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 


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.

 


Valuation and pricing lessons from the battle for Sky

Valuation is art not science

A recent finance editorial in The Guardian on the 21st Century Fox v Comcast battle for Sky was critical of the Sky independent directors.  It felt they should be embarrassed at recent events and should realise that valuation is art not science.

Sky-logo-b90e8c9Too good to miss?

Paraphrasing the argument - in 2016 the independent directors felt a £10.75 per share cash offer was too good to miss.  Surely offers 40% above the previous weeks share price don’t come a long too often.    In fairness at that time the share price had fallen from £11 in April 2016 to 769p as the market fretted about Netflix and BT.  And you can be sure that Brexit fears didn’t help either.  But at the same time based on the fundamentals including the benefits to be derived from getting Sky Italia and Sky Deutschland motoring properly UBS analysts reckoned a fair price for Sky was £13.70.   So they’d not have been sellers at that price.

Today in 2018, with the political and regulatory issues behind them the real bidding has begun and the action is around the £14.00 to £14.75 range - so far.

Price v Valuation

This is all about price v valuation.  So what are the lessons?  Well the discussions at the board are of course mostly about price.  First time around in a jittery market, amidst fears about market trends (the threat from streaming), and with a one horse race the independent directors view on price wasn’t too bullish.  They obviously weren’t feeling too confident.  Either that the value was light, nor were they sufficiently robust to turn it down and take and flak from further share price decline afterwards.  So that was all about what price to accept. 

But back in 2016 UBS valuation opinion based on fundamentals was clearly suggesting something much higher – I’d be surprised if that wasn’t also the view in the Murdoch’s camp.

Now it looks so different.  Better performance, better market sentiment, and true competitive bidding is driving a value c£7Bn higher than before!  No wonder Sky shareholders were angry in 2016.

The above is all about how it felt for the sellers, for some insight into how it might have felt on for the purchasers have a look at this blog post on the PEM Corporate Finance website on how to pitch an acquisition offer.

The need for competition to get the best price

Taking the lesson a step further this really underscores the need to sell your business at a time of your choosing and to get a competitive process going.  It also demonstrates graphically how much higher a price you might get as a result of real competitive tension between strategic buyers.


Six things you must know before selling your business

 There is lots of detailed material available on the internet on how to groom your company for sale.   But often its the basics of the negotiation that get forgotten. 

Here's a short video, less than 2 minutes long,  with six things I believe you should think about.

If you're selling your business, or beginning the process of grooming it for sale you might want to read more on our Company Sales page

 


Process makes perfect

Last year I met with the owners of an engineering business because they had had an approach from a possible buyer for their company. It was a good business, and the owners liked the people who had approached them. At the same time they were wary of business brokers (having previously signed up a big company which had charged up front fees yet achieved nothing) and of the perceived disruption of a sale process. They also felt that their business had an intrinsic value that the buyer was bound to appreciate and to pay.

I can understand their reservations – but the idea that a buyer would blithely cough up the “business value” – even if it could be known – is dangerous. This ignores the huge amount of the exit value which is down to a good exit process.

How a business is sold has as much to do with the eventual value obtained as the characteristics of the business itself. If you are selling a house you can get a good idea of what it’ll go for based on the other houses on the street, you can even do this yourself using Zoopla. That makes selling a house much more about finding the buyer rather than extracting the value. And yet some business owners believe their business has given value and once the right buyer comes along, a deal will get done at their price. Alas nothing could be further from the truth, for a number of reasons:-

  1. Business value is much more subjective than property and other assets. You can’t go and get Short-sale-processdefinitive comparables for businesses. The packaging and process play much more critical roles when selling a business.
  2. The “best” buyer for your business might not be “on your doorstep” nor a close trading partner or competitor. If you have a decent sized business the best buyers might be scattered all over the world. Appreciation of business value is pretty subjective and so you will need to court multiple motivated buyers. This takes a lot of specialised knowledge, skill and perspiration.
  3. The devil is in the detail in most M&A deals. Many companies for sale will have amongst their circumstances a few potential deal killers. A skilled advisor is essential for avoiding these “unexploded bombs” and getting the deal done.
  4. Selling a business is a sales process. Without good comparable sales data (i.e. competing offers), it becomes a negotiated process.
  5. Most business buyers know what they’re doing and are intent on buying low and out-negotiating their adversary on the deal terms. You need to at least match their knowledge of the art of the deal to can maximise value for the seller.

Alas some folk, like the owners of the business I spoke to last year, try to do it themselves or delegate it to their lawyers or to the local accountants. Even if the seller thinks he’s done well, money has probably been “left on the table”. Selling a business is complex. There are a lot of moving parts and many business owners and, and especially accountants, don’t quite realize it. They think that because they’ve been tangentially involved in a few deals they can run a process and manage it effectively.

Selling a business for maximum value is the realm of the specialist. Company owners fail to hire one at their own risk.

