How will the change of government impact on M&A in the UK?

M&A Activity Levels

M&A activity has been reasonably buoyant this year.  Indeed Morgan Stanley recently predicted a 50% increase this year at the big ticket end of the market as funding costs, inflation and recession concerns recede.  Overall, in the UK the rate of M&A is higher than it was in 2023, according to Idex Consulting, with over 400 deals in the UK completed in Q1 of this year.

Mark to Market’s most recent data (below) show UK deal volumes remarkably steady through out the year, although specifically comparing June 23 with June 24 shows a marked drop off in volume.   To early to form any conclusions from one month which included the election. M2M dataMore specifically looking at East of England data from Experian shows Q4 of 2023 and Q1 of 2024 showing a deal volume decrease, but an increase in deal value driven by a few in region mega deals, the sale of 337 Morrisons Petrol Forecourts, two AstraZeneca acquisitions, and Barclays buying Tesco’ retail banking unit.

Experian Data

Factors Influencing M&A Activity

Finance

Availability of funding for deals is a key factor.  Generally it remains available, although it takes longer to get hold of and prices have hardened a bit.  Private Equity should remain a driver.  Not just because of the large amounts of "dry powder" that is so often referenced, but also because many PE houses are sitting on more mature investments which must be getting closer to sale.  Pitchbook reckons that at the start of 2024 PE firms held more then 27,000 portfolio companies worldwide and approximately half of those had already been on the books for four years or more.  Expect sales. 

Price Expectations

Deals don't happen when buyers and sellers have widely differing price expectations for the target company in question.  Deals happen when the expectations gap narrows.  Anecdotally the gap may be closing as vendors and purchasers get used to the new normal of higher interest rates, and as inflation and financing costs stabilise. 

Business Confidence

Of course, confidence is always a factor in M&A, alongside money and motivation, and nothing erodes it like uncertainty. 

The IoD publishes a very useful quarterly update for members on all key aspects of the economy (another membership benefit) part of which is a confidence survey.  This shows it hitting a fourth month low in June 2024.    My money’s on confidence improving with certainty of the new government’s plans.  Although in the autumn the budget and the US election outcome may rock the boat.

IoD Data

So having the new government in place, and post Kings Speech a good idea of their plans will certainly help.    Perhaps in a reaction to the increasingly crazy turbulence of Johnson and Truss era Labour seem focussed on nurturing the UK as a good place to do business.  The obvious things to point to being fiscal stability (no budgets unless economic expert advice and guidance is given), infrastructure investment, improving relations with our European trading partners, and industrial strategy.

Investment

Investment should also help, in railways, and housebuilding particularly.   Other potentially positive changes are the National Wealth Fund, intended to “unlock billions of pounds of private investment” to support energy transition.

But related investment is the question of where the money comes from.  So tax remains an issue.  The government has lots of big plans, but where will the cash come from besides the already announced tax changes for non-doms and VAT on private school fees?

Private Schools

On the subject of private school fees there’s been a lot of noise about how VAT will hike fees, but in fact private school fee inflation was already pretty strong as the chart below from the Independent shows.   Will this change trigger some M&A in private education?  

Indepedent Schools Data

Tax

A burning question for many entrepreneurs will be what is to become of Business Asset Disposal Relief (‘BADR’) which effectively gives a lifetime £100,000 of tax saving on the capital gains from business disposals.  But the bigger question is whether or not income tax and CGT rates will be equalised – that would increase the tax on company sales from 20% (once BADR used up) to 45%, a big hike.   And while Labour said they have “no plans” to increase CGT, they haven't listed CGT as one of the taxes they're committed to not increasing the rate of in their manifesto.

This might lead to a rush to the exit, as entrepreneurs seek to accelerate sales. But given that a company sale process can take between 6 and 18 months it’s only those that are well down the track that could do anything before the date of the “fiscal event”.  If the change doesn’t happen until the start of the next tax year, then expect it to drive M&A activity, and buyouts.    If CGT does end up at 45% it ought to fuel interest in Employee Ownership Trusts as a means of exit potentially allowing the vendors to pay no CGT.

Conclusion

Expect the benefits of certainty and the prospect of investment measures to be a stimulus while the disruption of tax changes and potential geopolitical worries act as a counterbalance.  My feeling overall is that M&A activity will benefit and that we’ll see a gentle rise in activity across the rest of 2024.


VALUING START UPS AND EARLY STAGE BUSINESSES

Start up valuationValuations are quantitative and we rely heavily on financial and other numerical inputs.  Not only that valuations get better the more financial information is available.

