Just how much use is EBITDAC anyway?

EBITDA

At PEM Corporate Finance we live and breathe EBITDA – it’s the performance metric of choice for M&A advisers and valuers alike as, at least in simplistic terms, it’s a good proxy for cash flow. And ultimately it’s cash flow that a corporate purchaser, investor or valuer ought to be focused on.  That’s what they’re buying or valuing.

EBITDAC

Of course EBITDA needs to be cleaned up before use, often adjusting for the true economic costs of the directors, and adding back any one offs costs. One might think it would be enough to consider the effects of Corona Virus on business, be it in reduced sales, margins, disrupted supply lines, or increased debt, as an add back. But in fact a new acronym has been coined: EBITDAC or earnings before interest tax depreciation and corona.

EBITDAC mug cropYou can even get it on a mug!

How might it help in practice. Well it will depend on how readily you can quantify and clearly identify the effects of Corona. That might not be altogether straightforward. It might hit the business in many ways, some of which won’t become apparent until later. It is also likely that the Corona effect will vary over time, and by sector. So for example we’ve found that some businesses are picking up slowly after an initial hit, and some sectors particularly in tech weren’t much impacted.
I do think it’s worth trying to isolate EBITDAC. It’s going to be an ongoing difficulty for business valuers. But in M&A there are some immediate impacts:-

Price expectations

Coming out of the recession that followed the financial crash in 2008/9 one of the issues was a big gap that had opened between vendors and purchasers expectations as to price. This could be an issue in the short term now. Vendors will want to sell on the back of the EBITDAC profit metric and on pre-Corona multiples. Buyers will want to back off some of the risk that the current reported EBITDA is the new normal through a reduced price. In practice we’re already seeing the use of earnouts, convertible instruments and ratcheted deals to bridge this gap. Creative deal structuring is going to be needed.

Locked box v Completion accounts

The locked box has become quite common and is especially popular with private equity buyers as it gives them certainly as to price/structure and their funding requirements to allow them to draw down funds if needed. However in a fast moving situation where there’s ongoing uncertainty as to how Corona Virus will impact it may now suit both buyer and seller to move to Completion Accounts where the final deal structure is established on completion. It’s quite likely that deals will progress slowly over the summer as buyers and funders are cautious with their diligence – that further emphasises the need to see what the world looks like on completion if that’s going to take to the autumn.

Normalised working capital

Upon closing an M&A transaction there is always a debate around the normal level of working capital, and what are the debt like items are in the target. And from that just how much surplus cash can be taken off the table by the Sellers. Of course short term there’s a good chance that working capital will not be normal, with a build up of creditors on stretched terms quite likely – and so that needs to be dealt with.

Just how much use is EBITDAC anyway?

Short term I’d say it’s interesting, we must use it, but as a proxy for cash flow it’s useless and that will ultimately limit its applicability in M&A without consideration of other factors such as the fundamental value drivers of the business, it’s forecasts and scenario planning for 2021. As far as valuation opinions are concerned 2020 EBITDAC can only really be used alongside consideration of 2019 results, and a detailed scrutiny of the business fundamentals and prospects for 2021.  It really underscores the need to start planning now for the recovery, as it will be all about having a credible view of 2021 and beyond.   

For more on business valuations and corona have a look at our valuations site or this article on the PEM Corporate Finance site 


Filling in the gaps in the safety net

Today's the day that the government's Job Retention Scheme gets going in earnest with the portal open for firms to apply for payment.   And the word Furlough has well and truly re-entered the language with many firms already having Furloughed staff, and which will now be applying to get the grants.  I know that my tax colleagues have been active today helping with this.

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If you were being unkind you'd say that that government's support for business whilst swift and very welcome was full of gaps.  These are gradually being filled.  The Corona Business Interuption Loan Scheme (CBILs) was onerous in terms of the guarantees required from business.  But now the guarantee requirements have been softened.  Then there was a gap above CBILs and below the Corvid Corporate Financing Facility for larger businesses.  This has now been filled with the Coronavirus Large Business Interruption Loan Scheme (CLBILS) .  Incidentally why the confused approach to naming these, one's Coronavirus, and other Corvid?

All this still leaves a gap for businesses that don't pass the viability test for CBILs - ie that it would have been viable in 2019 and will be in 2021.  Such businesses are going to have to look to other sources of finance, including the various tax related supports that have been made available, and negotiations with their creditors.  Expect to see the insolvency practitioners busy with a rash of CVAs, prepacks and phoenixes in the Autumn for those firms that can get through until then.

