Corporate Finance Guides
Guide to Equity Release (Cash-Outs)
Guide to Management Buy-outs (‘MBOs’)
Raising Development Capital
The Sale Process
The Descision To Sell
Making the decision to sell a business is only the first step of the sale process. It is always advisable to start planning well in advance of the date that the current owners are seeking to exit the business, particularly if the objective is to maximise sale price.
The first stage of the process is to consider whether the business is prepared for sale. Key issues to consider are covered in more detail in the guide ‘The Decision to Sell’, but include recent financial performance, prospects for the future, management structure and reliance on key people, including exiting shareholders (continued involvement in the short term to affect a handover may be a condition of sale). It is important to take advice from an experienced corporate finance advisor on the value of the business at an early stage. Entering into the process with unrealistic expectations is not in anyone’s interest and will only lead to disappointment.
It is also important, both at this stage and as the transaction progresses, to consider the tax impact for the owners on their proceeds from the sale and review the options available to structure the sale in such a way as to minimise the tax liability.
One variation on an outright sale, which is becoming increasingly popular, is a partial sale, sometimes referred to as a ‘cash-out’ deal. In this scenario existing shareholders and management retain majority ownership and control of the business, whilst realising some of the value of the business. This is achieved through obtaining external funding in the form of a mix of bank debt and private equity to fund a payment to the shareholders. At this time other members of the wider management are often invited to become shareholders with a view to a gradual handover of management responsibilities in advance of a complete exit for the original shareholders in a small number of years time.
Some owners may have a clear view of the likely purchasers of their business, in fact some may have already been in contact, alternatively in other cases the purchaser may be less obvious. An advisor can research the market for potential purchasers and draw up a list including both trade purchasers (competitors or possibly suppliers or customers), financial purchasers such as private equity firms and consider whether a management buy-out, where existing managers take ownership of the business (see separate guide) may be a possibility.
From this a short list of credible potential purchasers can be drawn up. The criteria for choosing the short list will depend upon the objectives of the seller, which are likely to include maximising price, but may include other factors such as a desire to see the business remain independent or secure jobs for key members of staff. The advisor would also research recent acquisitions made by a potential purchaser and their current financial status to obtain a view of their ability to contemplate an acquisition.
The typical method of approach is for a third party (the advisor) to contact short listed potential purchasers to assess their interest in making an acquisition. At this stage only very limited information should be disclosed on a confidential basis (i.e. the company name would not be released) and the description would be sufficiently broad to avoid the identity of the company being easily guessed.
An ‘Information Memorandum’ is prepared by the advisor as a promotional tool, setting out information about the company’s activities, markets, operations, management structure, trading history and opportunities for future growth and development. Confidentiality is of paramount importance so consideration should be given to how much information is disclosed, partly depending on the likely range of potential purchasers. For example it may not be appropriate to disclose information about customers if the document is to be shown to competitors. This information could be held back until later in the process.
Those potential purchasers expressing an interest in pursuing the opportunity further would then be asked to sign a confidentiality letter, preventing them from using confidential information provided for any reason other than considering acquiring the business. An Information Memorandum can then be provided. It may be appropriate to arrange a meeting for the potential purchaser with key management of the selling business to enable them to understand the business better, although in some cases this is delayed until later in the process.
Potential purchasers will then be required to put forward an indicative offer setting out their valuation of the business, timing of payment, key terms or conditions of the offer, the status of their funding and the timescale and process through to completion.
The valuation of a profitable business is most commonly based on a multiple of its maintainable profits. That is its operating profit after adjusting for any items which are exceptional or non-recurring. For example above market rate salaries paid to outgoing directors. Typically a profitable private company would be valued at up to five times its maintainable profit, although in some cases a purchaser may be prepared to pay a higher multiple if there are significant synergies to be gained from putting the target business together with the purchaser. The offer may be made on the assumption that the business is cash and debt free i.e. any bank debt will be deducted from the price and any cash in the bank is added to the price.
Depending upon the range of offers received it is likely that some negotiation will take place at this stage to narrow the field to a preferred purchaser, who will be allowed greater access to the business to firm up their offer. Once an offer has been agreed between the parties it will be documented in ‘heads of terms’ and it is normal for this to allow the preferred purchaser a period of exclusivity to complete the transaction (during which discussions can not take place with other potential purchasers). This gives the purchaser some protection during the next phase in which they will incur fees in reviewing the target business in detail.
This formal review is usually referred to as ‘due diligence’ and covers all financial, commercial and legal aspects of the business. An advisor will help a company to prepare for this process and to anticipate likely problem areas so that these can be addressed in advance.
Various legal documents will be drawn up to document the sale, usually by solicitors acting for the purchaser and reviewed by the seller’s solicitors. During this phase final negotiations on the detail of the legal contracts will take place and any issues arising from the purchaser’s due diligence process will be addressed. Legal completion then follows.
Typically the process will take between three and six months, with the initial research and approach phase taking one to three months leading to heads of terms and then the process through to completion taking up to a further three months. Advisors will usually structure their fees in such a way that the majority of the fee is contingent on a sale taking place, therefore aligning their interests with those of the shareholders.
An important part of the advisor’s role is to minimise the disruption to the business caused by what can be a demanding and time consuming process. This is vital as a drop off in trading performance during the process could lead to a price reduction or even a deal falling through. Similarly managing the flow of information and co-ordinating the numerous parties involved is important to keep the transaction on a tight timetable and maintain confidentiality (both within the company and the market).
If you would like more information please contact Jeremy Cole or David Middleton of
Cole Associates Corporate Finance on 0161 832 9945