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.

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 

I was reminded again last night of the importance of anchoring while watching Oscar nominated film Marriage Story.  

It tells the story of a marriage break up, and both parties get sucked into dispute once lawyers get involved.   One of the lawyers essentially says you shouldn't be reasonable in your initial demands, and here's why.  The other side will start at "Crazy" and so if you start at "Reasonable" and you settle half way you will be settling half way to "Crazy".   The lesson being if you start at "Crazy" in the opposite direction - you might settle at "Reasonable".

Not I don't suggest that you start at "Crazy", apart from anything else in business negotiations you need a little good will, and the other side need to believe that it's worth putting the time into trying to get a deal with you.  Which they won't if they think you might be totally unreasonable.   But it's worth reflecting that anchoring the discussions will influence the subsequent negotiations.   

If you have some insight into the other sides negotiating strengths and styles that can help too - just how crazy or reasonable are they?

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/

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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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.

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. 

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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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.