The How-To: Five Ways To Better Your Business' Chances At A Successful Exit
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As the Middle East’s corporate landscape continues to develop, there is a growing need for owner-managed businesses in the region to consider, plan and prioritize their succession planning and exit planning. We, at Lumina Capital Advisers, are witnessing a whole new emphasis on exit planning by owner-managed businesses in the region, and many of these enterprises that started 10-15 years ago are now sizeable businesses, with significant value.
Typical owner-managed businesses can range from the smaller US$5-10 million range to in excess of $100+ million and beyond in value. We specialize in working with owner-managers on mergers and acquisitions (M&A) and corporate financing transactions across a range of sectors including healthcare, education, hospitality, manufacturing and distribution and construction sectors. On the buyer angle, as the large conglomerates (listed and private companies) in the region look for new ways in which to deliver sustainable top line growth, a combination of divesting non-core subsidiaries and acquisition of companies in their focus sectors are becoming an integral strategic tool for these groups to deliver on their stated growth plans.
This focus, combined with owner-managed businesses seeking exits, are creating a perfect storm for private company M&A in the UAE, and the region. If you are an owner-manager, it is likely that selling your business is the culmination of a lifetime’s work- a once-in-a-lifetime transaction. Your prevailing buyer pool is likely to be highly professional, experienced in M&A, and consisting of large conglomerates with specialist departments or private equity purchasers.
An acquisitive conglomerate or private equity fund would typically screen literally hundreds of opportunities annually. So, they will expect you to be well-prepared, the business structured for a sale, and shareholders ready to execute a transaction with very clear objectives, parameters and defined strategic plans for the business post sale or merger. In our experience, there are some key must-haves in order to not only generate buyer interest, but to give yourself the best chance of actually successfully completing the transaction intended.
1. Strong financial systems and timely audited reports
Timely and up-to date accounting and controls will significantly ease the burden of the often detailed due diligence process that can ensue. In addition to inspiring confidence to a buyer about the management and operations of the business, it spares months of data collection and information gathering on the seller’s part, which often means taking their eye off the ball and the decline of day-today operating performance. More importantly, a typical acquisitive company looks at several potential acquisitions a year, and quite often many at the same time, so this aspect is imperative, to avoid “deal fatigue.”
2. Keeping personal and business dealings separate
Having founded and guided an organization from its very conception to a flourishing and thriving business, many owner-managers view the business as an extension of themselves. Many owner-managers may therefore find it difficult to separate personal and business dealings, often leading to complex carve-out structures of personal versus business assets, unnecessary operating dependencies, and related party transactions. This is bothersome to a buyer– why? Because they cannot accurately ascertain if the business performs the same without these dependencies, and it is difficult for them define to what extent. This adds a level of risk perception which then reduces the potential price or value.
3. Key man risk
This comes to the heart of the “succession planning” issue. Grooming a second-tier management team that is competent, well-motivated, and have the authority and skills to lead the business post-sale is critical to capturing the ongoing operating sustainability of the business– which, in short, is how the business is valued, i.e. on its sustainable future earnings, and not on the past results of perhaps one key person, who is likely to transition out of the business post sale. In parallel with this, the business would be expected to have documented methodologies, decision making processes, operating procedures, manuals and ancillary policies. We often ask the question that if the owner-manager takes a 12-month vacation without being able to be contacted, will the business continue to function and show similar operating results for that year? If the answer is “yes,” you’re in good shape. If the answer is “no,” then you have work to do prior to considering a sale.
4. Revenue diversification
If your business is dependent on a handful of clients, projects, a particular supplier, or a particular personal or business relationship, this increases the level of risk of the future operating earnings sustainability and hence negatively impacts value. If you have diverse sources of revenue this will ensure there is less risk, and underpin the value of the business.
5. “Focused growth” versus “just growth”
A typical mid-sized owner-managed business’ core appeal to a potential buyer is its fundamental specialty and niche market. Growth in that focused market through customer revenues and operating earnings is what a buyer is looking for. Revenue streams outside of this core focus, may be viewed as a distraction and non-repeatable and usually taken at a discount or ignored. For example, one-off projects or gains from non-core trading activity. However, this is distinctly different from diversification of revenue streams mentioned above, that are within the business specialty (rather than without). For example, a healthcare business that generates diverse revenue from different medical specialties will be sold at a premium to a healthcare business that also generates part of its financial metrics from café’s and gyms for example.
What are you worth? How to assess a business offer
When selling your business, you can generally expect the offered price to be a multiple of annual profits. The most common profit measure upon which buyers are likely to assess the value of your business is EBITDA (earnings before interest taxes depreciation and amortization). The EBITDA measure is often used as a proxy for the cash generated by the business, and a multiple is often applied to value the business as an approximation to the future cash flow that the business is likely to generate for the buyer, in today’s terms. EBITDA strips out the effect on many non-cash charges such as depreciation, provisions and financing costs and taxes. It therefore represents the operating cash profits that the core operations of the business generate on a yearly basis (subject to growth/decline), in return for the lump sum invested, i.e. the purchase price.
It is important to note that the value of the business derived above is the value attributable to all stakeholders in the business– equity, debt and long-term financiers (such as finance companies providing long-term equipment leases, employees accruing their end of service benefits yet to be paid, and so on). What most business owners fail to appreciate is the amount of attributed value implicitly embedded in the business of stakeholders, other than equity holders. This often leads to a number of misunderstandings and negotiating points on purchase price versus business valuation between seller and buyer. We examine below the typical adjustments made to both EBITDA and value, in order to arrive at a fair estimate of what the equity price should be.
Adjustments to EBTDA or earnings
When assessing the earnings of a business, what a buyer is typically assessing is the expected sustainable level of earnings of the business into the future. Most owners expect that the higher the most recent year earnings are, the higher the value of this business. But there are a number of instances where this may be challenged. For example:
- One-off or non-recurring revenues. For instance, if the business benefitted from a one-off project that contributed significantly to the profits of the year, this may be adjusted downwards on the basis that this isn’t repeatable or sustainable on a future annual basis.
- Similarly, one-off costs or non-operational expenses incurred may be added back to show a higher level of earnings. For example, one-off rebranding or marketing costs, one-off legal fees incurred, charitable contributions, or a one-time cost of either expansion or closure of certain units, including staff costs.
- The shareholders’ salary is another key area of examination by a buyer. If earnings have been boosted by lower than market salaries for shareholders (who are often also the key management), often buyers will make an upward adjustment to reflect a market cost of the management. Similarly, in some cases, the reverse may apply. Every upward or downward adjustment to the adjusted EBITDA will have a multiplier effect on the value of the business.
How much value is attributable to shareholders?
We have discussed that the value of the business is attributable to all stakeholders above (the enterprise value). Once the enterprise value of the business is agreed, in our example, by the methodology described above, it is now key to examine how much of this value belongs to each stakeholder. Typically, this total value would be carved up into:
Net debt Typically bank borrowings and the capital value long-term finance leases outstanding less any cash in the business. This value is attributable to the debt holders.
Other long-term liabilities Typically employees-accrued gratuities or unfunded pension entitlements. This value is attributable to the employees.
Working capital requirements The deficit or excess of current assets (receivables, inventory and prepayments) over current liabilities (supplier payments due and other short-term liabilities due). This value is attributed to the day-to-day cash operating requirements of the business. What’s left over is then the value that is attributable to the owners or shareholders of the business.