And yesterday the Chancellor announced a £1.25Bn rescue package for start-ups.  He intends to grant c£750m to start-ups through Innovate UK's network of funds.  And to set up the Future Fund which will channel £500m via the British Business Bank to suitable candidates.  Cleverly the loans are conditional on private investors putting in 50% of the money, which should help to filter out the lost causes.  The government will have some kind of equity conversion after three years unless the loans are repaid.  That either means that they'll be left with equity in no hopers, or will have soft conversion rights - or new investors would surely take them out.  But I guess that's a small issue compared with the other burdens the treasury is taking on to support business.

This must be welcome news for venture capital / private equity funds which I know have been closely monitoring their portfolio investments through this crisis.

So the safety net probably still has holes in it - but at least they're becoming fewer.  It'd be nice however if the gaps could  be filled before business groups have to start lobbying as was the case with the start-up community which looked enviously at the generous support in places like Germany, and lobbied hard for this.

We have a Corona Virus hub on our website with lots of information and also practical insights on how to access the right funds.

If you're grappling with how best to access this support, or would simply like to discuss your strategy, get in touch - I'd be interested to hear how you're tackling it.  

 


Changes to Entrepreneurs' Relief in the March 2020 budget

After lots of speculation, and much lobbying to have it abolished Entrepreneurs' Relief has been spared in the last budget.  But with a reduction from relief from  £10M of lifetime gains down to just £1M it's a mere shadow of what it was.   This means  that someone who was planning to sell for £10M will now take an additional £900k tax hit.  The argument is that it wasn't the tax relief that was motivating them.   And that's perhaps true - but it will have an impact on timing.  A business owner who was planning to sell based on a given level of net after tax proceeds will now need to sell for a higher price, and so probably delay the transaction.

 

Here's a short video I've just done on the changes, their impact, and how business owners might address the problem.   There's more on our website or YouTube channel

PEM Budget Seminar

You can also watch PEM's budget webinar for an update on all the other changes in the budget.

 

 

 


Half way to crazy

MS
I was reminded again last night of the importance of anchoring while watching Oscar nominated film Marriage Story.  

It tells the story of a marriage break up, and both parties get sucked into dispute once lawyers get involved.   One of the lawyers essentially says you shouldn't be reasonable in your initial demands, and here's why.  The other side will start at "Crazy" and so if you start at "Reasonable" and you settle half way you will be settling half way to "Crazy".   The lesson being if you start at "Crazy" in the opposite direction - you might settle at "Reasonable".

Not I don't suggest that you start at "Crazy", apart from anything else in business negotiations you need a little good will, and the other side need to believe that it's worth putting the time into trying to get a deal with you.  Which they won't if they think you might be totally unreasonable.   But it's worth reflecting that anchoring the discussions will influence the subsequent negotiations.   

If you have some insight into the other sides negotiating strengths and styles that can help too - just how crazy or reasonable are they?

 

 


There are still deals to be done even in "difficult" sectors

Its often said that the reason lots of deals are still happening in uncertain times is down to the liquidity in the system, and those companies being in good sectors. Conversely if asked many investors and advisors will tell you the retail and construction are "difficult". So it's heartening to report that there's always cream at the top of the milk bottle and that deals are still to be done in "difficult" sectors provided you're working with really good businesses.

Specifically I'm pleased to look back on two recent deals we've completed over the summer at PEM Corporate Finance, the sale of English Architectural Glazing and the sale of ATP Architects + Surveyors.

We acted as lead advisers to the shareholders of English Architectural Glazing.  Based in Mildenhall in Suffolk and Attleborough in Norfolk, this is one of the UK's leading contracting businesses providing envelope cladding packages for project such as Great Ormond Street Hospital, Wimbledon Centre Court, DLR Station City Airport and the BBC TV Centre conversion. Their clients include the great and the good of UK construction such as Kier, BAM and Skanska. The business was sold to Irish Private Equity Fund Elaghmore LLP. This deal closed in August.

A couple of months later we were pleased to announce the sale of ATP Architects + Surveyors to RSK. ATP, which is based in Ilford in Greater London,  is a multi-disciplinary professional consulting firm, and its purchase was RSK's 7th deal so far this year. ATK, which was established in 1966 provides the complementary services of landscape design, interior design, space planning, employers’ agent, and health and safety. It works with a broad range of clients such as Barratt London, Sanctuary Housing Association and Hollybrook Homes.

