Buying or selling a business – how to approach?

First and foremost, it is very important to know how to deal with the M&A. Over the decades, the market has shaped the M&A process to such extent that it consists of the most optimal activities. It reflects the knowledge and experience of all participants who have dealt with mergers and acquisitions in the past. Therefore, going for a non-standard approach is unlikely to pay off. Information exchange, process dynamics, risk perception, and last but not least, trust gaps critically affect the likelihood of M&A deal success. Consequently, the misconduct of M&A process & M&A best practice is often just a waste of time and money.

Businesses for sale or businesses looking to acquire need a professional. They need someone to prepare them for the M&A process. Not only in terms of documentation, but also in terms of forming beliefs. The expert can be an internal or an external person. Since such transactions are more of a one-off nature than a continuous approach, companies usually seek the help of specialized financial advisers. The key to choosing the right expert is to have the right knowledge, experience and most importantly – your trust. Statistically, more than 60% of business acquisitions are unsuccessful from the perspective of shareholders’ value creation. Therefore, M&A deals are more than obviously very delicate, so critical assessment of the opportunity is of crucial importance.

Key hints LINKED TO BuyING or sellING businessES

Due to the complexity of M&A transactions, matching the needs and expectations of parties involved usually lasts and requires considerable effort. Changes in the business environment of the subject business, one-off events or something else normally require updates of financials, further explanations, etc. The latter is often seen as a burden. Motivation plays an important role in M&A deal-making, so don’t give up too fast!

Expectations of participants should be formed on a well-founded basis. Too big difference in expectations and perceived value is often negatively accepted by the opposite party. Such behavior does not improve the negotiating position, as many people think, but rather repels the potential investors. For that reason, more serious M&A players expect from the other party to engage the M&A consultant to conduct services such as due diligence and corporate valuation.

Many are surprised by the fact that a typical company is sold on average over a period of one to two years. Time depends on many factors, including equity share size and characteristics, attractiveness of the company and the industry, plans and activities of the controlling owner, capabilities of the management, profitability, growth, financial position, hedging options, dividend policy, general market conditions, etc. Due to that matter, ownership changes require preparation and vision. Especially for those older owners who may even be involved in running a business, it is crucial that they start thinking about transferring ownership on time.

Successfully executed mergers & acquisitions also require a great deal of tact and flexibility. The analysis of comparable transactions serves to determine the valuation and payment terms, but also provides a great insight into the individual M&A transaction structures and the specifics that participants have explicitly addressed in certain ways in the past. It is therefore possible to identify in advance how atypical the participants’ individual expectations are and to assess how likely they will be accepted by the counter party. Not being flexible may compensate through the loss of value, so make sure that you are aware what is realistic and what are the related boundaries.

No matter how much the participants of the M&A process strive towards rational behavior, it is always possible to detect involvement of some emotions. There is nothing wrong with it, as long parties are not misled. Some major fails can be linked to lack of proper control over individual’s weak points, unsuccessful prevention of extremely negative/positive thinking, no mechanisms to prevent irresponsible behavior, poor coping with pressure etc.

Business value is derived from discounted future benefits in the numerator and risks in the denominator. From that perspective, actively addressing probabilities of negative business surprises and unwanted operation turmoil is a must. To be more concrete, investors often appreciate the willingness of executives to remain on board, at least in the foreseeable future, after the stock purchase agreement (SPA) or asset purchase agreement (APA) is signed. If existing executives no longer see themselves working for the subject business, the M&A deal may easily fail. For this reason, it is important to understand how all parties see major risks and come up with mutually acceptable options of ownership transition.

M&A best practice business cases prove that integrity, objectivity and transparency importantly contribute to building the prerequisite trust among participants in the M&A process. The information should thus be presented as it is. For example, what does a SWOT analysis tell you if it mostly lists strengths and opportunities, although in reality the subject business also has plenty weaknesses and threats? It is likely that after one realizes the biased approach, he or she will be more suspicious about the information you will share next. Participants, however, appreciate that certain information also comes from the right mouth. Hiding things can have very negative consequences even after the M&A deal is done.

The prerequisite to successfully close the M&A deal is also to adequately inform the counter party. However, participants should also be aware of the sensitive nature of the M&A process and information. It is therefore necessary to responsibly agree terms and limitations of sharing and use of information. There is often a fine line between responsible handling and complication. From this point of view, coordination between participants is sometimes challenging and knowledge of standard practices is inevitable.

