Exits

Wake up to reality

Mar 09 issue

If you think your business is still valued at last year’s prices, then think again. Marc Barber looks at what companies are really worth in today’s market.

What a difference a year makes. Twelve months ago, vendors were desperate to find a buyer to get taper relief on a sale after Chancellor Alistair Darling introduced a capital gains tax rate of 18 per cent. Today, anyone looking to sell has a host of different and far more challenging problems to face.

Richard Glasson, CEO of marketing agency Gyro International, says: ‘People who have missed the boat of the last three to four years need a pretty good reason to sell at the moment, either because they can see their business model is running out of steam or they are staring in trepidation at their cash flow.’

That’s not a particularly attractive proposition for acquirers when protecting cash flow and margins are the main priorities. Mark Wignall, chief executive of Matrix Private Equity, observes: ‘The reason that so few deals are being completed, and why the pipeline is so thin for everybody at the moment, is that sellers aren’t selling unless they’re distressed.’

Well runs dry
The lack of capital resource from the banks has seen the funding for mergers and acquisitions (M&A) virtually dry up.

Graham Cunning, regional director of Scotland for acquisition finance at Clydesdale Bank, observes that deals are happening, albeit with a far greater degree of caution.

‘To be honest, I think the way a deal is being done now is how it should’ve been before. Perhaps that’s why we’ve got money and other [banks] don’t,’ he says breezily. ‘The process is not that different – it should involve a bank and a private equity house sitting down and conducting an assessment before an initial offer of funding. You’re probably talking an extra ten or 20 per cent on the time to do a deal.’

Using multiples of profit to price a business has always been a less-than-exact science and Cunning notes standard ratios have taken a tumble. ‘Typically, for deals up to £50 million, you’re probably only going to see three times earning before income, tax, depreciation and amortisation (EBITDA). It depends on the sector, but you would have been looking at four or five times EBITDA last year.’

Open for business
The good news is that deals are still going through. At Gyro, Glasson has overseen nine acquisitions over the past two years, seeing turnover rise to around £100 million. He says the company will be looking to make another couple of acquisitions over the next 18 months, with backing from a US-based private equity firm and a credit line with HSBC.

Chris Williams, a partner at Cobalt Corporate Finance, which specialises in mid-market technology, media and telecoms companies, comments that ‘deal volumes are down dramatically. I would say that they will remain so for straightforward M&A for at least another six months and probably for the whole of 2009.’ For good businesses with strong intellectual property rights and technology, Williams says deals remain on the table, especially as ‘there are a lot of corporates with good balance sheets in every sector who can acquire smaller businesses’.

For the latter type of disruptive, fast-growth company, surrounded by corporate suitors, ‘standard EBITDA multiples or price-to-earnings (p/e) ratios have never been relevant other than as a background context. If a company creates a new technology that unlocks a market worth £1 billion to a Microsoft-type organisation, it’s never been about a ratio’.

When it comes to less revolutionary types of businesses, Williams also warns against looking at earnings multiples to get a sense of value within a sector. ‘I think it’s one of the worst times in history to use a p/e ratio,’ he states. ‘The pace of change in the market has been so fast, we do not have perfect information.’

Glasson says the earnings multiples of Gyro’s listed competitors are ‘clearly a nonsense’ at the moment, so they couldn’t be used as a reference point when doing a deal in the private sphere. In an age where cash has become the equivalent of a rare mineral, equity will be the mainstay of many deals.

Previously, where a deal might have included 20 or 30 per cent of equity, explains Glasson, it’s more likely to be 50 or 60 per cent now. ‘We haven’t done any 100 per cent equity deals, and I’d be a bit cautious about doing them, but certainly there are lots of those around at the moment, I think.’

It is interesting then to hear Steve Rebbettes, operations director at BCMS Corporate, which specialises in selling privately owned businesses, say that he’s seen deal volumes remain steady and that pricing is yet to change significantly.

‘In the last eight weeks we have done £33 million worth of deals in the SME sector, so that’s pretty healthy and on a similar level to last year when we completed 11 deals in the same period compared to nine this year. But, that said, average deal values have increased.’

According to Rebbettes, these are not distressed deals from predatory buyers or specific to a sector. ‘Anybody who is going after a weak business is probably not that wise,’ he states. ‘It’s the stronger businesses that are more in demand.’

Specialising in the mid-market, Rebbettes claims the number of companies looking to buy has increased, with interest coming from cash-rich businesses and high net worth individuals. He isn’t surprised by the upsurge in demand. ‘If you think about it,
if you’re a large company and you’re losing market share or customers, a quick way to regain that is to make an acquisition. In an odd way, there can be a spike during a recession in sector to sector acquisitions.’

