It’s a cliché that business valuation is both and art and a science.   Or as it’s been more aptly put it is a craft.   Either way it needs to be done thoughtfully.   You don’t need to look hard online to find sites that invite you to put your data in and I’ll value your company for a low fixed fee.  Trouble is that “under the bonnet” this is just some maths – this is a problem because you have no idea if the site is asking the right questions, and more importantly its only as good as the data input.   As they say garbage in garbage out.

But if you do treat valuation as a craft, to be conducted thoughtfully, making insightful and supportable judgements about the business at each step you need to guard against bias – and this can arise accidentally.

Anchoring is a well documented phenomenon.   There have been psychology experiments that have demonstrated this.   Business students are asked if they’d pay the last two digits of their national insurance number for each of several items.   Then they’re asked the maximum they’d be prepared to pay item by item.   Despite it being random students with higher NI numbers consistently indicated higher maximum bids.    The anchoring phenomenon can work to ones advantage – it’s a reason why it’s often helpful to go first in a negotiation – to try to anchor the debate at your end of the value range.    But it has no place in valuation as the valuer should form an independent judgement.     

So as a corporate finance adviser I’m keen to understand what my clients objectives are as input to negotiations. Conversely as a business valuer I need to be deaf to the client’s desired valuation.  This might be a business valuation for divorce purposes, or to do with shareholder exit, or tax.  But I need to avoid anchoring bias to make sure I arrive independently at my best judgement of valuation which is supported by the evidence and by my understanding of the business. 

For more information on our Business Valuations service have a look at our website - based in Cambridge we provide valuation services to business owners around East Anglia, in London, nationally and internationally. 

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Why revenue multiples aren't very helpful

Asman Damodaran of the New York University Business School had a go at valuing the Star Wars franchise.  Disney paid $4Bn for it – so did that turn out to be a good deal?

Damodaran reviews the franchise to see where the revenues have come from.  Interestingly the original film is still the biggest grosser to date at nearly $4Bn.  But the other revenue streams are even more important; VHS/DVD/Rentals, Toys, Gaming, Books, and TV series.  These other revenues dilute Movie income to 20% of the whole alongside 23% for rentals, 15% for gaming and books, and a whopping 36% for toys and merchandise.

So how do you value it?  Like any other business, one needs to take a stab at future earnings potential.  In the absence of Disney’s,  no doubt closely guarded, forecasts Damodaran makes educated guesses.  Starting with Disney’s intent to make another two films he then assumes they’ll each gross something similar to “the Force Awakens”.  I’d have assumed some slight decline each time around (as the history suggests) but you have to start somewhere.  He judges that add-on revenues will continue be more important - streaming replaces rentals and he assumes $1.20/dollar v $1.14/dollar thus far, Toys continue to generate $1.80 for every dollar of movie income, Books drop 25% to $0.20/dollar, Gaming stays at $0.5/dollar, and he assumes that with the distribution power of Disney and Netflix (rumoured to be planning 3 live action series) TV rights will increase to $0.5/dollar. 

One needs to keep making assumptions, when the films will be released, inflation, and of course the margin levels on the income streams – he uses sector averages here, for example toys/merchandise at 15%.  Put it all together and you get an overall net income projection which he discounts at 7.61% being the average cost of capital for the entertainment sector.   Net result a valuation of $10M.   So Disney did a good deal.   If you want the full calculation Google “Galactic Finance: Valuing the Star Wars Franchise” which will take you to his blog.

It shows you can build up a cogent case to value almost anything, although I’d  have factored in some kind of discount just because of the existence of Jar Jar Binks. 

May the force be with you.

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Why revenue multiples aren't very helpful

Planning for exit and succession can be difficult in any business, but in family businesses there are additional factors to consider.   One of the problems with family succession planning is that the two key objectives – liquidity and preservation of the business legacy appear to be in conflict – how can you get cash without selling up?   A sale to a trade buyer may be unattractive if the plan is to keep things in the family, and this is where the idea of a sale to family comes in.  

This is a form of management buyout – the family members buying the business are very often the team running the company.    Often it goes beyond that to key managers – hence the occasionally used abbreviation the FAMBO. This is meant to mean Family and Management Buyout, or Family Buyout, although just to confuse things I’ve recently seen it used in East Anglia to refer to a Franchisee and Management Buyout.   It can also be called a VIMBO or Vendor Initiated Management Buyout – because the its usually (though not always) the older generation which initiates the sale to the younger family members.  At PEM we prefer to refer to such deals as Succession Buyouts – because that neatly encapsulates the overarching strategic intent of the deal.