Mergers & acquisitions are usually of more significant importance to parties involved. Decisions made are therefore not really a matter of reckless behavior. Both sides play own tactical game to maximize benefits. Regardless of different views, respectful and professional communication is expected. Often, the M&A process progresses faster, when neutral person intermediates, interprets, complements and guides both parties.

One of the most important things we all too often forget is that the bargaining power of buyers and sellers throughout the M&A process is not always the same. In the initial stages of the M&A process, when more potential buyers are on the horizon, the seller is in a much better position than the buyer, but towards the end of the process, when only a few are given the opportunity to advance, the situation is reversed. Due to that, any missed opportunities are difficult to make up for. For example, the letter of intent often comes incomplete, also as a reflection of the desire to continue with “more serious” activities. The seller should strive to point out the LOI deficiencies immediately, since the bargaining power is in this stage at its highest levels. Nonetheless, the way how the letter of intent is drafted also very well indicates the true motivation for the party and the level of experience.

Source: Consilue analysis.

To successfully target the potential investors, one needs to be aware of the situation that best describes subject businesses for sale. Are we talking about the growth capital, succession, MBO, carve-outs, spin-offs, distressed business or others?

Potential strategic acquirers typically focus their attention on consolidation of business entities or business assets. In other words, generation of synergies through economies of scale, diversification, resource transfer or a combination of the above plays an important role. The more synergies there are, the higher the appeal to buy certain business. Finding the right players and informing them properly about the investment opportunity is therefore crucial to successfully complete M&A transactions.

It is important that participants enter the M&A process well-informed, determined and with clear expectations. The following is of extreme importance especially when skillful buyer leverages its negotiation power and agrees on exclusivity period in exchange for resources invested in due diligence, corporate valuation and negotiations. For the seller, this is often seen as a sort of a bet, since the decision has to be made on the pre-formed sense of the market.

WHEN TO Buy or sell business?

Competition today is increasing. More and more companies and industries are entering in the mature phase of their life cycle, which reinforces the need for inorganic growth. This is the reason why lots of them nowadays have M&As even as part of their strategies. In the mature phase smart M&As often boost shareholders’ value creation more than organic growth.

Source: IMAA. Consilue analysis.

Despite the increasing number of M&A transactions, times to sell or buy a business are not always appropriate. It is important to be aware of where we are on the M&A activity curve and what are the factors that influence this situation. Currently (in 2019), the EU M&A market is positively affected by relatively attractive corporate valuations, high liquidity, easy access to credit and others. The graph clearly shows that current levels are lower in value terms than they were before the financial crisis, which is not the case for the United States. As Europe loses on its competitiveness, it also becomes less and less attractive in terms of consolidation trends. However, it is true that every industry and every market has its own specifics of movement and it is good that the participants are aware of them.

Our success in mergers and acquisitions is also significantly influenced by M&A trends. Recently, for example, investors have been giving an increasingly important role to technology. Then there are unexpected tariffs initiated by the US, which caused a wave of Chinese investment in Europe and so on.

HOW TO DECIDE WHETHER OR NOT TO Buy or sell business?

The decision to sell or buy a business must be made rationally. Every business opportunity has its own life cycle in the eyes of every individual. But also times are good and bad in the eyes of every individual. The market requires more each day. Wiser ones use their ability to adapt as their advantage, others don’t. The important thing is, that we either take the opportunities or we begin to lose. There is no room to debate when selling and buying businesses. Investing is not politics. Selling or buying a business is not a bad decision. Not making a progress when running a business is. The market sooner or later eliminates those that operate below its requirements, so it is wise to realize this as soon as possible and take action.

It may happen that one is forced to make an investment decision (buy or sell business) due to third factors, so knowing the probabilities of such events is important. Sometimes it is better to take a preventive action as well, especially when we are on the edge of major macroeconomic or geopolitical concussion.

Corporate owners often get asked how much their business is worth. Most of them are not able to answer this question properly. Such ignorance is detrimental and can also be a reason for lost opportunity. Behind many such questions there is a potential acquirer, so it’s always good to be aware of your investment’s value.

Investment decisions, in knowledge, in technology, in assets, or something else, tailor our destiny. What we invest in today impacts our yield tomorrow. Compound interest is the thing that makes us, or not, more successful in time. According to Albert Einstein, this is the most powerful force in our universe, so it is nonsense to oppose it.

