In mid-February two of our clients were about to go live on transactions and then suddenly cancelled. The first was a small listed company which had agreed a price to make a small acquisition and the role of PCW was to project manage the financial and legal processes on behalf of the buyer as it did not have the spare capacity, skills or experience to manage this process on its own. The second client, was a Private Equity Investor which wanted to launch a sale process of an investee company that it had owned for some three years and wanted to outsource the whole management of the sale process to PCW.
Now there were no links between the two clients and the businesses operated in completely different markets. So, what caused them to pull the plug at the same time? The answer lie in the fact that since the 19th February 2020, global stock markets have fallen dramatically – at a rate not seen since 2008 and the start of the last recession. The stock markets have been over bought for some time and the bubble was burst by the pin of Coronavirus. At the time of writing the UK FTSE 100 had lost one third of its value in one month. So, these clients were now seeing the same thing – a big step change down in private company valuations.
For the Private Equity client, it had a set a target valuation for a sale at the end of 2019 to deliver its target cash return on investment. So, it immediately recognised that this would not be achievable under the current market conditions. As a financial investor operating out of the public eye and being able to take a long-term view, it simply put the sale process on hold and will continue to grow the company until it can achieve its target exit cash amount.
For the PLC client, it had seen a sharp fall in its share price fall and a reduction in its quoted market value. This put it in a position where the price it had agreed with the seller was at a multiple of profits which was higher than its own multiple. To continue with the acquisition at the pre-agreed price would produce a further reduction in the price of its own shares. Needless to say, the process was aborted and will only every happen in the near future, if the seller agrees to reduce the price to reflect the step-down adjustment in market values.
A recent high-profile example of the impact of the market crash is the aborted £28 billion of HP by Xerox, – a further reflection of the waves of valuation adjustments hitting the market and there will be further cases to follow in the weeks ahead.
Many private company owners struggle with link between stock market values and the value of their business. They ask the question – “well nothing has changed with my business – we are still making the same level of profits – why should this affect the price I receive for selling?”
The answer lies in the fact that the stock markets are the main external reference points for company valuations and companies listed on the stock market will have values that move up and down with the movement of the markets. The stock market value is based on a multiple of the company’s most recent profit after tax – it’s price to earnings ratio (‘p/e ratio’). A company with a p/e of 10 pre-crash is most likely now looking at a multiple of 7 based on a 30% fall in market value.
When we look to sell a privately owned property, we can check with the land registry for recent transactions within the locality of the property in order to get a good idea of what our property would sell for. For the private company sale market, only a minority of company sale prices are publicly disclosed, so there is very little price visibility. Therefore, this is why the private company sale market needs to look at the stock market values for businesses operating in the same market sector to get a reference point for valuation.
Another factor that is very relevant is the fact that stock market values reflect a forecast on what the market expects to happen to the economy in the future. So, you may not be seeing any impact on your trading performance today, but a fall in the stock market if forecasting that there is a risk that your business will see some deterioration in your business in the future. The extent of any impact will be largely dependent on the sector in which your business operates. So, for example, a business in medical supplies should prosper looking ahead, while a third-tier supplier in the motor industry will have a difficult time.
- What are the options for sellers?
Given that there has been a large downward adjustment in company valuations, where does that leave the owners of business who a month ago had hopes of exiting through a sale in a few months. For the lucky minority, you may find that events have suddenly made your business more valuable, for example, businesses in the field of medical supplies. However, for the vast majority of business owners, the exit market has been turned upside down and it for these people that this discussion document has been written.
There are many reasons why companies are put on the market for sale. The most common are as follows:
- The owner may be seeking retirement;
- For an MBO or MBI the exit is part of the original investment plan to return funds to the buyout funders;
- The business may require significant investment and hence a sale of all or part of the business is appropriate to mitigate an owner’s risk;
- The owner may feel the market is as good as it is going to get, or even worse, they may feel it could deteriorate;
- Key employees may be seeking to retire within a couple of years and could be difficult to replace; or
- For large corporates, particular subsidiaries may become non-core through changes in group strategy, or there may be a need for additional cash.
One thing in common, however, is that whatever the driver for the sale, the choice is to either delay the sale or take action to differentiate the business from the long queue of businesses now looking for a buyer in a market where there are a much smaller number of genuine acquirers.
If the decision is made to stick with the business the owner must ensure that there is a strong growth plan in place if the business is to avoid drifting and slowly bleed value over time.
If the decision is to continue with a sale in the current market, any previous sale plan needs to be torn up and re-written to address the sudden and fundamental change in the market place. The exact nature of the exit needs to be realigned and then the necessary changes to the business need to executed to ensure that it looks attractive to the new face of the buyer market.
- What do the current buyers look like?
Company buy and sell transactions will still happen, but the sentiment of the rationale will have changed. Gone for a period of time will be those buyers that were in the market to buy to find a profitable home for their spare cash resources. In times of market shock, the natural instinct of this type of buyer is to conserve cash and this will leave a big hole in the buyer market. So, what type of buyer will we see more of:
- The Bargain Hunter
- The Consolidator
- The Value Seeker
- The Trophy Buyer
We have all seen the newspaper adverts: “We buy houses for cash!”. These buyers are looking for company vendors that have an urgent need to sell. They fill a need in the market place, so I am not going to be judgemental, but sellers need to be aware that a significant discount will need to be given to this type of buyer – this is of course on top of the existing market price adjustment that everyone needs to adjust to.