We've not done anything in retail recently - but are always keen to speak with good businesses and to help shape their exit plans.

More on our website  about the EAG and ATP transactions.

 

 


Is this the end for Entrepreneurs' Relief?

There is a growing chorus of voices urging the government to scrap Entrepreneurs' Relief.  The Institute for Fiscal Studies which suggested that business owners respond more to changes in taxes by adjusting how and when they take money out of their companies rather than by changing their investment plans.  It also claimed that many owner managers hold significant sums of cash in their companies in order to access lower CGT rates and to save tax - no sh*t Sherlock!   IFS issue with the system is that while higher income tax rates encouraged lower income take from companies, especially if it kept owner managers just below the next tax threshold, but that the cash retained wasn't invested just squirreled away.

ER
Now the former head of HMRC has called for ER to be scrapped, as it costs the country c£2bn a year in lost tax but with "no real incentive for entrepreneurship"

An earlier HMRC research paper by IFF, found that in most cases ER was not the primary motivating factor for entrepreneurs when making decisions about investing in assets, or disposing of them.   But it did find that those most likely to be influenced by ER at the point of making their initial investment were those most likely to planning to set up a new company.  Perhaps it's motivating serial investors - and so perhaps this is a driver for enterprise?

It's difficult to predict anything in British politics, and that's also true about the future of ER.   Phillip Hammond tinkered with it in his 2018 budget but resisted calls at that time for it's abolition.  So perhaps more tinkering is the likely outcome post election?

Whether or not a transaction will qualify for ER is always an agenda item in exit planning discussions.   And it's relevant in any M&A activity, whether you're selling your business, doing a management buyout, or even if you're buying business (because it will influence the seller).  But we're now finding, in discussions with entrepreneurs around Cambridge and East Anglia, that the availability of ER is becoming a factor for some in accelerating their exit plans before possible tax regime changes.  It's certainly true to say that it's unlikely to get any more benign.  

Ultimately exit decisions are driven by personal factors such as age, and a desire to do something else in life.  Or by business factors such as the value of the company, and it's strategic plans.  So the tax tail actually doesn't often wag the dog, but it would be helpful to have some certainty on how capital gains on the sale of businesses are going to be taxed.

In the short term the best way for business owners to wrest back some control from the politicians is to have some exit planning discussions, work out a range of dates and values for you exit, and what needs to happen to deliver that.    We're always happy to have this kind of discussion, because it makes it easier for business owner and adviser to act swiftly when opportunity arises.  If you'd like to read more about exit planning and selling your business have a look at the PEM Corporate Finance website https://www.pemcf.com/services/selling-a-business/


5 Reasons why Brexit might not be so bad for M&A

Despite recent evidence of Brexit hitting M&A it may not be so bad after all.    Here's five reasons why.

1 Liquidity

Companies might be put off attempting larger deals due to the difficulty in raising sterling debt.  Also there’s evidence of some Brexit planning being rolled out with stockpiling of goods and relocation of corporate head offices outside the UK.

But these things are seen mostly at the really large end of the market, and smaller deals should hold up.

Why so?  Because confidence and cash are key drivers of M&A.  Whilst confidence may be in relatively short supply, at least in some markets, there’s still lots of cash around.  Companies and PE houses are holding record bumper levels of dry powder so the Global M&A market isn’t about to grind to a halt, even some fear the UK could.

Given all that corporate liquidity smaller deals especially technology or strategically driven deals should not be hit as hard if at all.  

Brexit2 Specific sectors will hold up

The uptick in inbound European M&A activity in 3Q18 should continue in sectors which remain relatively unaffected by the current tumult.  It’s hard to predict which sectors those might be!  But it’s safe to say that UK technology companies, and other businesses with a real edge, market access or strong business proposition are likely to remain attractive to potential purchasers.  

So I’d imagine that the Cambridge tech cluster and other areas of excellence should continue to see activity.

3 Change as a driver for M&A

Change often drives opportunity, capital flows and M&A activity.  And companies seek to capitalise on disruptive factors by buying and selling companies.

4 The UK as an attractive economy/jurisdiction in which to do business

English law will remains attractive to international companies. 

5 Continued Sterling weakness

A hard Brexit will probably punish the value of Sterling, but as we saw after the referendum the currency effect of a “cheaper” British pound has been a real driver for M&A deals.  Overseas buyers particularly from US, Europe and China have been very active.  