Are you interested in the M&A support that we can offer? Share with us some data through web form – Mergers and Acquisitions – M&A consulting!

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THE LEADING MULTINATIONAL COMPANIES EXPLOIT ADVANCED KNOWLEDGE OF STRATEGIC CORPORATE FINANCE (INCL. VALUE-BASED MANAGEMENT) TO MASTER THEIR DECISION-MAKING. WITH OPTIMAL OPERATIONS THEY BUILD THEIR WAY TO RECOGNIZED MILLION DOLLAR POTENTIALS.

Nowadays we are witnessing a serious competition among companies in the market. The world changes at extremely fast pace. Requires agile, self-learning businesses, flat organizational structures, innovativeness in the whole supply chain and wider, implementation of digital in all processes and many other characteristics, which are nowadays preliminary for the success of corporates. Doing business became complicated in its simplicity, while one of the crucial questions being asked today is “How the right decisions are made in the firm on every level?”

Value-based management became in last two decades the “religion” of the leading corporations around the world. It refers to the theory of corporate finance, focused on shareholder’s value maximization. The value is the only indicator that reflects information in a complete, comprehensive and non-biased way. What is more, value added approach enables one to address all processes and stakeholders in a simple way, with one single number.

»The only relevant KPI for owners is the value of their equity share.«

Value-based management – GOOD PRACTICE?

One of the cases where good practice of value-based management is present is Sika Group, a chemical producer giant with HQs in Switzerland. This multinational has 200 companies around the world and is present in 101 countries. It generates 6,25 bn CHF net sales and constantly brings 25%-30% return on invested capital (ROIC). Added value per employee is 115.000+ CHF. Under the umbrella brand Sika, 850+ product brands are promoted. The company persistently grows, organically and with M&As. Only in 2017 the company executed 7 acquisitions and registered 74 patents. And why this multinational is so successful? Definitely also thanks to strategic choice that EVA (Economic Value Added) analysis are performed for every strategically important decision being made.

Let’s look at the business of this multinational from another perspective. Sika Group is a collection of projects. Every project has its own returns and risks. Resources are limited, so decisions are rational. There is nothing wrong with the projects with relatively modest return, if very little is being risked. Also there is nothing wrong with high risks, if high returns are expected. To sum up, the company makes their decisions in line with the value generation and promotes those projects where most value is added with the underlying risks considered.

VBM decision-making in practice

Demonstration of value-based management findings in case of Turkish company acquisition (graphic is symbolic; numbers are not actual):

Commentary of value-based management findings: Acquisition of Turkish company generates significant economic value added (chart: 195 mio CHF). Management proceeds with the execution of the acquisition, since ΣEVA (PV) is positive and in terms of relative project performance among the Tier I projects.

Demonstration of value-based management findings in case of new production line implementation (graphic is symbolic; numbers are not actual):

Commentary of value-based management findings: Purchase of production line for the penetration of selected developed markets with new products is not confirmed, since this decision, due to the relatively low profitability, destroys the value for shareholders (chart: -5 mio CHF). Management seeks alternative business opportunities.

As it can be seen from the two examples above, understanding of the economic value added is simple. This is making value-based management a desired approach for the decision-making. Furthermore, it is a uniformed system, that clearly prioritizes best projects and thus defines priorities of the company. The approach makes sure that the company does the right things first and only then the efficiency of making these right things is considered. In this way the comparison of short-term, mid-term and long-term choices is simplified; only top-notch investments are preferred; allocation of resources is improved; transparency of operations is better etc.

Value-based management is due to its advanced nature more and more often also referred to as smart management tool. It leverages all the knowledge of the capital markets in combination with advance analysis of operations, industry and market opportunities. It helps companies strengthen their relative power. In the long term, using value-based management means heading the optimal way forward, heading in the direction of success. The advantages of value-based management are well understood by the leading multinationals, this is way value-based decision-making is their preferred approach for quite some time already.

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Optimal capital structure (often also referred as or optimal financing mix) is one of the basic things required for a sound business. It refers to the way how companies finance their assets, how much it costs them and what they risk with it. Generally speaking, we talk about payables financing (suppliers), debt financing (banks) and equity financing (shareholders).