This is why start-ups and early stage businesses can be difficult to value.  For a valuer there’s a death-zone somewhere between seed funding and the emergence of sustainable financial performance.   As anyone doing business in and around Cambridge will tell you most start-ups have a spell when there’s few reliable numbers to work with.  So how can we value businesses when they’re in the data death-zone?

Comparable Transactions: Of course no two companies are identical but acquisitions of “somewhat” comparable start-ups can provide useful reference points.  Without usable financials we can compare based other metrics – for example IP portfolios, number of subscribers or drug pipelines.  It may feel like horse trading and exact matches are rare, but a couple of close comparables can support a relatively accurate valuation.

Cost Approach:  While some entrepreneurs might not agree, until a company passes a meaningful proof-of-concept milestone, a start-up is valued on a time and materials basis, if that. A potential purchaser might add a premium for timing and the cost of trial-and-error, but will mostly view early stage technology as something they could recreate internally.

Transactions in Start-up’s Own Shares: This is a bit like calculating the market cap of public companies; start-up valuation can be derived from the value of its individual shares. To use this approach one has to assume that the transaction was fairly negotiated at arm’s length and by a professional investor. Not all equity shares are equal and simple multiplication, while widely used, won’t often work. But a well-negotiated funding round can provide a usable value indicator.

Rules of Thumb can sometimes be used, but this is best left for corroboration of other methods.  For example the Berkus Method (invented by US business Angel Dave Berkus) seeks to “price” different qualitative stages of a start up’s development such as having a sound idea, a prototype, or a decent team and ascribing a fixed $500k value to each step.    One could defend this slightly arbitrary approach because if enough business angels use.

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Use the Private Companies Price Index (PCPI) with caution in Business Valuations

The Private Companies Price Index or PCPI is a widely reference index of private company exit multiples published by BDO.   It is useful for establishing trends in the market.   However from what I can see its often used in Business Valuations, call me a cynic but I suspect this may be partly because its widely available and free?  I’ve always said it should be used with caution.   

PCPI-Q2-15So I was interested to read of the recent case of Foulser and Foulser v HMRC, part of a long running serial litigation concerning a failed tax avoidance scheme, and the transfer of two food companies.  The valuation of the companies was in dispute, and two valuers presented different methodologies.  This roundly rejected one valuer’s use of the PCPI as the best indicator of price earnings multiple to be applied saying "There is no transparency of the PCPI. No information is available as to the number of private company acquisitions on which the average P/E ratio is based. Nor is anything known about the companies concerned, including their activity and size. It is thus impossible to take any view on comparability."

The problem in this case wasn’t that the PCPI is of no use, rather that it was a poor measure to focus exclusively on.   When I’m doing a business valuation I’d typically look to use it as additional data to corroborate more specific and transparent data on comparable companies and comparable transactions.

To illustrate why this went to law you only have to look at the taxpayers valuation of £243,750 versus the HMRC valuation of £2.1M.    The tribunal came out at £1.75M in the end.

Read about our business valuation services at PEM


Cambridge and East Anglia Businesses asked to think strategically about growth

Flyer_front_cover_Cambs_Oct15With 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.

The seminar will run from 8.30am to 12.30pm at The Trinity Centre in Cambridge on 22 October. Registration is free; for more details or to book, please visit http://www.pem.co.uk/corporate-finance/growth-cambs


Valuation neither art nor a science?

It’s often said that valuation is neither an art nor a science but a little of both.  I’m sure I’ve said something along those lines myself.  Clearly it’s based on some hard data, but then the art is in building a convincing defensible case often based upon a number of judgements.    So I was interested to read a recent blog post by valuation guru Aswath Damodaran (Professor of Finance at the Stern School of Business at New York University where he teaches corporate finance and equity valuation).  

He takes the line that valuation is neither an art nor a science but a craft.   As he puts in unlike, say, Mathematics valuation has principles but not at the level of precision to be a science.    It’s not an art he says because you can’t just let your creative juices flow and make things up.   He reckons it’s more like a craft, more akin to cooking or making things with wood.   It has rules, but requires adjusting and “crafting” for each set of circumstances.

His other key points, which bear repeating, are that a valuation must have a narrative.  I’ve blogged on this before – but as he puts it Valuation = Story + Numbers.   Also valuing an asset is different from pricing it – “much of what passes for valuation, in practice, is really pricing, sometimes disguised as valuation and sometimes not”.   I've certainly seen a few technology company valuations around Cambridge which are at the "pricing disguised as valuation" end of the spectrum.

Read about our Cambridge based business valuation team at PEM


Why revenue multiples aren't very helpful

In some industries people talk about multiples of revenue when working out what their business could be worth.  It has some relevance in some industries which use it as a metric (financial services/advisory for example) and in early stage businesses where profit is an alien concept.