Because family relationships are involved things can go wrong so as to delay the transaction or even kill it completely.  So here are some key thoughts on how to preserve family harmony whilst successfully completing a buyout.

Plan ahead and don’t rush each other. It is really important that harmony and trust is maintained. Nothing breeds suspicion more than the idea that one family member wants to take advantage of another, either by being pushy or appearing to scheme behind the scenes. This is true whether a family member is a buying or selling. An aggressive buyer almost ensures that the seller will react negatively; an aggressive seller communicates desperation and may undermine his or her own negotiating position.   Actually this is also true of Succession Buyouts amongst long standing colleagues who are not related.

Take account of peoples personalities Families ought to know one another pretty well. They know about personality traits or past circumstances giving rise to unusual levels of loyalty, or even resentment, or jealousy.   This might all come out in the run up to a transaction, sometimes they are deep-seated psychological feelings, and can be almost childlike—“Dad always preferred you.”   Being alert to such attitudes and steering the transaction in a sensitive way that respects feelings will help ensure success. Often the most important thing is to make sure everyone is listened to.

Get the business professionally valued If your shareholder agreement doesn’t prescribe a valuation methodology, it will be helpful to everyone involved in negotiating a transaction that there should be an independent assessment of valuation. Fairness is the key to completing the transaction and maintaining positive family relationships, and possibly sanity.  Neither buyer nor seller wants to looking back on the transaction with regret or suspicion.

Find some trusted advisors. Truly independent advisors who have the best interests of the family in mind can be hugely helpful in communications and facilitating agreement amongst the family. Each family member can get some independent advice, but its much better to select an adviser with a track record of brokering/facilitating such deals amongst close knit family or business groups to work for the company/family as a whole with the objective of reaching an agreement that works for all.  A skilled adviser will listen to all the agenda’s and try to manage any emotional pressures that arise during negotiations.

Tax and estate planning My tax colleagues would point out that it’s really important to consider the tax and financial affairs of the whole family, up and down the generations. And a deal like this is an opportunity to consider these things holistically.   Has the family provided for everyone as they intend and have they done inheritance tax planning?  Again these are things that need to be done early. One of the consequences of some buyout structures is that IHT planning becomes more important – don’t leave it to the last.

Family businesses are important to us all – according to INSEAD they account for 57% of US GDP.   There’s a general perception that many don’t make it beyond one or two generations. I’m not sure that’s true, INSEAD reckon there are 5,500 bicentenary family businesses around the world, and we’ve certainly worked with some family businesses which are now at fourth or fifth generation stage.  Visit our website to read about some of the family buyouts we've worked on.

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Management Buyout at Hospitality Software Business

Bloopers are the mistakes made by cast or crew on a film that end on the DVD extras. Sometimes they can be better then the film.   Business Valuation bloopers on the other hand are no laughing matter.   You might need a business valuation for divorce purposes, a shareholder exit, or as part of some kind of tax planning. Whatever the reason, whether you’re valuing an early stage technology company in Cambridge, or a mature SME in London there are some common business valuation bloopers to avoid.

As valuation experts we are often get to look at and comment upon other advisers valuation reports.  Often basic flaws in valuation methods, logic, or lack of decent data lead to challengeable advice being given. 

Here are some valuation out-takes, make sure you avoid them.

"I believe you"

Believing everything you’re told isn’t a good idea.  But I see lots of report where advisers have based all of their calculations on profit figures supplied by directors without having challenged them, or having reviewed the business.   Sometimes its pretty clear that most of the text is templated and applied to any and every business.

Lies, d*mn lies and statistics

You can find statistics to prove anything – just ask any politician. When valuing a business there a range of indices available from which to source an earnings multiple.   The lazy adviser might just reach to for one of these without either questioning it, or corroborating it with other data.   This is a problem because these indices by their very nature are averages – and so they say nothing in particular about any one sector or company.  It doesn’t matter whether they use, the BDO Private Company Price Index, FT All Share PE ratio, the Leading Edge Alliance’s PERDA, the Argos Soditic Mid Market Index, or the UK200 Group SME Valuation Index, a generic multiple will rarely give you the right answer in a business valuation.