He insists that valuations haven’t dropped: ‘Market forces are kicking in.

If you have more buyers than sellers, that has an upward impact on price.’ A company which is making a profit and has three or four companies looking to buy it, will always go for a decent amount. ‘Ideally, we want companies with strong balance sheets who can buy outright. We don’t mind some of it being in paper, provided the bulk of it is in cash.’

Smell the coffee
The general assessment of the buy-out market seems to be somewhat different. Wignall argues that deals will remain in stasis until there is a wider acceptance among entrepreneurs that the world has changed. ‘People are still looking to value
or sell their companies at the fully taxed p/e ratio of eight to ten. And that is applied to earnings which, in the current environment, have questions about them in terms of maintainability.’

He says he finds it ‘staggering’ that management teams are trying to negotiate cash-out deals. He continues: ‘There is an aspect of management teams and business owners having their heads buried in the sands. I feel pretty confident, I’m afraid, that things will get worse and management teams are ignoring such forecasts.’

New strategies
A reality check is needed, insists Wignall, if the market is to get moving again. Adrian Alexander, a partner at professional services firm Mazars, observes that there is less ‘room for gamesmanship’ when negotiating a deal, and that now is ‘the time for realism’. He says: ‘If you had a deal conceived pre-September or October, holding the price and structure has been difficult. People on all sides need to take a deep breath and figure a way to do it. If someone was slightly reluctant or half-hearted, then a deal falls apart very quickly.’

Assuming interest in a deal remains, then the structure may be altered. ‘So what would have been an all-cash deal now involves a loan note,’ he comments, noting that he fully expects a rise in strategic alliances, joint ventures and, like Gyro’s Glasson, mergers with no cash exchanging hands, so that overheads are cut and equity shared. ‘Egos will have to be put to one side,’ adds Alexander.

Whereas debt may have been taken for granted in days gone by, Alexander observes that now it’s the first thing to be discussed. ‘All conventional rules have gone out the window as far as funding goes; you have to get the [backers] around the table early and see what their appetite is.’

Clydesdale’s Cunning says that ‘we’re in a twilight zone’ when it comes to expectations and pricing. ‘I recently saw a couple of deals which have been priced a lot more sensibly, but I had one where the vendor is holding out for last year’s price. I suspect he’s in for a pretty nasty shock – either he’s posturing to get a buyer to come toward the figure he wants, or when the first round of offers come in he’s going to reject them and look to sell the business in a few years’ time.’

The danger is to hold out for the types of prices being paid 12 to 18 months ago. Cunning explains: ‘If I was an entrepreneur, the conundrum I would have is: my business certainly isn’t worth what it was last year. But to be honest with you, last year’s value wasn’t really real. It might have felt real at the time, but we were right at the top of the cycle. So they now have two stark choices. They either accept £12 million or £15 million for a company that had been valued at £20 million, or they trade on for a period and hope the market picks up.’

That uptick in value may not occur for some time. Cunning, like Wignall, uses the term ‘reality check’, saying entrepreneurs must adjust to a different, harsher economic order. No one is suggesting such a shift is easy, especially if you’ve spent the previous five or so years building up your business and felt you had everything in place for a sale.

Move on
So if your company is performing robustly and your reasons for an exit are sound, such as reaching an age where you want to explore other interests, then pragmatism is the order of the day. Cobalt’s Williams says: ‘For people like that, my advice is: be realistic. You have to put the current price expectations into the market and the current market won’t change much this year. Values for mainstream businesses have come down.’

For those management teams that are maintaining market share and remaining profitable, the best option may be to keep focusing on the business. Some would argue that’s what you should be doing anyway.

Dan Conlon, founder of data storage specialist Humyo, doesn’t believe in exit strategies. ‘Businesses are there to make money and as soon as people talk about the value of users or the strategic value of technology, I get extremely worried. The best strategy is to build a product or service that people want and value and are prepared to pay money for. That encapsulates all the other strategic elements.’

Although only 28, Conlon can speak from experience, having sold his first venture for £5.9 million in 2004. His ambition for Humyo is undimmed by the recession and he is confident he can tap the ‘huge potential’ he sees in his business.

While an exit is the last thing on his mind at the moment, he is adamant that creating a profitable concern, by definition, makes a business desirable, whatever the macroeconomic environment. ‘If you have a business that is profitable, you don’t need an exit strategy. It’s entirely up to you what you do and when.’