Corporate finance theory often addresses financing through weighted cost of capital (WACC), signaling the minimum level of return on assets engaged for which the economic value of the company is not being destroyed. For a perfect capital mix, the WACC is the lowest and the value for shareholders is maximized.

Financing mix: Balancing debt – equity

The chart presenting WACC in relation to the D/E ratio is U-shaped. Right part of the curve (area where the D/E ratio is above the optimal levels) is much steeper than the left part, signaling the fact that being too indebted is a bad decision to make.

The risk-taking of creditors is by its nature normally limited and therefore the financing is relatively attractively charged … at least as long the company indebtedness is in the healthy zone. When the company bridges that zone, the creditors start demanding higher collateral, decreasing the days of receivables outstanding, seeking to securitize receivables with third parties and increase the prices of goods sold, increasing the interest rates for refinancing activities etc. In this phase the company is already operating on the edge, risking increased illiquidity threats.

Optimal debt level is a relative term

Interestingly, levels of a sound financial debt globally significantly varies and is very much correlated with the 1) attractiveness of the region for the investors and investment flows as well as 2) growth potential. As expected, the highest debt levels are in developed countries such as USA and Western European countries (roughly 60% D/E ratio; 7x-8x Financial obligations / EBITDA ratio), followed by the developing Latin American countries, China, African & Middle East countries (roughly 50% D/E ratio; 6x-7x Financial obligations / EBITDA ratio) and relatively poorly indebted Eastern European countries and India (roughly 40% D/E ratio; 3x-4x Financial obligations / EBITDA ratio).

Almost half of the companies globally operate without or with minimal (<10%) financial debt and from that perspective do not exploit their full value maximization potential. On the other side, the debt of larger companies is often above the industry averages, transforming the debt into the strategical competitive advantage. In this context, we sometimes also see marginal leverage buyouts (LBOs) cases, that due to the leveraged nature and long-time periods often generate some value on the debt side.

Access to the right financial resources is crucial

Financing resources are the prerequisite for the company to operate as well as grow – organically (i.e. own investments in PPE) or inorganically (i.e. through M&A). When the company is growing at a fast pace and the business is either working capital intensive or PPE investment intensive, the company needs to be able to sufficiently provide new sources of equity as well. Generally acceptable is that the more mature the company is, the easier it is to find, maintain and optimize the financial resources. Companies in the early stages of development therefore often need to seek the seed and venture capital, since their risks are simply too high for the standard and risk-averse (not risk-loving) creditors. Furthermore, also companies in the early and mid-developing phase with high growth potential often come across liquidity problems, if they are not efficiently gathering their financial resources.

Equity financing is on one side most exposed to risks, but on the other side also unlimited upwards in terms of reward, since all the potential profits go to shareholders.

To sum up things, in terms of value for shareholders, a sound mix is preferable. Liabilities (payables financing & debt financing) help the company to exploit the full potential of value generation, while equity normally serves as a buffer.

Despite the fact that most successful companies in the last decade generated their value mostly through digitalization and non-asset intensive growth, the financing structure overall is not losing on its importance. Quite opposite, the market is becoming more competitive, leaving less & less space for errors and non-optimal financing structure.

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Normally company receives equity financing in several rounds in order to motivate management and decrease the underlying investment risks.

If a company is worth 60 units (pre-money valuation) and an investor makes the investment of 20 units, the new, post-money valuation of the company amounts to 80 units. The ownership share gained in exchange for a new investment thus amounts to 25%.

In case of start-ups, the value estimation is due to high risk somehow vaguer. Therefore angel investors and venture capitals often offer certain investment amount for a particular ownership share based on their experiences and insights. Let’s say 25% for the investment of 20 units. However, by doing so, they have implicitly set the post-money valuation of the company to 80 units and pre-money valuation to 60 units.

This basic example illustrates the general concept. However, in reality the calculation of post-money valuation is more complicated due to convertible loans, in-the-money warrants and in-the-money employee stock option plans (ESOP).

In fact, the pre-money and post-money valuation should derive from the calculation of price per share multiplied by the total number of shares. Therefore, one has to consider the number of shares on a fully diluted and fully converted basis.

If the value per share increases compared to the previous round, then the investment is called an upround. It eventually means that the pre-money valuation is higher than the post-money valuation of the previous round. For the vice-versa case industry practitioners use a term downround.

