We often meet business owners who have an ideal exit value they would like to achieve, but who have not really considered how that value might be delivered. The value equation can be very different between sellers and buyers:

Seller: sweat + inspiration + the perceived need for a comfortable retirement = value

Buyer: reliable profitability + future expansion, less costs of reorganisation/investment x sector multiple = value

Before unpacking this, I would urge entrepreneurs to seek good financial advice early, as it can help you work out what you really need. It may also help you work out if a reliable home for your employees or maximising price is the priority.

Once you are clear on your desired exit value/financial plan, you can have your business valued and understand what you need to do. If the value and needs do not match up, growth through acquisition can be a solution.

A larger business with stronger management, a good track record, and some international element will deliver a higher multiple than a small, domestic business reliant on its founder and a few clients.

Example:

• Target exit value £20m, with EBITDA (earnings before interest, tax, depreciation and amortisation) at £2m.
• If your sector delivers a multiple of 5x EBITDA, you will be £10m short of your target. 

If organic growth is around 5%, and you need to plan your exit soon, an acquisition can help.

What can an acquisition deliver?

• New territory, an established sales team, logistics, and customers (speed to market).
• Skilled workforce and equipment.
• New product lines.
• A complementary business which has a higher multiple on sale – an obvious example would be a software product which complements a manufacturer’s product.

How you finance an acquisition will be important

Raising equity: introducing investor(s) will avoid debt financing costs, putting pressure on working capital, but you will be sharing your ultimate exit price and control. You will need to change your constitution (usually articles of association) to make sure you can control key decisions (including when to sell – a “drag along clause”). Disruptive shareholders can be a big distraction.

Debt finance: avoids the need to manage investors and allows the founder to retain 100% of the equity. If you acquire a business which can be scaled quickly, this can be the most straightforward option. Cash flow projections and forecasts (with risk factors built in) are critical.

Using cash: within your business or within the target. If the target has cash reserves, use them to help fund the acquisition by releasing them to sellers as capital in a tax-efficient manner.

Delayed payment: most deals today involve an element of deferred consideration, whether through an earn-out (performance of the target post-acquisition) or a deferred payment. Earn-out helps avoid overpaying and can help close a value gap between buyer and seller.

Risk

The benefit of an acquisition can be lost if risk is assumed without protection. Deferred payment, combined with warranties and indemnities, is designed to protect buyers. Having a professional team able to support you is critical to assessing this risk and designing the deal to protect you as a buyer, and working out where you can make compromises. 

Examples:

• A risk associated with a key customer renewing a large contract could be covered by deferred consideration or a condition precedent.
• A business which relies on independent contractors who work predominantly for the target could have part-time employees incorrectly characterised for tax purposes. This may need to be corrected pre-deal, because the risk can be high.

Warranty and indemnity insurance is now available to cover (unidentified) risk. Buyers should, however, consider the impact of management distraction, which can result from warranty claims.

Key People

Tying in key people is critical. Normally, sellers remain for only one to three years, motivated by the prospect of an earn-out. Key managers will typically need enhanced deals, with improved service contracts, share options, or growth shares. These need to be taken into consideration when reaching a price.

Back to the Price

Why can a larger business justify a higher multiple when calculating price? Of course, that is not always the case, but these are commonly perceived benefits:

• Access to larger trade buyers with greater resources.
• Private equity value increases: PE multiples often rise as management scale and sophistication increase (resilience and reliability).
• Synergies increase: Synergies are far greater for a larger business.
• Greater resilience
• Culture: Less reliant on a founder.

Finally… leave space to take the value

If you buy with a view to future exit, your eventual sale multiple should be greater than your acquisition multiple.

Example: Buy a retirement sale at 3x EBITDA and sell it at 6x as part of your larger business.

For an early discussion on growth and acquisitions, please contact enquiries@dmhstallard.com