In 1985 after 95 years of success, and when nobody was asking for it Coca-Cola  decided to change the formula for Coke.  The new drink was imaginatively called "New Coke".  But reaction to it was overwhelmingly negative and it was withdrawn in just 79 days. 

Surely the world record for the shortest time for announcement to withdrawal of a high profile commercial venture.  Until now.  The recent attempt by 20 of the top football clubs to create a European Super League went from initial fanfare to abandonment in just 3 days.

It highlights the huge value of football and of the clubs.  The top 10 clubs are collectively worth c£26Bn and enjoy more than c£4.4Bn of revenues. The UK contingent in the top 10 in declining order by value are Manchester United, Liverpool, Manchester City, Chelsea, Arsenal, and Tottenham.  Together they're worth c£16Bn.

 So how do you value a football club?

Conventional valuation methods don't work terribly well when compared to the prices paid for clubs. The market method which seeks to compare with publicly traded entities is hard to use effectively given the small number of public listed football clubs. The discounted cash flow method relies on a clear quality forecast of profitability which is never going to happen in this sector.  And using revenue multiples is a bit simplistic and takes no account of things such as the clubs stadium, assets and cost base.

So how do you value a football club?

Well it turns out that there is a model to do so. Dr Tom Markham is a graduate of Liverpool University's MBA in Football Industries.  His dissertation on valuation, in which he came up with the model, won the Premier League Best Dissertation award.  And is it seems to be quite widely used.

The Markham model is basically an enhanced revenue multiple valuation.  But it factors in the state of the balance sheet, profitability, stadium utilisation and the wages ratio.  These are all KPIs that are tracked for clubs.

Value = (Revenue + Net Assets) * ((Net profit + revenue))/revenue) * (%stadium filled/% wage ratio)

Put simply the bigger the turnover, the greater the asset value, profitability ratio, and how close to stadium capacity attendances are the higher the valuation. And a higher the wage ratio (wages/revenue) lowers the valuation. 

Interestingly for the 6 UK clubs their revenue multiples are remarkably consistent with the top five ranging between 6.2x and 6.6x with only Tottenham at 4.7x much adrift from the average of 6.2x. 

It would be interesting to see statistics for the lower leagues which of course will have smaller stadia, and revenues but lower wage bills.   There’s not enough information in the public domain to do the same calculation with Cambridge United – but I’d hazard a guess that the revenue multiple could be a low as half the above.

As if the Chancellor’s need to raise tax to pay for his vigorous shaking of the magic money tree this year wasn’t enough to fuel the fear of CGT rises in the Spring the recently published Capital Gains Tax review by the Office of Tax Simplification (entitled Simplifying by Design) makes it look very likely.  Also Capital Gains Tax for business owners has been about as benign as it was going to get for some time now.

https://www.gov.uk/government/publications/ots-capital-gains-tax-review-simplifying-by-design

Some themes emerge from the conversations I’m having with business owners, funders and other advisers at the moment.

It’s not a vote loser and yet the Tories would never prejudice entrepreneurship

That’s an interesting comment – and it’s probably true that the average voter won’t weep for too long at the thought of business owners paying more tax.  And yet it’s successive Conservative chancellors who’ve advocated that income tax and CGT should be at similar rates, while in contrast it was Labour under Gordon Brown which introduced the concept of Entrepreneurs’ Relief.  Quoting below from the OTS report:

“When the tax was introduced in 1965, Chancellor James Callaghan said that ‘…gains confer much the same kind of benefit on the recipient as taxed earnings… [and]… the present immunity from tax of capital gains has given a powerful incentive to the skilful manipulator.’ 1 In 1988, Chancellor Nigel Lawson said, when aligning the rates with those for Income Tax, that there is ‘little economic difference between income and capital gains’ so income and gains should be treated along similar lines.2 In 1998, Chancellor Gordon Brown said, when replacing indexation allowance with Taper Relief, that the ‘capital taxation system should better…reward risk taking and promote enterprise.’ 3

It is needed to pay off the national debt

It’s true that the Chancellor needs to raise more cash from somewhere.  But CGT is a drop in the ocean.  As it stands right now raises that national debt of 2.08Tn is 250 times the annual take from CGT.    So using CGT to pay of the national debt is like bailing the Titanic with a teaspoon.