Business sale value upon exit is made up as follows:

What you get for your business = Enterprise Value + Packaging + Process + Deal-Maker Skill

Enterprise value is the intrinsic value of the business. In theory this might be obtained by the DIY business owner/seller or the novice business broker (if they can sell it at all).

Packaging is putting together the Information Memorandum. Skilled packaging can in itself make the difference between a sale and no sale.

Process includes both process design and execution, and it’s about locating the highest and best buyers and working them all at the same time.

Deal-maker skill is the secret recipe. It’s the skill, knowledge and experience of the individual (or team) running the process through to closing.

In short, there is real benefit to be had from working with a specialist M&A adviser, a specialist in company sales. Look for someone with demonstrable experience, plenty of credentials to be found on the internet, and someone who will help you get the deal across the line. Ask your peers for references, talk to your existing lawyer or accountant, search the Internet.

If y ou are thinking of selling, which you will surely have invested lots of personal and financial capital into, then its worth getting the right people working alongside you to make it happen.


Business Valuation Basics: Four Key Questions

Business valuation can be complex but the underpinning of any good valuation assessment is the answers to four simple questions:

What is being valued?FourQuestions

The first step is to clearly define what is being valued. If it’s a going concern – i.e. an ongoing trading business - then it is the income stream of the business that is being valued.

A business is nothing more than a group of assets – people, ideas, processes, products, intellectual property (especially in technology companies), and equipment that together produce an income stream.  If there are any assets not used in the generation of profits, they get excluded from the valuation (and added back separately if you’re valuing the shares of a company for example).  A good example might be a surplus investment property held in a company.  Conversely if there are assets not owned by the business but used in generating profits, they must be contributed to the business by the owner or the cost of acquiring the assets needs to be taken off the valuation.

You also need to clarify if you’re valuating the assets or the equity of the business. An assets valuation assumes the seller retains all non-working/non-interest bearing liabilities of the business and, in a hypothetical sale, pay them off with cash received from the purchaser of the business. If the equity of the business is being valued, it is assumed the hypothetical buyer would get all assets of the business and assume all liabilities as well.

Value to Whom?

The answer can be an individual, investment group or another company. Once this question is answered, all the factors adding to or detracting from the valuation need to be factored in.   So a strategic buyer who sees potential in the business will value it at more than a similar buyer without any special reason to be interested in it.   I’ve seen some Cambridge technology businesses valued for well above their asset value, or any reasonable assessment of an income multiple – simply because their technology had true strategic value to the purchaser.   For example we advised on the sale of a pre-revenue business where the North American purchaser had decided to invest in a particular area, and purchasing my client meant that they would save around 2 years “time to market” over developing the technology in-house.   They thus had a pretty well developed idea of what they were prepared to pay for it.

What Definition of Value?

An alternate value definition is fair market value. Selling a business for maximum value can be a frustrating task. First, what is the maximum value of a business? Actually nobody knows – and any broker, corporate finance house, or M&A adviser who offers you a guaranteed price needs to be challenged.  How will the seller know if a particular offer he receives is the best he can get?  And would he get more if he waited?

This can be a difficult judgement for business owners who are thinking of selling – and it really helps to have an experienced M&A adviser giving input to what would be a realistic price given the nature of buyer, seller and the market.  Add the possibility that the maximum value might include some vendor financing, in some form of earnout perhaps, then the seller needs to consider, assuming the buyer’s ability to pay will in part come from future profits of the business, whether the buyer will do a good job of running the business once he takes over.  Faced with the “what is maximum value” dilemma, in practice sellers need to make a reasoned assessment of fair market value before embarking on a sales process.  We always invest time and resource in helping business owners to reach a thoughtful assessment of what would be a realistic “price expectation” ahead of a sale process.

Fair Market Value

What is “Fair Market Value”?  It’s the price at which an asset would change hands between a willing buyer and willing seller, both of whom are suitably knowledgeable of the facts and neither are forced to do the deal.  It’s a simple definition, but of course the technical process for estimating fair market value can be pretty complex – it’s an art AND a science.  

Value as of What Date?

The fourth question to be answered before a business can be valued is “value as of what date?” And it’s not always “valuation as of today” that’s relevant.  In litigation or tax driven valuations we’re often asked to produce a valuation opinion as at a particular date in the past. Conversely, in finance it’s often a requirement to predict what the value will be at some date in the future, perhaps as part of a strategic planning exercise.

If you'd like to know more about business valuations have a look at PEM Corporate Finance Business Valuations - valuing businesses in Cambridge, East Anglia, London and beyond.


Private equity funding for worlds first IVF clinic

I'm pleased to say that PEM Corporate Finance has advised on the recently completed private equtiy funding for Bourn Bioscience Ltd, the parent company of Bourn Hall Clinic.   They raised equity finance from Mobeus Equity Partners to support their plans for geographic expansion. An initial £3.5 million investment for a minority shareholding is supplemented by a commitment to invest significant follow-on finance.