Out of code information

As in any field business valuers need to keep up to date, and to use current data.  I recently saw a valuation based solely on the Private Companies Price Index.  Just relying on that would be bad enough, but the valuer then applied it to the wrong profit figure in the companies accounts.  My guess is he has been using PCPI for years and has never noticed that it changed a few years ago from an EBIT multiple to an EBITDA multiple.  

Apples and Pears

Don't mix apples and pears or you'll get a curious byproduct.  Likewise there are a range of profit measures, EBITDA, EBIT, PBT, PAT, Operating Profit.  And a range of multiples  including EV:EBITDA and the price earnings ratio or  PE ratio.   If you apply a price earnings ratio to EBITDA you will significantly overstate the result.

Rules of Thumb

As a business valuer I wouldn’t disregard rules of thumb in a particular industry, so transactions involving shops, cleaning companies, and professional service firms are amongst those where one comes across them. But I’d only ever use them as corroboration of more rigorous methods.   So shops are often sold for a number of weeks turnover plus the value of the stock – ultimately this must also equate to an earnings multiple, but where data might be patchy it’s probably a useful ready reckoner of valuation. The trouble is one often see’s quite inappropriate, and unquestioning, extension of these rules to other sectors. So for example I recently saw a service firm valued by a valuer who I suspect must specialise in valuing corner shops for after arriving at a (not entirely supportable) earnings valuation he then added the balance sheet value.  

I could go on. There are lots of ways to go wrong, indeed a quick Google produces an academic paper entitled “110 Common Errors in Company Valuations”

The answer, and you’d expect me to say this, is to find a business valuation expert who knows what they’re doing, and produces a well reasoned valuation that would stand up in court if you ever found yourself there.

Have a look at our http://www.pem.co.uk/corporate-finance/business-valuation

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 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

Many entrepreneurs are wary of selling equity to outside investors.   Whether its at the early stage where the main source of funding is likely to be Angel investors or later when VCT and Private Equity investors may be the sources.   

The concern is of course about control, and how it will change the business.  Will the new investors meddle?   Of course get the right investor and what to some feels like meddling will in fact be a truly positive value added contribution to the business.  The right investor, or their appointed non-executive director, can bring additional experience, knowledge and contacts to the company.

But before you get to raising equity its worth challenging whether or not you really need it.    And sometimes you just need some good housekeeping to reduce your cash needs.  How about these simple thoughts:-

Supplier investment

Your supplier base may be able to part fund your growth.   Maybe not through direct investment, but they may be able to go for extended credit, or perhaps the will be prepared to support you through marketing costs.

Change your working capital profile

Could you do business in a different way?  How about charging for some or all of your work up front?  Could you introduce deposits or progress fees?  Better still could you get your customers to pay up front and move to a subscription basis? 

Narrow your aiming point

Sometimes the big cash requirement is because businesses aim to make a big step forward, or to tackle a lot of new things at once.  Could you scale that down to the true priorities, grow the business and then if you need to raise equity later it will be at a time when you’re profitable and so you’ll be able to raise capital at a higher valuation?

I'm pleased to report that we helped the management team at Alacer Software to acquire the company from its parent company Lifecrown Investments.  

Alacer is a developer of hospitality software that allows all manner of businesses in that sector to run their businesses more efficiently.     Instead of having a patchwork of various different systems Alacer brings together all elements of their business (bar, conference, spa, front of house, reservations and so on) into one system.   This makes life much easier as it then involves one supplier, one system and is properly "joined up".

Alacer was the only software business in its parent group, which itself was focussed on a very different market sector - so the logic of the buyout was compelling.

We were able to help Rob Day, MD of Alacer, to negotiate and structure the deal.  I'm glad to say that we continue to help them with the business in an advisory role post transaction.

A big thanks to Rob for agreeing to appear in our first PEM Corporate Finance video, and to the spielbergian skills of Peggy McGregor of PEMCF and Connor Nudd of PEM for pulling the video together.   Alas too late for this years Oscars.

Have a look also at coverage of the deal in Business Weekly and on our website.

As a business owner, you too need to be prepared when opportunity strikes. The two most common reasons owners sell their business are getting approached with an unsolicited offer and having a health scare. Either way you’re not in control of the timing, but you can be in control of how prepared you’ll be when opportunity knocks or necessity strikes.  Here’s 7 things to do right now to get your business ready to sell

1. Make sure your customer contracts include a “survivor clause,” stipulating that the obligations of the contract “survive” the change of ownership of your company. That way, your customers can’t use the sale of your company to wiggle out of their commitments to your business.