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In other words, EBITDA gives you an indication of how much earnings before interest, taxes, depreciation and amortization the company makes with all the invested capital. Negative number is a red alarm for a company, meaning that the company is facing fundamental problems with its operations.

Normally practitioners consider normalized EBITDA only (management adjustments, pro-forma adjustments and other adjustments), since one off events may sometimes represent a significant role.

Due to fast and easy use of EBITDA, the metric is dominating the financial world. Its applicability makes it a #No.1 indicator. Furthermore, it is often used in relation with debt, value and performance indicators:

– Leverage: Financial obligation/EBITDA

This metric measures how does the debt relate to the ability of generating the operational profit. It can be argued that a leverage > 4 is not acceptable for banks anymore.

– Interest coverage: EBITDA / Interest expenses

This metric measures the ability of a company to cover its interest out of its operations. It is obvious that a ratio <1 is not sustainable.

– Value multiplier: Enterprise value/EBITDA (EV/EBITDA)

This metric measures how the market values the firm according to its ability to generate operational profits.

– Performance indicator: EBITDA / Total revenues (EBITDA margin)

This metric is a relative indicator and offers a great way to compare the company performance with its competitors.

EBITDA is further developed into EBITDAR and EBITDARM in cases where costs such as rents, restructuring fees and management fees represent a significant amount. These is especially typical for retail industry, REITs, hospitals, etc.

Nowadays more and more financial practitioners are aware of the underlying interpretational problems of EBITDA. The metric that overcomes the disadvantages of EBITDA is the economic value added model (so called EVA model). Even though the model as such is more advance, it relays on subjective assumptions related to the cost of capital calculation.

Are you interested in boosting your EBITDA? Check our performance improvement services or contact us directly!

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Business valuE determinants

Business value is affected by cash flows from operations, changes in net working capital, net investments, growth potential and underlying risks. Any measures improving these determinants will influence the business value.

However, not everything is in the power of companies to influence. Business worth is significantly impacted by macro factors. In this context one should understand the importance of economic climate as well as industry developments and trends. This is why timing to M&A is very important.

Hint: As consultants we often prefer to present the client the value development cycle. Business valuations in various points in time is a good reference point for them to see if they are confident with the business value at a particular time.

Prioritizing the measures – doing the right things counts

The more value the company adds to the supply chain, the more important player it is and higher its business value. For that reason, it is important to understand first the needs and requirements of key stakeholders and ways to meet them effectively and efficiently. Based on that fact, one should then be prioritizing the recommendations shared below … 

Tips & tricks for higher business valuE

Step 1 to higher business value: Ensure high cash flows from operations

– Differentiate your business
– Brand your product
– Tie your clients to your products/services
– Focus on most profitable products and/or services
– Acquire the right sales & marketing techniques and grow your revenue
– Appreciate and retain your key employees
– Establish barriers to enter the market
– Gain bargaining power against other companies in the supply chain
– Exploit large prepayment discounts
– Supervise the COGS
– Enhance the productivity of employees
– Optimize interest rates and taxes

Step 2 to business value boost: Optimize your net working capital

– Establish partnership relation
– Negotiate better payment conditions
– Optimize inventories and inventory turnover

Step 3 to business value maximization: Optimize your net investments

– Be aware of consumer trends
– Choose the right timing for acquiring new technologies
– Carefully plan capital investment – make investments that will support growth
– Increase the capacities in line with demand
– Ensure that the level of investments covers the growth potential
– Optimize financing

Step 4 to business value enhancement: Enhance your future growth potential

– Innovate with business model and come up with creative strategy
– Rethink processes and stick only to those that add value to your clients
– Develop new products and services

Step 5 to high business value: Minimize the risks related

– Keep the level of indebtedness at the level of comparable companies
– Endeavor appropriate product/service mix diversification
– Disperse your sales geographically
– Gain deals of appropriate size
– Supervise the creditworthiness of clients and suppliers
– Assure the level of fixed costs as low as possible
– Inform owners extensively and on a regular basis
– Give priority to transparency

Maximizing the business value is the most important criteria there is in running your business. For that reason it is important to follow the value of your company continuously, strive to bring the value maximization goals closer to the stakeholders involved, introducing the value based management techniques and setting up the KPIs based on business value maximization principles etc.

As a rational investor, one should always keep in mind also the exit strategy. The fact is that as an owner you will not be able to run or follow the company forever, so have a plan how you plan to divest your investment from the very beginning.

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