M&A Prediction for the rest of 2018

Intralinks, which is a provider of virtual data rooms produces a "Deal Flow Predictor" by tracking early stage M&A activity by looking at sell-side deals that have begun their diligence stage, or are being prepared.  They reckon those deals are typically about six months away from any kind of public announcement.  This is the data for H2 of 2018 just published.    The chart below plots the year on year percentage growth in the number of announced M&A deals for the next two quarters. 

It shows Europe  (EMEA) to be pretty flat contrasting with real growth in the APAC region.  Given that  activity, certainly as far as we're experiencing it, is strong then stable represents a continuation of a pretty active deal market.   That certainly is reflected in the number of companies in and around Cambridge and East Anglia that are preparing for transactions.  And also the number of unsolicited approaches that we hear about.  We're currently mandated to advise on a number of mini-auctions where companies have been approached by a few buyers at the same time.  Those wouldn't necessarily be picked up by this survey which is driven by those preparing sale side deals - by its very nature a mini-auction which arises when a business has been approached by one, two or three buyers wouldn't get picked up.

Intralinks deal predictor H2 2018

 

 


Prices paid for mid market companies reach record level

One of published indices of unquoted company achieved exit multiples has recently been published and shows a record level.   

Argos 270718

Argos Soditic is an independent European private equity Company supporting management buyouts of medium sized companies and has offices in Paris, Geneva, Milan and Brussels.  The Argos Index measures the trends of euro zone private mid-market company valuations.  Carried out by Epsilon Research for Argos Soditic and published every three months, it reflects median EV/EBITDA multiples, on a six-month rolling basis, of mid-market M&A transactions in the euro zone. 

It has shown steady growth since 2013 and the latest end June results are a record 9.9x.

Before you get geared up to sell your company for this multiple you need to dig into how these indices are constructed.  Bear in mind that this is a basket of different types of companies, and is categorised more by the size of deals and the availability of data (always an issue in private company valuation reporting).  The index targets deals in the 15M to 500M range for EuroZone countries and only deals where a majority stake has been acquired.  It also excludes some industries such as financial services, real estate and interestingly "high tech" (which it doesn't define).  The latest results are based on deals with an average Equity Value of 142M Euros.

However as with all indices it's the trend that's useful - and it's certainly a reason to be cheerful. 

PEM Corporate Finance's regular publication "Valuation Snapshot" tracks Argos and other indices to take the temperature of private company sales prices on an approximately quarterly basis.   Here's a link to the latest one.  If you have a look you'll see that what's also interesting is how the various indices diverge from time to time and why.

 

 

 


Numbers with no narrative :-(

I always stress the need for numbers in any of our reports at PEM Corporate Finance to have some narrative, some thought, some insight to go with them.  Otherwise one might conclude anything or nothing from them.

Experian H1 2018 coverSo I was interested to read a rather doom laden article in today's Insider email newsletter.   "East of England Deal Market Declines - Experian".    This is reporting on Experian's H1 2018 figures for deal doing activity nationally and around the country by region.  For the East of England it went on to report that "the value of deals struck in the East of England in the first has 2018 suffered a steep drop, according to new data released by Experian"  "Values fell significantly by 75% to £3.5Bn from the £14.1Bn announced 12 months ago."

Now on the face of it that's true, and pretty much lifted from the Experian report.  What it doesn't do is ask why.  This drop is compared to the same period last year.  So a quick look at the Experian report for H1 2017 shows that the 2017 period included two huge deals, the sale of a stake in Arm Holdings plc to Vision Fund Japan for £6.41Bn and Tesco's acquisition of Booker Group plc for £3.7Bn.  So the two largest deals in 2017 were together worth £10.11Bn.   In H1 of 2018 the two largest deals were the sale of petrol station/convenience store group MRH GB for £1.2Bn and the sale of Northgate Public Services to a Japanese buyer for £0.475Bn, taken together there were worth £1.675Bn.

The trumpeted 75% decline in deal value between H1 2017 and H1 2018 came to £10.6Bn.   In other words  80% of that decline was due to the two largest deals in 2017 being particularly big.

Can you conclude from this that the market is in decline?  Don't think so.

However over the same period there was a 23% drop in the number of deals from 324 to 249.  Given the drop by value is so skewed by those two big deals, this probably means a real slowing in volume of smaller deals.   Harder to be sure why.    This might be of more concern, although anecdotally we just don't see any slowing in activity with many companies seeking to transact, and sustained appetite from overseas buyers and financial players alike.

So you can put narrative on the value decline, but as regards the volume decline it's much more difficult to conclude as to why from this data.