2. Cultivate a group of a dozen “reference-able” customers that an acquirer could interview. When you sell, the buyer will want to speak with your customers; so you need a group of people – customers who are also friends – that would be willing to say good things about your company. In particular, the acquirer will be looking for assurance that the customer will keep buying after you leave, so make sure your reference-able customers are loyal not just to you but also to your business.

3. Keep in mind your elevator pitch to a potential acquirer. Writing your elevator pitch now will crystallize the important attributes of your company and ensure you focus on the right metrics in the coming years. It should the Who, What, Where When and Why of your business:

• Who: describe why your management team is a winner. 
• What: describe what you sell and why customers choose you.
• Where: where are you located and what is the potential to expand geographically? 
• When: how long have you been in business? 
• Why: What are the strategic reasons someone would want to buy your company? Do you have a niche? Is your product a world-beater? Make decisions for your business now through the lens of how the results of your decisions would be perceived by a potential acquirer down the road

4. Identify 10 companies with a strategic reason to buy your business. Once you have a short list of potential buyers, study their M&A activity. What do they buy? What do they list as the strategic reasons for their acquisition in their media releases? Who are their lead corporate development executives?

5. Do business with your short list. Once you have a short list of potential acquirers, try to do business with as many of them as you can. Companies buy companies they know; so if you can find a way to work with a potential acquirer (either as a partner, supplier or customer) it’s a chance for them to become familiar with your company.

6. Professionalise your financial management – there’s nothing that freaks a buyer out more quickly than disorganised accounts.

7. Stop doing the selling. If you’re the rainmaker, nobody will buy your business without a soul-crushing earn out. Keep in mind that sales people take time to train and to hit their stride. Depending on your industry, it may take them a year or even two to start cranking out deals, so now is the time to hire and train them – not six months before you want out.

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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 definitive 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.

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Is Now a Good Time to Sell Your Business or Buy a New One?

EXIT STRATEGIES FOR FAMILY FIRMS

We’re often asked how to achieve succession within family businesses.  For this type of business Business Exit Strategies mean how to pass it on and not how to achieve a trade sale of the company.  Very often this will be done in the form of a Vendor Initiated management buyout, particularly if those who are to succeed are not just family members.   The VIMBO or succession buyout structure can also work well in a family deal, if Mum and Dad want full value rather than gifting the business, and if they need some sort of carried interest or ongoing income.

SIMPLEST CAN BE BEST

That said simple is often best.   And particularly in small deals variations on the share buyback theme can be useful. 

SHARE BUYBACK

We recently helped a family business in Suffolk achieve succession using this type of structure.   It wasn’t a huge business, but was sustainedly profitable, and had grown to have branches in Essex, Norfolk and Cambridgeshire.   Mum and Dad had been running their business as a company for many years, but had involved their two sons in the business as full time directors.  As the sons took more responsibility in the business they felt that it was time for them to take control.  The aim was to achieve the transfer and for the parents to have the profits which had accumulated in the company to be paid out to them tax efficiently.    If the arithmetic stacks up this can be done using a buyback of shares.  

The tax legislation which gives favourable tax treatment to an individual when a company purchases some of its own shares provided certain hoops are jumped through.   In outline the steps are:

• The sons get given some shares (a 32% minority holding) in the company a few years before Mum and Dad were ready to fully hand over the reins.  Result = no tax charge for parents or children due to the availability of tax reliefs - it qualified as a trading company.
• More recently, when Mum and Dad decided to retire, the company bought back their shares.  This was done     correctly and so the proceeds will be taxed as capital receipts for the sale of their shares (and not subject to income tax).  Entrepreneurs’ Relief should be available as both the individuals and the company meet the conditions and so the tax charge is only 10%.
• The company then cancelled the shares so that the shares held by the next generation are the only shares in issue and they all of the company.

THE GROUND RULES

In all deals there are some company law rules to be observed, or the danger is that the purchase of shares is an invalid purchase with unfortunate consequences.  As ever there are also tax rules to follow – and they’re often not quite so clear cut.   In this case the two keys matters that had to be established were that the company was a trading company for the purposes of Entrepreneurs’ Relief and that the purchase of shares is for ‘bona fide commercial reasons’.  The ability to “clear” this with the revenue in advance is helpful.   Of course there is usually a financing issue too.  In this case the company had the cash to payout. But what if the company doesn’t have enough cash?    There are ways round this – and indeed this might be a cue to consider a Newco buyout structure.

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