However for the most part it needs to be used with care as a secondary measure - and here's why.

Revenue is generally a poor indicator of value.   Its rather like focussing on cost per square foot of an office building.   But assessing the price for accommodation as rental/square foot will be driven by other factors, including quality but above all by location.  Or location location location.   So office space in a fenland village, for example, is going to be less per square foot than in Station Road Cambridge.

When we're selling a business potential buyers look at a number of financial metrics of which revenue is one.  But of course its not the only one, and as you'd expect profit is usually most important.  Specifically EBITDA as it can be a good proxy for cash generation.   A buyer will also be looking at qualitative aspects of the business or value drivers, that will influence its price/valuation.  These might include perceived weaknesses such as customer concentration or over dependence on the vendor.  In contrast positive value drivers could include having a strong intellectual property portfolio or significant market share/quality customers.

Business typically don't sell for multiples of revenue but for fractions of revenue as the chart (of US data) below shows

What this does show clearly is that revenue multiples vary over time and by sector.  

So when a company sale is reported as being an impressive multiple of revenue its probably because it has some other factor driving the sale - technology and intellectual property for example.

If you need a business valuation for whatever reason visit PEM Business Valuations to read more.

 

 

 


Stats and stories: why valuations need both

Aswath-DamodaranIn a recent blog post, Dr Damodaran (Professor of Finance at New York University and something of a ‘valuation celebrity’) highlights the need for both numbers and narrative when valuing a business:

“If you do a good valuation, it’s like composing a tune,” He says. “So it forces you if you’re a storyteller to be disciplined. And it forces you if you’re a numbers person to think about the narrative.”

Many valuers suffer from the illusion that numbers ensure precision, objectivity and control, he explains. Yet figures can be just as biased as words, and worse are protected by the belief that ‘numbers don’t lie’. Damodaran underlines a few key dangers of a numbers-heavy approach:

-         the valuations become mere tools used for sales pitches or to confirm pre-conceived values

-         endless line items can lead to the creation of a business that only exists in ‘spreadsheet nirvana’, not to mention hair-splitting about inputs

On the other hand, Damodaran warns against narratives unrestrained by numbers, which can fast become fairy tales. Further, relying solely on narrative makes measuring progress difficult, as it provides no obvious benchmarks.

Read about PEM Corporate Finance's business valuation service based in Cambridge


Business Valuation Basics: Four Key Questions

Business valuation can be complex but the underpinning of any good valuation assessment is the answers to four simple questions:

What is being valued?FourQuestions

The first step is to clearly define what is being valued. If it’s a going concern – i.e. an ongoing trading business - then it is the income stream of the business that is being valued.

A business is nothing more than a group of assets – people, ideas, processes, products, intellectual property (especially in technology companies), and equipment that together produce an income stream.  If there are any assets not used in the generation of profits, they get excluded from the valuation (and added back separately if you’re valuing the shares of a company for example).  A good example might be a surplus investment property held in a company.  Conversely if there are assets not owned by the business but used in generating profits, they must be contributed to the business by the owner or the cost of acquiring the assets needs to be taken off the valuation.

You also need to clarify if you’re valuating the assets or the equity of the business. An assets valuation assumes the seller retains all non-working/non-interest bearing liabilities of the business and, in a hypothetical sale, pay them off with cash received from the purchaser of the business. If the equity of the business is being valued, it is assumed the hypothetical buyer would get all assets of the business and assume all liabilities as well.

Value to Whom?

The answer can be an individual, investment group or another company. Once this question is answered, all the factors adding to or detracting from the valuation need to be factored in.   So a strategic buyer who sees potential in the business will value it at more than a similar buyer without any special reason to be interested in it.   I’ve seen some Cambridge technology businesses valued for well above their asset value, or any reasonable assessment of an income multiple – simply because their technology had true strategic value to the purchaser.   For example we advised on the sale of a pre-revenue business where the North American purchaser had decided to invest in a particular area, and purchasing my client meant that they would save around 2 years “time to market” over developing the technology in-house.   They thus had a pretty well developed idea of what they were prepared to pay for it.

What Definition of Value?

An alternate value definition is fair market value. Selling a business for maximum value can be a frustrating task. First, what is the maximum value of a business? Actually nobody knows – and any broker, corporate finance house, or M&A adviser who offers you a guaranteed price needs to be challenged.  How will the seller know if a particular offer he receives is the best he can get?  And would he get more if he waited?

