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 

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

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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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This was the view yesterday, in spring sunshine, from the windows of PEM Corporate Finance's attic looking at the reflection of 3 Salisbury Villas in the modern office block across station road.

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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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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With the Cambridge and the East of England economy continuing to perform strongly we're hosting a free educational morning seminar targeted at local small and medium size business owners (in the £1m-£100m turnover band).

Alongside our own corporate finance, and tax specialists we have speakers from our joint event hosts Barclays and Business Growth Fund who will give insights into raising debt and equity finance.   The whole event is designed to give business owners practical ideas on developing a strategy for growth.

Any acquisition should have a sound strategy underpinning it.   And it should look not only at the why and how, but also at the long term implications – when will you see benefits? Will it make your business more attractive to buyers?”

As well as giving advice on acquisition, we'll cover using strategic growth to maximise the value of a business.  The event is going to be comprehensive, guiding attendees from growth right through to succession or trade sale.

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.

To underscore our interest and committment to the food and agriculture sector - following on recent deals such as the sale of Elsinore Foods to Golden Acre Foods and the sale of Phaseolus to Place UK  - PEM recently took a stand at Cereals 2014 the leading event for the UK Arable Industry.    This was held at Chrishall Grange near Duxford.

Nice to see our friends Max and Ian of Redfox Recruitment at their very busy stand just along from us, and to catch up with Hannah Croft (formerly of PEMCF) on the Duncan & Topliss stand.

PEM Stand

Stephen Peak, Partner at PEM, supervises Sanchia Norris one of our Private Clients Tax Partners, and Rebecca Porter Assitant Director VAT Services in the errection of the Peters Elworthy & Moore stand at Cereals 2014

Car Park 1 at Cereals 2014 - if you have a grey, black or silver car then you will NOT stand out from the crowd!

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Business Exit Strategies

I'm pleased to be able to report on a recent management buyout that we advised on.   Lee Green, Matt Higgs, Phil Dascombe and Dan Todd have acquired Kloeber, a manufacturer and supplier of glazing products. 

Based in Somersham in Cambridgeshire, Kloeber is a manufacturer and supplier of glazing products - including bi-folding, sliding and entrance doors, windows, roof lights and bespoke glazed screens.

It has had a lot of attention in the media, with its products featuring on TV programs such as Grand Designs and DIY SOS. In 2012 the company’s signature ‘FunkyFront’ door – a contemporary take on entrance door design – received Build It magazine’s Best Joinery Product Award.

Very often management buyouts take place at long standing mature businesses.   In fact Kloeber has not been around that long, and its rapid growth is a real success story.  Launched in 2006, the company capitalised on the high demand for quality glazing products from the home improvement and self-build sectors.

Despite a general decline in the UK window and door market, the bi-folding door market grew by 17% (to £43 million) in 2011, an expansion that greatly benefited Kloeber. Within the first year of trading the company had designed a full range of timber glazed products. It later added uPVC, composite and aluminium products to its range.

The management team having run the company on a daily basis for the past three yearsacquired the company from its founder Director, Gavin Morris who now wants to focus on his other business activities while retaining a reduced involvement and shareholding in Kloeber.

What is also noteworthy about the deal is the raising of raise finance from RBS in a still tight debt market - particularly for this type of buyout funding.

Legal advisers to the deal were Rob Matthews at Keystone Law for the vendor and Jason Williams at Hewitsons for the buyout team. Finance for the transaction was arranged by Steve Noon of RBS in Cambridge. 

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