The Consolidator will become more active, as much as a way of defence as a way of expansion. It is also a potential win-win for both buyer and seller. The Consolidator is primarily a competitor in some form and its objective is to grow through buying customers and turnover and removing duplication in costs. Once the costs have been removed the buyer enjoys the benefits of the resulting higher profitability and it has taken a competitor and threat to margins out of the market. This synergy upside provides some potential to discuss sharing this improvement in profitably during negotiations. The Consulting Engineering sector is a prime example of this, where there has been a succession of mergers and acquisitions in recent years, primarily to achieve a global presence.
At PCW, our team includes experience of leading successive corporate acquisition consolidation strategies and therefore we understand the mentality and processes employed by corporate buyers in selecting and completing multiple consolidation acquisitions.
This is the time that the Private Equity market will be keen Value Seeker buyers. They seek long term value and when they see a strong market driven valuation adjustment, they will seek to deploy the vast amount of capital they hold in reserve to benefit from next recovery period. The private equity options will vary depending upon the industry the seller business operates in, the quality of the management, the business growth prospects, profitability and cash generation.
Private equity buyers will want the business owners/senior management team to retain part of the company and, subject to finding the right partner, is a proven success for an owner wishing to have a partial exit and stay in for the next up-turn. In the current market, there a vast number of PE companies, most choosing in invest by different sector specialisations and time periods for holding investments. It is critical to find the right partner at the start – as you will be stuck with each other for three to five years. At PCW, our people have worked in and around the private equity market for over 30 years and have the experience to guide you to making the right choice.
The Trophy Hunter will always be in the market. Strong brands that have proven to be sustainable throughout time will always be attractive acquisition targets. However, this will have limited impact on the mainstream UK business seller market place. For the majority, an exit to a Consolidator or Value Seeker is likely to be the most successful outcome and a plan should be developed to increase the attractiveness of the business in the eyes of these types of buyer.
- Actions to be taken now
For many owners, it is the threat that the business’s performance may deteriorate that starts them thinking about an exit. If this is the case then the exit may come too late to get the best price. In this case, a recovery plan is the first step to take as discussed in:
When exiting a business, it is always important to sell some ‘growth’ to the new owners. An important part of the exit strategy, therefore, is to identify the immediate and medium-term prospects of the business and be able to sell them as benefits. These may include, for example, the following:
- Exploiting a new product range;
- New geographical markets; or
- New legislation supporting growth in a company’s products or services.
It may be beneficial for a company to have realised some upside in these areas by the time of exit to put some substance behind the claims of growth.
Possible threats to a business can have a negative impact on the attractiveness and therefore value of a business, for example:
- New and competing technology in a company’s markets;
- An adverse change in legislation; or
- Consolidation of its customers.
In these circumstances a defence strategy needs to be formulated and implemented without hesitation or the seller will pay the price in negotiations with potential buyers.
As previously stated, a key aspect to an exit strategy is making sure that the business looks like something that trade purchasers or investors would want to invest in. At PCW Consulting we believe the only way of ascertaining this with any certainty is through dedicated research. This involves talking to the relevant trade and financial organisations to clearly understand what they are interested in and why. Consequently, at any one time, PCW’s research analysts have on file thousands of acquisition criteria from businesses that are actively seeking investment opportunities. This results in a thorough analysis of the exit opportunities and will also provide a guide to the valuations that owners could expect on exit.
The process of identifying the most likely exit route and implementing the changes needed to increase attractiveness to buyers will drive outmany important aspects of the exit decision:
- Is there an optimum time to exit?
- What is the current estimated exit value?
- Does the business currently look sufficiently attractive to potential new owners?
- Will the business exit on a rising level of profitability?
For many other owners the timing of the exit is centres around the current valuation, which at the current time will be less than what the owner would like to achieve and therefore a delay in marketing the business may be the right thing to do. In many ways this can act as a catalyst to “re-booting” the future growth of the business and put in place a growth plan which includes the actions described in:
- Value improvement objectives
To improve current business values towards desired values requires specific goals to be achieved by either increasing the profits, enhancing the value of the price earnings multiple, balance sheet improvements and management of people.
Some examples of these various methods are detailed below.
- Small bolt-on acquisitions
- Remove less profitable work
- Increase or decrease level of sub-contractors
P/e ratio Enhancement
- Reduce reliance on key customers/suppliers
- Prove the business has growth opportunities in new markets or products
- Legally tie in key employees and intellectual property
Balance Sheet Improvements
- Reduce working capital to free up cash for the owners at no cost to the buyer
- Review the need for capital expenditure
- Generate cash from the sale and lease back of major assets
Any business sale preparation strategy needs the full support of those allocated the responsibility of delivering the targets set. This may be restricted to the owners of a business, but very often involves non-shareholding management. Most owners prefer not to disclose their intentions of exit, whilst others may be more forthcoming. The pros and cons of disclosure need to be weighed up and potentially incentive arrangements put in place to tie management in, but all of these aspects should be discussed with an advisor first.
Implementation of the strategy is not a not a one-off process, and it needs to be reviewed on an ongoing basis to ensure value benefits are being delivered. We, at PCW Consulting Group, have added value to businesses across a broad range of industrial sectors. Our Exec are ready to share their knowledge with you and get straight to the catalysts for your successful growth, putting checks and balances in place to give you the protective governance that you need to help you fulfil your ambitions and achieve the success you deserve.
Every initial meeting with prospective clients starts with a “Company Saleability Test”. This involves a series of questions, which collectively provide an assessment of the areas in the business that need to be addressed before a business is considered to a position to seek a buyer. If you would like to undertake a free and confidential “Company Saleability Test” with a member of our Senior Executive Team, please contact us.← Back to all articles