This can be a difficult judgement for business owners who are thinking of selling – and it really helps to have an experienced M&A adviser giving input to what would be a realistic price given the nature of buyer, seller and the market.  Add the possibility that the maximum value might include some vendor financing, in some form of earnout perhaps, then the seller needs to consider, assuming the buyer’s ability to pay will in part come from future profits of the business, whether the buyer will do a good job of running the business once he takes over.  Faced with the “what is maximum value” dilemma, in practice sellers need to make a reasoned assessment of fair market value before embarking on a sales process.  We always invest time and resource in helping business owners to reach a thoughtful assessment of what would be a realistic “price expectation” ahead of a sale process.

Fair Market Value

What is “Fair Market Value”?  It’s the price at which an asset would change hands between a willing buyer and willing seller, both of whom are suitably knowledgeable of the facts and neither are forced to do the deal.  It’s a simple definition, but of course the technical process for estimating fair market value can be pretty complex – it’s an art AND a science.  

Value as of What Date?

The fourth question to be answered before a business can be valued is “value as of what date?” And it’s not always “valuation as of today” that’s relevant.  In litigation or tax driven valuations we’re often asked to produce a valuation opinion as at a particular date in the past. Conversely, in finance it’s often a requirement to predict what the value will be at some date in the future, perhaps as part of a strategic planning exercise.

If you'd like to know more about business valuations have a look at PEM Corporate Finance Business Valuations - valuing businesses in Cambridge, East Anglia, London and beyond.


So what does Maximising Value really mean to a business seller?

ValueWhat Does Maximum “Value” actually mean when selling a business?

When the time comes for business owners to think about selling their business it is usually one or, if not the, most valuable assets they possess.   And so it’s important that they get something truly valuable in return.   Typically, that’s money.   But most transactions have lots of other valuable features – so in company sales it’s not just about the money.

When a company owner hires an M&A adviser like PEM Corporate Finance to work with him or her on the sale of his/her business we are typically charged with helping to maximize value.  But not all business sellers appreciate fully that “value” can mean much more than money.   “Value” can of course be extracted in many forms other than cash, such as:

  • Loan Notes
  • Earn-out agreements
  • Releases of liabilities, such as guarantees.
  • Waiver of contingent liabilities
  • Ongoing benefits, such as insurance coverage or use of a vehicle or premises
  • Consultancy agreement for the Vendor
  • Employment agreements for employees
  • Agreement to lease certain real estate or other assets

In the sale preparation process, we work with Vendors to determine what they would enjoy or find value in.  Of course there’s no telling what a strategic buyer might be prepared to pay until we can get them into a competitive process, but its useful to prioritize before going into an auction.

For example:

  1. Cash at closing
  2. Long-term “market” lease of property that the Vendor owns personally or in his/her pension fund
  3. Firm obligations to pay cash post-closing – i.e. deferred consideration rather than earn out.
  4. Employment agreements for top 3 executives
  5. Earn-out agreements
  6. Release of contingent liabilities

This priorities list can then inform the negotiation, and it’s a useful expectations setting exercise ahead of the sale process. 

So “maximising value” relates to anything that is of value to the seller.  It will probably should be much more than cash because the buyers have a limited amount of cash they can provide at closing, and yet they usually have other “things of value” they can deliver if the negotiation is skilfully handled.  This is one reason why its better to have skilled experienced M&A/corporate fiannce advisors on your side rather than working with a brokerage which simply puts buyers and seller together and then leaves them to it.


How - and why - to value your company - a practical approach to Business Valuations

ValueWe're once again running our Business Exit Strategies seminars this autumn.   These are not just about selling out.   Many of our attendees are looking at longer term planning, and the topics we cover including how to build value in the company through grooming, saving tax, and valuation can all help with such planning.

People often need formal valuations for the tax authorities, or perhaps during divorce or a shareholder dispoute.  But its just as important to measure how the value of your businsess is growing as you execute your plan.

We cover how to value your business in the event.   There are many myths out there about business valuations.  It is probably true that its an art, but its also a science.  We try to convey the basics, and to debunk some of the myths that are peddled about this important subject.   I promise we do this in a lively and interactive way - no dry theoretical content.

Other key topics covered include putting in place your ownership strategy : succession planing : management buyouts : tax planning : selling your company : negotiating the deal.

The events are being held in Northampton, Stevenage and Brentwood on 7th, 21st and 28th November.

Visit our website for full details and to book or you might like to call Peggy on 01223 728280 and she can take your booking personally.


Enterprise Value v Equity Value don't mix apples and pears

Apple Googole
At our regular Business Exit Strategy Seminars one of the topics we cover is how to value a business, including the important distinction betweem a businesses Enterprise Value and its Equity Value.   This disticntion has suddenly become topical as Google's Enterprise Value has just overtaken that of Apple.