Bucking the trend – how owner-managers can exit at full value

Jim Keeling, Chairman, Corbett Keeling

There is a category of sell-side M&A that, in order for sellers to realise the maximum value in an exit, requires a specialist ‘hands-on’ approach. Businesses in this category are characteristically:

• owner-managed – i.e. they have limited if any ‘institutional’ ownership;

• generating £1m to £10m annual profits;

• strong in a niche market but perhaps not yet well-known more widely; and

• operate a light-touch, efficient management structure.

As we will see, buyers looking at this ‘lower-mid market’ category are predisposed to undervalue businesses, and sellers can be susceptible to accepting buyers’ valuations. Bucking this trend is possible, but it requires focus, drive and hundreds of man hours. Such lower-mid market businesses are typically valued between £10m and £150m. Even at the bottom of this range, a modest value increase of, say, 10% is usually well worth the time and expense.

Valuing a business is subjective

Ask a hundred City analysts to value a well-known mid-size business making a £25m annual profit and, given the standard information routinely prepared for such a business, they will produce a hundred different, but very similar, valuations.

But what about valuing a relatively unknown lower-mid market business making a £5m annual profit, with only limited and non-standard information? Valuation invariably becomes considerably more subjective.

Buyers of businesses in this category often look at multiple opportunities simultaneously and commonly start from a ‘default’ valuation model, at least when initially assessing an opportunity.

Oversimplification locks away value

The default model is to multiply the most recently available historic profits of a business by the generally accepted ‘sector multiple’, i.e.

Historic Profits x Sector Multiple = Value

For sellers, this means the business they have lovingly grown and nurtured, perhaps over many years is, at least initially, simplistically valued by buyers in terms of its historic performance (sometimes a year or more out of date) and a multiple calculated as an average over a wide range of different businesses, many of which can be entirely irrelevant to the seller’s business. Inevitably this simplification ignores, or at least heavily discounts, the true strategic value of businesses – locking value away from the seller.

To unlock this value, sellers must clearly demonstrate their business’ full potential strategic and synergistic value to the best buyers.

Identifying the best buyers and demonstrating value

The buyer that will pay the most for a lower-mid market business is often not obvious, and may initially be unknown to the seller. Likewise, potential buyers often have little or no starting knowledge of the seller’s business or market.

For example, the best buyer of a health food distributor in the UK might come from any of the following buyer groups:

• German herbal medicine producers;

• US-based private equity investors; or

• Debt funds backing incumbent management.

The value of the health food distributor is not going to be the same to each of these very different buyer groups and each would look at the business through their own value ‘lens’.

Finding the best buyer requires identification of the key value drivers of the business and each potential buyer group, typically by analysing financial performance, internal business quality, external market mechanics and negotiation power.

Understanding these value drivers, how they interact and the potential synergies enables development of one or more compelling investment cases, each targeted at a particular buyer group.

Of course, an investment case is only as compelling as the evidence behind it. Well organised and rigorous supporting data and analysis is required which can be a substantial challenge for sometimes resource constrained lower-mid market businesses.

Only once planning is complete should selected buyers be approached and a process run to secure the maximum possible value for the seller (a topic for another day).

Once in a lifetime transactions

It is all too easy for lower-mid market businesses to be undervalued and undersold. The onus is on sellers to understand the key value drivers of their business and the universe of potential buyers. For most owner-managers, the opportunity to extract life-changing amounts of capital from their business is a once in a lifetime event. In a category where it is common for sellers to accept offers 15% to 35% below their businesses’ true value, it pays to buck the trend.

Written by: Matt Dixon, Managing Director, Corbett Keeling | Corporate Finance

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