Preparing your business for sale : How to maximise value and reduce transaction risk.
Introduction:
There has been an increasing number of Irish businesses being sold or taking on investment over recent years and in particular in 2021. There is significant interest inIrish, UK and European private equity firms and trade buyers who are looking for businesses in Ireland that fit with their strategic goals. The prices paid for these businesses have been very strong. 2022 has seen a large number of transactions already and will see a significant number of transactions involving Irish SME’s throughout the year.
If you are an SME looking to sell or take on investment in 2022, how do you position yourself so that you can effect a transaction and get the best prices/terms possible?
Selling your business or taking on investment is an intense and complex process. It can take up to 12 months to complete such a process. The workload in agreeing of valuation terms, due diligence examination and the negotiation of the legal agreements will feel like having a second full time job as you need to balance the pressure of the corporate finance process while also ensuring your business continues to perform so you can maximise value from the process.
Very often, Irish SME’s look to get into a process before they are properly prepared. The KPMG M&A outlook for 2022 cited “A growing proportion (50%) of respondents identified lack of readiness and unexpected diligence issues” as reasons for deal failure. This is especially true in the case where the owners / management have not experienced a corporate finance process before. This can lead to value being lost or indeed the deal collapsing.
Taking the time to prepare the following areas in advance of a process will help you to maximise value and minimise transaction risk.
Financial
Most of the information that a potential buyer/investor will want to review in due diligence will be financial in nature. They will ask a lot of questions about the financial workings of your business. This information will be integral to the valuation they will place on your business.
To be ready for this, the following are some examples of financial areas to prepare in advance of launching a sales process:
The due diligence will focus on are the profit and loss where they will examine sales, cost of sales, your gross margins, overheads in detail to understand the maintainable profit in your business. They will want to understand how invested your overheads are and if you have passed the “operational gearing point” where profit margins will increase in greater proportion to increases in sales as this business grows. The more detailed information you can produce to demonstrate this to a buyer/investor the better you will be able to defend your valuation expectations.
In your balance sheet, ensure you have extensive knowledge and detailed records that correctly account for fixed assets and how much capital investment the business may require in the future. Review your debtors and creditors to ensure they are performing to terms, taking the time to resolve older debts before getting into a process. A buyer/investor will be particularly interested in your cashflow and how much of your EBITDA will convert to cashflow. Reviewing the working capital of your business in advance to ensure as much of your EBITDA converts to cashflow as possible will put you in a stronger position.
The potential buyer/investor will also want to understand what the future looks like for the business. What is the growth strategy, where will the revenues and EBITDA of the business be in 3 to 5 years? Having a detailed financial model that outlines the growth strategy will assist the buyer / investor to understand the cashflows coming from the business allowing them to make forecasts on how they can fund the purchase.
Ensuring your financial information is in good order and your knowledge of it is very strong is crucial.
Commercial
The requirement for commercial due diligence on targets by buyers and investors has increased in recent years. Private equity and family office buyers (more so than trade) in particular like to see this exercise performed as it provides useful information on the future of the target and the markets it operates in.
A commercial due diligence will focus on many areas, but the most typical areas include:
Detailed analysis of your revenues covering such areas as products/services being sold, routes to market, their growth over the past three years and where growth will come from in the next three years. Customer analysis to understand who they are, what industries they are in and your dependence on a small number of key customer or a well spread customer base.
The markets you are operating in (and are looking to grow into) will be reviewed to understand your competitive position within those markets, the growth outlook for those markets and what will influence that growth over the coming years
A review of competitors will be undertaken. The review will analyse your competition to understand what market share your business has. This will provide them with an understanding of the growth opportunity and how significant it is.
The commercial due diligence will combine these elements and evaluate your growth strategy in the context of the findings from the above reviews. Many Irish SME’s don’t have enough market intelligence that appropriately outlines the real market opportunity which can raise a number of unanswered questions during this process. The outcome of commercial due diligence can significantly impact the valuation placed on your business as it influences the buyers/investors perceptions of where the business can go.
Legal
Potential buyers/investors will perform legal due diligence taking the form of several hundred questions on areas of your business ranging from employee, environmental, data protection, contracts, insurance, pensions, intellectual property among others.
Significant value is at risk here. Negative findings in a legal due diligence such as not having contracts in place with key customers or being in breach of them or not having sufficient intellectual property protection can lead to price chipping or the deal collapsing.
Engaging with your legal advisors in the period before you start a sales process to ensure these areas are addressed and any remedial actions taken will put you in a stronger position during the process.
Tax
There are two areas where tax is important in a sale/investment process. The first is the tax due diligence itself. The due diligence will look over your tax returns (Paye/Vat/Corporation Tax) for the past three years and look to understand the nature of any outstanding or pending liabilities. In recent times, there is a lot of focus on Covid supports and if they have been correctly calculated and reviewed / accepted by Revenue. As with the legal preparation, working with your tax advisors/auditors in advance of a process to ensure all documentation is there or any arrangements that need to be made with Revenue are done before the process commences is very worthwhile.
The second important area is tax planning. Ensure you understand the tax implications of a proposed transaction on the business and on the shareholders. Some appropriate tax planning structures may need to be put in place before a transaction to ensure the most tax efficiency as possible. Linking in with your tax advisors on this issue early is important as sometimes you may need to put a structure in place 6-12 months before a transaction.
Team
The success of your business will almost always be dependent on the team you have around you. The buyers/investors will be looking to you and your team to deliver the growth plan for the business.
Having an experienced and well resourced team is important to maximising value in a sales/investment process. Look at your team and evaluate if they are a strong enough to run a process. If not, put a plan in place over the 12 months before you launch a process to fill any gaps the appropriate people.
Ensure your finance team is well organised and experienced. They will be fielding the majority of the workload in the process. Significant time and value can be lost if your finance team can not manage the day job and the process at the same time.
Your team will need to be able to impress the buyers during presentations. Buyers want to see that they are getting a good business and a strong team they can trust to deliver the growth plan. Take the time to prepare them to impress in a process.
Conclusion
There is a lot of funding out there looking for investment in good Irish SME’s. 2022 will see a lot of sales and investment transactions involving Irish SME’s from private equity, family office and trade.
If your business has EBITDA in excess of €500k, the entry point to attract this type of interest, depending on your ambitions and strategy, you should be able to find a buyer or investor with similar strategic interests in 2022.
Taking the time to prepare your business, yourself and your team before launching such a process will put you in a much stronger position to command the best price possible and to reduce as much transaction risk as possible.
Karl Cleere is managing director of Solara Corporate Finance
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