Editor's View Business Bulletin Trailblazers Business Tools Finance Expansion Strategy Leadership Flotation Exits Columns Enterprise News Deal Listings Backchat	Exits Wake up to reality Mar 09 issue If you think your business is still valued at last year’s prices, then think again. Marc Barber looks at what companies are really worth in today’s market. What a difference a year makes. Twelve months ago, vendors were desperate to find a buyer to get taper relief on a sale after Chancellor Alistair Darling introduced a capital gains tax rate of 18 per cent. Today, anyone looking to sell has a host of different and far more challenging problems to face. Richard Glasson, CEO of marketing agency Gyro International, says: ‘People who have missed the boat of the last three to four years need a pretty good reason to sell at the moment, either because they can see their business model is running out of steam or they are staring in trepidation at their cash flow.’ That’s not a particularly attractive proposition for acquirers when protecting cash flow and margins are the main priorities. Mark Wignall, chief executive of Matrix Private Equity, observes: ‘The reason that so few deals are being completed, and why the pipeline is so thin for everybody at the moment, is that sellers aren’t selling unless they’re distressed.’ Well runs dry The lack of capital resource from the banks has seen the funding for mergers and acquisitions (M&A) virtually dry up. Graham Cunning, regional director of Scotland for acquisition finance at Clydesdale Bank, observes that deals are happening, albeit with a far greater degree of caution. ‘To be honest, I think the way a deal is being done now is how it should’ve been before. Perhaps that’s why we’ve got money and other [banks] don’t,’ he says breezily. ‘The process is not that different – it should involve a bank and a private equity house sitting down and conducting an assessment before an initial offer of funding. You’re probably talking an extra ten or 20 per cent on the time to do a deal.’ Using multiples of profit to price a business has always been a less-than-exact science and Cunning notes standard ratios have taken a tumble. ‘Typically, for deals up to £50 million, you’re probably only going to see three times earning before income, tax, depreciation and amortisation (EBITDA). It depends on the sector, but you would have been looking at four or five times EBITDA last year.’ Open for business The good news is that deals are still going through. At Gyro, Glasson has overseen nine acquisitions over the past two years, seeing turnover rise to around £100 million. He says the company will be looking to make another couple of acquisitions over the next 18 months, with backing from a US-based private equity firm and a credit line with HSBC. Chris Williams, a partner at Cobalt Corporate Finance, which specialises in mid-market technology, media and telecoms companies, comments that ‘deal volumes are down dramatically. I would say that they will remain so for straightforward M&A for at least another six months and probably for the whole of 2009.’ For good businesses with strong intellectual property rights and technology, Williams says deals remain on the table, especially as ‘there are a lot of corporates with good balance sheets in every sector who can acquire smaller businesses’. For the latter type of disruptive, fast-growth company, surrounded by corporate suitors, ‘standard EBITDA multiples or price-to-earnings (p/e) ratios have never been relevant other than as a background context. If a company creates a new technology that unlocks a market worth £1 billion to a Microsoft-type organisation, it’s never been about a ratio’. When it comes to less revolutionary types of businesses, Williams also warns against looking at earnings multiples to get a sense of value within a sector. ‘I think it’s one of the worst times in history to use a p/e ratio,’ he states. ‘The pace of change in the market has been so fast, we do not have perfect information.’ Glasson says the earnings multiples of Gyro’s listed competitors are ‘clearly a nonsense’ at the moment, so they couldn’t be used as a reference point when doing a deal in the private sphere. In an age where cash has become the equivalent of a rare mineral, equity will be the mainstay of many deals. Previously, where a deal might have included 20 or 30 per cent of equity, explains Glasson, it’s more likely to be 50 or 60 per cent now. ‘We haven’t done any 100 per cent equity deals, and I’d be a bit cautious about doing them, but certainly there are lots of those around at the moment, I think.’ It is interesting then to hear Steve Rebbettes, operations director at BCMS Corporate, which specialises in selling privately owned businesses, say that he’s seen deal volumes remain steady and that pricing is yet to change significantly. ‘In the last eight weeks we have done £33 million worth of deals in the SME sector, so that’s pretty healthy and on a similar level to last year when we completed 11 deals in the same period compared to nine this year. But, that said, average deal values have increased.’ According to Rebbettes, these are not distressed deals from predatory buyers or specific to a sector. ‘Anybody who is going after a weak business is probably not that wise,’ he states. ‘It’s the stronger businesses that are more in demand.’ Specialising in the mid-market, Rebbettes claims the number of companies looking to buy has increased, with interest coming from cash-rich businesses and high net worth individuals. He isn’t surprised by the upsurge in demand. ‘If you think about it, if you’re a large company and you’re losing market share or customers, a quick way to regain that is to make an acquisition. In an odd way, there can be a spike during a recession in sector to sector acquisitions.’ He insists that valuations haven’t dropped: ‘Market forces are kicking in. If you have more buyers than sellers, that has an upward impact on price.’ A company which is making a profit and has three or four companies looking to buy it, will always go for a decent amount. ‘Ideally, we want companies with strong balance sheets who can buy outright. We don’t mind some of it being in paper, provided the bulk of it is in cash.’ Smell the coffee The general assessment of the buy-out market seems to be somewhat different. Wignall argues that deals will remain in stasis until there is a wider acceptance among entrepreneurs that the world has changed. ‘People are still looking to value or sell their companies at the fully taxed p/e ratio of eight to ten. And that is applied to earnings which, in the current environment, have questions about them in terms of maintainability.’ He says he finds it ‘staggering’ that management teams are trying to negotiate cash-out deals. He continues: ‘There is an aspect of management teams and business owners having their heads buried in the sands. I feel pretty confident, I’m afraid, that things will get worse and management teams are ignoring such forecasts.’ New strategies A reality check is needed, insists Wignall, if the market is to get moving again. Adrian Alexander, a partner at professional services firm Mazars, observes that there is less ‘room for gamesmanship’ when negotiating a deal, and that now is ‘the time for realism’. He says: ‘If you had a deal conceived pre-September or October, holding the price and structure has been difficult. People on all sides need to take a deep breath and figure a way to do it. If someone was slightly reluctant or half-hearted, then a deal falls apart very quickly.’ Assuming interest in a deal remains, then the structure may be altered. ‘So what would have been an all-cash deal now involves a loan note,’ he comments, noting that he fully expects a rise in strategic alliances, joint ventures and, like Gyro’s Glasson, mergers with no cash exchanging hands, so that overheads are cut and equity shared. ‘Egos will have to be put to one side,’ adds Alexander. Whereas debt may have been taken for granted in days gone by, Alexander observes that now it’s the first thing to be discussed. ‘All conventional rules have gone out the window as far as funding goes; you have to get the [backers] around the table early and see what their appetite is.’ Clydesdale’s Cunning says that ‘we’re in a twilight zone’ when it comes to expectations and pricing. ‘I recently saw a couple of deals which have been priced a lot more sensibly, but I had one where the vendor is holding out for last year’s price. I suspect he’s in for a pretty nasty shock – either he’s posturing to get a buyer to come toward the figure he wants, or when the first round of offers come in he’s going to reject them and look to sell the business in a few years’ time.’ The danger is to hold out for the types of prices being paid 12 to 18 months ago. Cunning explains: ‘If I was an entrepreneur, the conundrum I would have is: my business certainly isn’t worth what it was last year. But to be honest with you, last year’s value wasn’t really real. It might have felt real at the time, but we were right at the top of the cycle. So they now have two stark choices. They either accept £12 million or £15 million for a company that had been valued at £20 million, or they trade on for a period and hope the market picks up.’ That uptick in value may not occur for some time. Cunning, like Wignall, uses the term ‘reality check’, saying entrepreneurs must adjust to a different, harsher economic order. No one is suggesting such a shift is easy, especially if you’ve spent the previous five or so years building up your business and felt you had everything in place for a sale. Move on So if your company is performing robustly and your reasons for an exit are sound, such as reaching an age where you want to explore other interests, then pragmatism is the order of the day. Cobalt’s Williams says: ‘For people like that, my advice is: be realistic. You have to put the current price expectations into the market and the current market won’t change much this year. Values for mainstream businesses have come down.’ For those management teams that are maintaining market share and remaining profitable, the best option may be to keep focusing on the business. Some would argue that’s what you should be doing anyway. Dan Conlon, founder of data storage specialist Humyo, doesn’t believe in exit strategies. ‘Businesses are there to make money and as soon as people talk about the value of users or the strategic value of technology, I get extremely worried. The best strategy is to build a product or service that people want and value and are prepared to pay money for. That encapsulates all the other strategic elements.’ Although only 28, Conlon can speak from experience, having sold his first venture for £5.9 million in 2004. His ambition for Humyo is undimmed by the recession and he is confident he can tap the ‘huge potential’ he sees in his business. While an exit is the last thing on his mind at the moment, he is adamant that creating a profitable concern, by definition, makes a business desirable, whatever the macroeconomic environment. ‘If you have a business that is profitable, you don’t need an exit strategy. It’s entirely up to you what you do and when.’