For business owners and entrepreneurs looking to strengthen or expand their commercial interests, buying an existing business often represents a sensible step forward.
Such acquisitions inevitably come with a number of challenges and issues to take into account. For example, it’s important to find out why the existing owner is selling up, how the staff view the sale (particularly in relation to staff morale), and how this may affect your ownership. You will usually need to invest a significant amount of money up front, as well as allocating a budget for professional fees, and ensuring you have enough working capital to help with cashflow over the first few months. And as well as honouring (or renegotiating) contracts that are already in place, you may find that some areas of the business have been neglected before the sale, requiring additional investment on top of the purchase price to have the best chance of success.
But despite these challenges, buying a business can represent a real opportunity for growth. If you do the right research and groundwork, you will know that you are buying a business with an established market for its products or services, with an existing customer base, a reliable income, a reputation to build on, and a workforce who can help you achieve your aims. With a business that is up and running, many of the potential problems will have been identified and overcome, and a business plan should already be in place.
Being able to make the most of these opportunities will also depend on two key considerations – deciding on the right business to buy, and making sure you pay the right price for it.
Finding the right business to buy
To identify the right target to enable you to expand your business interests, you will need to take into account a range of issues. These include your own strengths and abilities, the business sector (and geographical location) you’re interested in, how much you are able to invest, what level of commitment and involvement you want to have in developing the target business, and what level of profit or return you are looking for from the deal.
Some of these issues you can resolve yourself. For example, making a list of your own strengths and weaknesses, what skills and experiences you can bring to a new business, your lifestyle aspirations, and your long-term aims from an acquisition or investment, will give you a much clearer idea of the size, type and sector of business that would present the best opportunity for you.
But it’s also important at this stage to talk to your professional advisors, to help you find the best fit for your business investment, and ensure that your aims and aspirations are achievable.
The right advisors will have their own networks, databases and clients that should unlock domestic and international acquisition, and – where necessary – funding opportunities to find the right acquisition opportunities that match your aims.
Doing the research
Once you’ve identified a business that could be the right fit for your investment, you will need to research the business in more depth – and again, it is important to seek professional advice at this stage.
You need to be sure exactly what is for sale, or decide which parts of the business you are interested in buying. The vendor may be looking to sell the whole business, or just its assets such as equipment, stock and order book.
You will also need to work out the value of the business, and there are a range of business valuation methods to choose from, including earnings multiples, discounted cashflow, comparable, and asset-based valuations – all of which require an in-depth understanding of the calculations and figures used. This also means that you will need to obtain accurate financial information about the target business.
Show me the figures…
If you are considering buying a business, you will need to ask the vendors for any information you wish to see. They should be happy to provide this, although initially you may only have access to the business’ sales memorandum.
Sellers will usually ask you to sign a confidentiality undertaking or non-disclosure agreement before you can access sensitive or detailed information. They may still want to protect certain aspects of the business, so some information may be off limits until close to completion – even if you’ve signed a confidentiality agreement.
But a lot of financial information is available from other sources. For example, if the business is legally formed as a company, you can use the Companies House Service (CHS), and its WebCHeck facility, to examine business accounts including the detailed management profit and loss account, the annual return and balance sheet.
Companies House will also be able to provide information on issues such as current and resigned officers, mortgage charge data, previous company names and any insolvency information.
If possible, you should also talk to the existing customers and suppliers of the business. The vendor must be comfortable with you doing this, and you must also be sensitive to their position, but customers and suppliers may have important information affecting your valuation, and market conditions affecting the business. For example, if the vendor is being forced to sell due to decreasing profits, your valuation might be lower.
What happens once I’ve got the data I want?
Once you have examined the financial information, established a value for the assets and explored the legal conditions, you may feel comfortable in making an offer for the business. But if the offer is accepted, research and investigation into the target business’ position does not end there.
You and your advisors will then have a period of time to access the business’ books and records in more detail, which is known as due diligence. This will give you a much more realistic picture of how the business is performing now, and how it is likely to perform in the future.
There are usually three types of due diligence – legal, financial and commercial – which should ensure that there are no ‘black holes’ in the figures, unexpected legal issues or hidden market and performance concerns that would affect the sale.
The due diligence process doesn’t usually begin until you have agreed a price and terms with the seller, and the investigation period is negotiable – but most small businesses need at least three to four weeks.
A practitioner’s view
Getting an offer letter right can be a tough exercise for acquiring management teams who are not used to making acquisitions. There can be real challenges in both accessing and then interpreting financial information and this can often lead to a mismanagement of expectations between buyer and seller. The key thing is to understand the drivers of value in a business combination – this means identifying how the economics of this deal create value. This sounds easy in theory but, in practice, in a competitive auction, it can be hard to know how to structure the right deal the right way.
Central to this is getting financial information on the target – the seller and their advisor should open up a data room of financial, commercial and legal information to help acquirers piece together the right information. In the old days this used to be having a scheduled time to go to an office and browse through a series of files; now this is normally hosted in the cloud. However, it is vital that acquirers go into that data room knowing what they are looking for rather than being led by the structure that has been put in place. Serial acquirer’s get into a rhythm and can flip this process on its head and ask targeted questions that flow directly from their acquisition rationale.
There is another side to this. Often, sellers haven’t been through the process before and, especially if their advisors are brokers (rather than offering full advisory support) it can be quite a difficult process. It is common to find that the seller doesn’t understand the information requests that are sent to them because they have never had to think about value creation in this way before.
This post was written by Chand Chudasama, one of Price Bailey’s Strategic Corporate Finance Directors. If you would like to know more then please contact Chand using the form below.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.
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