on the balance sheet and a certain amount of goodwill.’

Keeping a cap on advisers’ fees is also necessary. ‘No sale, no fee isn’t standard,’ cautions Yates. ‘I absolutely agreed a ceiling on fees. I asked for a band between two set amounts and said I wouldn’t pay a penny more.’

As negotiations go on, it may become apparent that the deal isn’t right. Assuming it’s still a fantastic business and sales are strong, don’t be afraid to draw a line under proceedings and wait for a deal that meets your expectations. Says Ward: ‘If the buyer keeps chipping the price or incorrectly digs into the balance sheet, arguing about the interpretation of accountancy standards, then I will walk away from the deal.'

A matter of timing

There’s no doubt that paying an extra 80 per cent tax is going to hurt. Jon Breach, corporate finance partner at BDO Stoy Hayward, observes: ‘If you’re thinking about selling, I would encourage you to press the button now.’ However, as the deadline looms nearer, the vendor will be on the back foot. Breach says: ‘If you believe that you can grow your business by 25 per cent over the next couple of years, it makes sense to hold off and pay the 18 per cent.’

If you’re not persuaded and want to sell up fast, it’s worth noting that corporate finance firms are busy with the demand. To grease the wheels and make the process go faster, Breach says that ‘astute owners of businesses want to give their advisers an incentive to get things done as quickly as possible’.

Market share or profitability?

It’s said that you should have an exit in mind from day one of starting your business. If you want to sell, it’s advisable to ask yourself what strategy you intend to adopt to maximise the value of your business.

Ashley Ward, chair of the European Leadership Programme, says: ‘If you’re entering a new market, then there’s no doubt that you would sacrifice profitability to gain market share. However, if you’re in a business where there are many players in an established technological area, then you must position yourself as the most accretive player in the sector.’