The system if full of distortions so it needs tidied up

Its true that there are lots of distortions and complexities in the system.  And that’s what the OTS report ostensibly sets out to address.   For example, gains on different types of asset, and differences in treatment between IT v IHT v GGT.   An interesting one highlighted in “Simplifying by Design" is the distorting effect of the annual GCT exemption.   They show a distribution of the frequency at which individual’s realise certain levels of capital gain each year.  It has a huge spike generated by people making use of their annual exemption.

A new focus on relief for retirement

This is why it’s not all bad.  The OTS suggest that for business owners who plan retirement there’s a strong case for a CGT relief.    It says that Business Asset Disposal Relief (the new name for what’s left of Entrepreneurs’ Relief) is too broad to do this and needs to be “reformed”.   

OTS makes a few suggestions:

• That the Government consider increasing the minimum qualifying shareholding to 25% so that relief goes to owners managers and not to passive investors
• Increasing the qualifying hold period to 10 years to direct relief only to people who have built up their businesses over time
• Reintroducing an age limit perhaps linked to age limits in pension rules to reflect the intent that it should be a retirement focussed relief.

What conclusions to draw?

If you’ve held more than 25% of a business for more than 10 years, are of pensionable age and are headed for retirement there are reasons to be cheerful.   For those who are younger, built their business more quickly, or have a smaller shareholding it’s time to get ready for a much more fearsome CGT regime.   More about Succession Planning for that age group on the PEM Corporate Finance website

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.

You 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 

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.

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.

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/

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.

So 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.

The latest Argos Mid-Market Index which shows movements in private company prices has just been published. It shows data up to Q3 2017 and indicates a record high of 9.5x.  As you can see from the graph it has been steadily climbing since 2009.   So if you're a business owner it's a good time to think about exit.  Or at any rate to make sure you have a credible exit or succession plan in place.   Many owners of private companies have much of their wealth locked up in their shareholding and so even an equity release transaction - perhaps by selling shares to a third party like a private equity house can help balance their personal portfolio.

The other factor I now start to hear in conversation with business owners is concern about the tax regime that a new government might bring.    The capital taxes regime re the sale of company shares is particularly benign with Entrepreneurs' Relief effectively reducing the rate to 10% on the first £10M of lifetime gains.  Whilst Entrepreneurs' Relief was brought in by a Labour government there is an up swell of concern that a Corbyn led government might change things.

None of this may happen of course but it does underscore the need for every business owner to have a plan for exit and succession - even if it is explicitly not intended to happen for some time.

We're running our Business Exit Strategies Seminar in Stevenage on 23 November the day after the Chancellor Philip Hammond's budget speech.  So we should have clarity at least on his short term tax plans.

Our event, which is free, gives useful insights into a range of topics:-

• The current M&A market
• Strategic planning
• How to build value in your business
• Business valuation
• How to achieve succession through a management buyout
• Tax - how to mitigate and also how to use your tax affairs to build value in your company
• Company sales - how to sell your business, pitfalls, why some companies don't sell

There are a few places still available - and the venue (Novotel just off the A1M) is easy to get to from Hertfordshire, Bedfordshire, Northamptonshire, Cambridgeshire, Essex and North London.  So have a look at our website for the full program and booking.  http://www.pem.co.uk/corporate-finance/business-exit-strategies-stevenage

Related articles

Why revenue multiples aren't very helpful

Buyout at Molecular Dimensions

Motivation

Like Hercule Poirot you should be on the lookout for ulterior motivation.  Was the forecast prepared with one eye to selling the business (usually inflated) or getting a valuation for a matrimonial dispute (this often produces a low valuation if the business owner is the defendant).  Or perhaps it was prepared for bank funding – in which case be sure the bank will scrutinise and sensitise the forecast.

Poor track record of forecasting

If the business has historically been poor at predicting its results which should it be different now?

The pattern of growth or margins look odd

It’s always possible to benchmark the figures against public companies or other data.  If the business producing the forecasts has wildly different growth rates, or margins one needs a good explanation as to why that should be.

