It’s been a long time since I posted here. 

It’s been a busy year and we’ve been busy advising on some interesting transactions.  Here are some of the highlights

Sale of Young Calibration to NMi Certain BV. 

Another sale to an overseas buyer.    Young Calibration is based on the South coast near Brighton.  And this was a first for me in that the whole transaction was conducted virtually.   I’ve done deals substantially virtually, but in this case right from first meeting with the selling shareholder Adrian Young to the complete everything took place in Teams or Zoom.     Young Calibration has UKAS accredited labs and industry leading knowledge and experience in thermal fluid systems testing, cleaning and development. It works with a wide spectrum of industry sectors including automotive, aviation, medical, environmental, and pharmaceuticals.  The deal is strategic for NMi and should allow the companies to capitalise on opportunities in electric vehicles charging, and respond to new regulations in automotive and motorsport sectors.

MBO of Titan

Titan is a St Neots based engineering company.  It began in motorsport racing and having changed and broadened over the years is now at the forefront of manufacturing complex steering technologies for advanced vehicles.  This was an MBO lead by an experienced team who bought the business from its private shareholders.  These shareholders had had the foresight to bring in a professional management team to develop and grow the business, and it’s great to see that coming to fruition in a good exit for them, and a great opportunity for CEO George Lendrum and his team to continue to grow the business.

Sale of Cambridge Bioscience and Research Donors to Nordic BioSite Group

This deal sees three European life science distribution businesses coming together.  NMI’s plans to assemble a pan-European life science research distributor took a big step forward with thee acquisitor  gives them an entre into the market for high quality bio specimens.    Another international deal, and another conducted virtually.  I have at least met Mike Kerins the CEO since the deal was done over a glass of Champagne.

Sale of X-On to SOuthern Communications Group

Last but not least, completing within a couple of weeks of our firm’s financial year end we advised on the sale of X-On a cloud telephony business focussed on the UK primary care sector.   Approximately 11 million GP patients in the UK are now served by 1,400 GP practices using X-On’s Surgery Connect.  This is about 17.5% of the telephony market in primary care.   X-On was sold to Southern Communications Group and it should allow X-On to further capitalise on demand for its market leading product.   Again, a deal conducted largely virtually, but I had met CEO Paul Bensley and his co-Director Paul Heeren before the process kicked off.

Themes

What themes can one draw out from the last year.  Increased digitisaion of deal doing – which is oiling the wheels.  And that there’s plenty of activity still.  That strategic buyers and PE funds are still very active and there’s plenty of liquidity in the market.  From what I can see so far, it’s continuing into 2022/2023

What does the crystal ball say about M&A in 2022 going into 2023

This last section is an edited version of an article I wrote for Business in East Anglia

Deal volume has held up well despite Brexit, and even global pandemic.  So how about the dual impacts of war and inflation?  Maybe better than you’d expect.   A recent Deloitte survey (admittedly done before Putin’s tanks started moving) found that 92% of businesses expected deal volume to increase.   Many owner managers are ready to sell because their businesses are doing well and yet after some difficult years they now feel they’d rather do something else and buyers are paying good prices as they have the means and the motive.

Here’s some 5 drivers of activity we’d expect to see:

1. The private equity sector has record levels of cash which needs spending. This is driving activity and supporting prices, whether PE funds are buying directly or supporting their existing portfolio to buy.  I don’t see this lessening, and with the turmoil in the quoted market, and lack of returns to be made elsewhere I can see investors continuing to pile into Private Equity as an asset category.
2. Deal making digitisation is increasing as the examples above show. This allows us to be more agile and to reach further from base to advise businesses – so if whether you’re based in Cornwall or Caithness I'd love to hear from you!
3. Cross Border M&A is a strong driver with well funded overseas buyers finding the UK an attractive place to do business. As illustrated by the Cambridge Bioscience and Young Calibration deals above.
4. The war for talent there’s been much talk about “the great resignation”, and we’re already seeing deals being done where the acquisition of a good team is the main driver. Expect to see more acquihires – acquisitions driven primarily by the desire to get hold of a team of people - particularly of knowledge led businesses such as consultants, agencies, and professional firms.
5. Hot spot sectors driving activity - Tech deals remain buoyant– COVID led to an acceleration of the transformation of many areas of commerce to harness cloud based technologies. Healthcare also a hot spot, our recent deals underscore this trend.   We’re also seeing a lot of activity in Fintech particularly around London.

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.

Valuation is art not science

A recent finance editorial in The Guardian on the 21^st 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.

Too 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.

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. 

 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

The government is keen to encourage entrepreneurs to create wealth and employment, and it has repeatedly used the tax system to try to do so.  All the focus is now on Entrepreneurs’ Relief but before that it was on retirement relief, and business taper relief.   Entrepreneurs’ Relief began its life as a relatively minor effort – a maximum of £80,000 of tax saving for an individual over a lifetime – much much less attractive than it is now. 

The relief is now much more attractive and it would seem that every entrepreneur believes that when you sell your business you will only pay Capital Gains Tax at 10%.   Which of course means that most people are assuming they’ll qualify for Entrepreneurs’ Relief.   Alas its not quite so simple.  The tax rules are complex, and if you get it wrong you’ll pay the full rate of 28%.

There are quite a few ways in which it can go wrong.  Entrepreneurs’ Relief only applies to trading companies but alas there is no definition of what constitutes a trade and court decisions over the past 160 years are not altogether helpful.

In many businesses its pretty clear that there is a trade.   So what doesn’t qualify for the relief?  Generally speaking property investment businesses or other business relying on passive investment income, would be exempt.   Less clear cut would be businesses such as caravan parks, which the tax man generally considers to be investment businesses, even where the owners carry out related activities, such as providing utilities or other facilities.  So before you go ahead and appoint an M&A advisor to help you to sell your business give thought to the trading status of your company.

If you’re a sole trader or partnership you should qualify for Entrepreneurs’ Relief, but its more complicated if you trade through a company.  Firstly you must own at least 5% of the company’s ordinary shares and hold at least 5% of the voting power in the company.  Secondly you must be an employee or officer of the company.  And you must satisfy these conditions for a full year immediately before a sale of the company.   I've often met people who had sufficient shares to qualify but hadn't met the officer or employee criteria for a full year.  That's fine if you have time to plan, but if a strategic buyer knocks on your door with a great offer you may not have the time for that.

Where it can also start to go wrong is situations where employees get non voting shares, or where husband and wife own the company but one spouse has never been a director or employee of the company.  

There can also be problems associated with the type of deal you do with the purchaser of your business.  If you were to provide some Vendor Finance for the deal, ie you accepted a loan document rather than an immediate cash payment from the purchaser of your business, such a “share exchange” can be problematical.  If you go down this route the upfront cash you get when you sell may qualify for the Entrepreneurs’ Relief but the later loan note redemptions will not – so you might end up paying tax at 28% every time you redeem a loan note.

The key, as ever with tax, is to plan ahead.   And of course if you do have some of the issues above such as husband and wife ownership, skewed voting rights, or issues around the trading status - there are always planning options.