Bourn Hall LogoThe first IVF clinic in the world, Bourn Hall Clinic was founded in 1980 by Robert Edwards and Patrick Steptoe - the IVF pioneers whose work led to the birth of the first test-tube baby in 1978. Since its founding, this internationally renowned clinic has helped to make over 15,000 births possible.

Today the company boasts three full service IVF clinics, based in Cambridge, Colchester and Norwich and supported by a number of satellite units. With 120 staff and the delivery of over 2,500 IVF cycles per annum, Bourn Hall Clinic is the largest independent fertility services provider in the East of England.

The UK market for fertility services has grown considerably in recent years, driven by increasing awareness and acceptance of IVF procedures, favourable demographics and improved success rates. Bourn Hall Clinic is looking to continue its geographic expansion, leveraging its strong brand and reputation.

We have worked with Mike Macnamee and his team at Bourn Hall before, advising on their original management buyout from Serono and later on their acquisition of ISIS Fertility.  Hopefully with this warchest there will be more deals to come.    More detail on this on our webpage

 

Buying and Selling Companies - the biggest mistakes both sides make

The biggest mistake buyers make definitely overpayment.     Buyers can get caught up in the thrill of the chase and end up overpaying and accepting less favourable terms than they should have.  In that frame of mind it can become only too easy to rationalise the risk factors and ignore the voices of caution.   What they need to be doing is to keep in mind that their goal is to make money and succeed financially over the long term.  To quote Henry Kravis of KKR “Any fool can buy a business. Celebrate when you sell it for a profit.”

The biggest mistake sellers make is failure to understand it’s a sales process.   If done correctly, the process alone can add big dollars to the sale price.   You can argue that the final price is a mix of the underlying enterprise value of the business, the grooming and packaging process, and then the process and negotiaton skills of the M&A adviser.   You need to find a good number of high-quality buyers and get them into true competition.   In short this is neither a part time nor “do it yourself” project.


How to make a Safe Acquisition

Buying a business can be difficult enough, but that’s just the easy part. You’ll sleep in the bed you made. ChecklistMany an acquisition has turned to nightmare because of mistakes made during the purchase. Don’t let it happen to you.   Here’s some thoughts from our M&A experiences of both buying businesses and company sales to help you avoid the key pitfalls.

Seller financing

Not only does seller financing help minimize the equity required, it provides ready and meaningful recourse in the event the seller breaches duties, obligation, representations or warranties. Try to get “right of offset.”

If you can purchase assets instead of shares

Buying shares can be more risky, and you will need to conduct some due diligence on tgeh company you’re buying.  Its easier if you can negotiate to only buy the aseest. Asset purchases also reduce taxes.   But of course its much less tax advantageous to the seller, and most sellers will insist on a share sale or a greater price to compensate.

Reasonable returns

If the business can’t safely pay, beginning on day one, a resasonable return to you and comfortably service your debt and equity financing then you’re paying too much.  Remember that the bank that's helping to fund your deal will want to see a detailed business plan, and to agree financial covenants that are robust before supporting you.    And if you're raising Private Equity finance they'll also want to scrutinise the returns profile closely.

A clear, actionable penalty for every seller promise

Seller promises are frankly meaningless if your agreement doesn’t have specific, clear, actionable and valuable recourse outlined for each.  Make sure you're corporate lawyer has this all covered in the Sale and Purchase Agreement.

Verify seller’s ownership and rights to sell

Don’t trust that the owner legally owns anything, especially intellectual rights like trademarks, trade names, web domains, websites, formulas, patents, copyrights, etc.

Ensure that the non-compete is enforceable

No matter how sick or old or ill or tired or incompetent the seller says he is, nor how far away he says he’s moving, get a non-compete that your competent lawyer says is enforceable.

Pay no more than can be comfortably serviced by proven, historical cash flow

By all means count up all the synergies and cost reductions you think you’ll enjoy post completion, but try to pay only for the profits that are historically stable and proven.

Get personal recourse for seller breaches

For each and every promise, get the seller to agree to be held personally liable for any breach.

New, valid, lease on key property

Don’t  assume that the landlord will renew the lease or keep the same terms. Get it in writing!

 List the three things that could put you out of business the fastest

And be prepared to answer the question: “When the worst happens, how will I survive?” Don’t accept, “it’s unlikely to occur,” as an answer. If it “could,” you better plan for it.

Much of this is  common sense, but its amazing how people push through acquisitions only to regret them afterwards – I can think of a few examples in Cambridge and around East Anglia where folk have got this wrong, but there are some really glaring corporate horror stories out there in the UK banking sector.  Royal Bank of Scotland, Lloyds Bank and Coop Bank probably all wish they’d not done the deal!   But if you take your time and work with an M&A adviser and corporate lawyer who will challenge you on all the key points – even if it means telling you not to do the deal, then you’ll be fine.