Forecasts prepared in isolation by the finance director

The CFO or FD in the business needs to canvas inputs from the key mangers in the business before he or she can produce anything meaningful.

The forecast is based on a huge assumption

If there’s one or two huge assumptions that drive the forecast, such as being able to raise millions of pounds of equity finance, or winning a significant new contract then you should consider what happens if those assumptions don’t prove realistic.

Forecasts conjured out of thin air

Of course if there are no, or few, supporting assumptions to check out then the forecast will lack credibility.  I recently valued an early stage technology company where it quickly became clear that the forecasts beyond the first twelve months were just round figure guesses – so I had to discount them altogether in my appraisal.

No balance sheet

I do sometimes see forecasts based on a profit and loss account and some cash flow assumptions.     Without a balance sheet a vital logic check is missing.

This 2012 High Court case is interesting for the comments made by Justice Eder about Expert valuations.

Stabilus was a leading German manufacturer of gas springs and hydraulic vibration dampers used in the automotive industry which was the subject of a number of transactions. In 2008 it was bought by Paine & Partners LLC for €519M. Shortly afterwards got into financial difficulty and underwent a major restructuring in 2009 which carved up all the value to the Senior Lenders leaving nothing for the Mezzanine lenders.

Unsurprisingly – with €83M at stake in the Mezz layer – the Mezzanine lenders challenged the validity of the restructuring. Three different valuation firms gave opinions and three of the “big four” accounting firms were involved one way or another.

The judgement 100 pages long judgement had some key lessons for business valuation.

Use of previous valuations

If they’ve been prepared for internal reporting purposes rather than “fair market value” then they’re not suitable support

Business plans

Adjusting forecasts without considering the reasons for variations is not acceptable, and past variations from plan are not an automatic indication that there will be future variations.

Other Experts Reports

The Expert must request to see other Witness reports to check assumptions and any deviations from their viewpoint. Any deviations must be fully supported.

Discount to EBITDA multiples relative to guideline companies

The judge was happy that EBITDA multiples should be discounted. He commented that applying a discount is qualitative rather than quantitative.

The Expert needs to compare the risk, size, growth pattern of the business being valued to the guideline company when estimating a suitable discount. Stabilius had a lower growth rate than the rest of the industry which justified a lower multiple.

Hindsight

The valuer must focus on the facts and business outlook as at the valuation date. Hindsight is not a sense check for assumptions at the valuation date.

Ultimately the Judge agreed for the most part with the American Appraisal valuation – that the mezzanine debt had no economic value at the date of valuation.

I was asked this question by a business owner very recently.   We had been discussing his exit options for some months, and not unreasonably he is trying now to work out the effects of a post Brexit world on his decision making, in particular how it should affect timing.

Timing is the key given that successful company sales are often significantly about getting the timing right; timing re your business, your sector, and of course one cannot ignore the overall economic outlook.

My considered opinion is that I think it is too early to tell.

But there are, as yet anecdotally, some positive signs. We have 3 sales on the go at the moment at Heads of Terms or legal stages, all with foreign buyers, all are unaffected.  Also we have another just begun where the directions asked themselves the same question – and decided to proceed, on the basis that if buyers are all running scared we’ll find out quite early on and they can pause the process.  

At a more general level if the purchase is strategic I think folk will push on, however there must be some buyers out there who will wait to see what happens. 

What about foreign buyers wanting an EU base – how will they behave? For some businesses that will clearly have an effect.   Again it will depend on the precise business being sold and the buyers specific motivation.  

Of course there is potentially a plus from exchange rates depending on how that pans out. We have clients which will do well from that, and those that are already hurting.

In short nobody knows – only way to be sure is to try it.

Finally, just as with the political campaign, we're seeing some daft statements associated with the post Brexit world.   I received a marketing flyer re a company sale today from another adviser which cheerfully concluded that the business was "Wholly UK focused, so not affected by Brexit".   Presumably any downturn in the UK economy due to Brexit would not affect this business despite being wholly UK focussed?!  Dubious logic that even Boris would have been proud of.