It is a sad fact that across the UK SME market 4 out of 5 private companies will fail to sell, meaning only 20% of those taken to market achieve a successful outcome.

When selling a business, it’s crucial to have an experienced advisory team working with you.  In this series of articles, we will look at the way EvolutionCBS and our professional partners work with clients to maximise sale value, achieve the best deal structures and significantly increase their chances of a successful transaction.

The results speak for themselves, as, in stark contrast to the market average, 73% of businesses taken to market by EvolutionCBS in the past 2 years have sold successfully. In addition to this success rate, over the past 6 years our average multiple is an industry leading 8.5x EBITDA with over 63% of all deals completing without any earn out.

In the first article of this series we focused on the importance of having professional advice during the sale preparation period, to ensure that exit value is maximised.

In this second article we will cover the second of the BIG 4 reasons businesses fail to sell – Poor financial information

From the very start of the business sale process, a company’s financial performance comes under intense scrutiny. To achieve the maximum value for a business it is imperative that potential acquirers can fully understand and evaluate the financial performance of a target company.  It is one of the key acquisition criteria, being a determinant of future value, enabling the buyer to calculate Return on Investment (ROI). The clearer the financial landscape, the less risky it will appear and in simple terms less risk equals better value and more straightforward transactions.

Whilst every business uses an Accountancy firm, this is often just to produce statutory accounts and deal with tax matters. However, they can provide invaluable assistance during the sale preparation period:

Entrepreneurs Relief

Most business owners will be aware of entrepreneurs’ relief as a means of paying a reduced capital gains tax rate of 10% on a disposal of shares.

However, this is subject to fulfilling the necessary criteria which were changed in the 2018 budget. Your Accountant will be able advise you whether you will qualify and on any changes you need to make in order to qualify. No business owner wants to end up giving a big chunk of the proceeds of sale back to the government.

Accounts

Typically, buyers will need to see a minimum of 3 years statutory accounts in order to attain an accurate historical picture of the business.

Whilst these will form part of an acquirer’s valuation, they do not provide an in-depth, month by month analysis of a company’s financial performance and its cash requirements, nor do they give a view on seasonality.

For this reason, acquirers will always request monthly Management Accounts.

Many companies use accounting software, such as Sage or Xero, which can produce monthly management accounts.

For those that can’t produce them, an Accountant can provide them.

These accounts will inevitably differ from the statutory accounts, and to give the clearest picture possible, sellers must understand the differences in their reporting processes and be able to explain why these differences exist.

Adjustments

Often referred to as “add backs” and “add forwards”, adjustments are used to give an impression of how a change of ownership would affect the Profit and Loss numbers. These adjustments are made to normalise EBITDA which is often used to value companies by applying a multiple. Therefore, because EBITDA can drive the valuation of a company, normalising it to present the best financial representation makes sense.

Add Backs

Typical add backs include any items within the overheads of a business that would not be there under different ownership, this could include above market rate salaries, vehicles and other benefits for the shareholders, their family members or anyone else not essential to the running of the company. Other add backs can include one off and exceptional items not related to the day to day activities and do not recur in the future. For example, one-off legal fees and not forgetting the fees for selling the business.

Add Forwards

Add forwards are commonly (but not exclusively) related to replacement staff. A pitfall to be aware of here is where shareholders take their remuneration in a mixture of salary and dividends. It is important to note that money taken in dividend form comes off the company’s balance sheet and is not related to the Profit & Loss account of a business.

As a consequence of this and by way of example, if a shareholder receives £100,000 before tax on an annual basis, split as £20,000 salary and £80,000 in dividends then from a buyer’s perspective the profit of the business is potentially reduced by £80,000. Using EvolutionCBS’ historical, market leading multiple of 8.5x, this can effectively reduce the value of an offer by an average of £680,000.

Forecasts

An acquirer will expect to see at least 2 years’ forecast results in order to inform a valuation. After all, why would an acquirer risk spending millions of pounds on a business with no quantifiable future earnings?

Accurate, defensible forecasting is a very powerful tool in achieving high value for a business. As part of the preparation phase of our marketing process, EvolutionCBS challenges clients’ forecasts to ensure that, in meetings with potential buyers, the owners can talk through the forecasts and present them in a credible manner.

Many SME business owners do not prepare either forecasts or budgets, and in these instances we work with our clients to help them generate forecasts which are presented within the Information Memorandum or Sale Prospectus. From a buyer’s perspective a company that can show a history of accurate forecasting and budgeting presents a lower risk and therefore will give greater credence to the forward-looking numbers making them more inclined to offer at a higher level.

Best Practice

When you’re negotiating with a potential buyer you will be considerably more assured if you know your numbers and can confidently explain the forecast growth figures on which a premium price may depend.

Even if you are considering a longer-term exit, viewing your accounts from a potential buyer’s perspective is best practice for running your company in the most financially effective way possible. We strongly advise all our clients to gain a deeper understanding of their company financials, and to adopt monthly Management Accounts, Forecasting and Budgeting as basic tools for business management.

If you haven’t had your business valued recently and would like to receive a free valuation report, please visit www.evolutioncbs.co.uk/free-valuation.