Josh Gurton, Corporate Finance Senior Executive, shares his expert advice on how to prepare your business for sale and increase its value in the current economic climate in our latest ‘5 minutes with Corporate Finance’ article.
Since March 2020, businesses have faced some of the toughest economic conditions since the financial crisis in 2008. Emerging from the pandemic, businesses have been faced with high inflation, increasing interest rates and the lowest UK consumer confidence on record, according to the OECD.
For some owner-managers, the stress of the COVID-19 pandemic and the subsequent economic conditions has accelerated their retirement or sale plans, heightened further by the threat of a rise in Capital Gains Tax (CGT), exacerbated by the increased likelihood of a Labour government. This is despite many would-be sellers being concerned that high inflation and impending recession will result in a poor realisation of value. This can probably be explained by the importance of remembering:
- that the economic strains impact different sectors to varying extents, some even benefitting; and
- that a well-prepared business leading the way in its sector, to paraphrase Warren Buffet, “will be worth a great deal more than a lack-lustre one”; and
- that unless the seller has a realistic, short to medium term, prospect of improving profitability to a greater extent than the potential loss of net proceeds through raised CGT, then it would be sensible to explore a sale now, rather than navigate future unknown territory.
Picking up on the matter of preparing a business for sale, purchasers carry out increasingly extensive due diligence processes to ensure that the business is sound and is performing as reported – meaning it is more important than ever that businesses are prepared for sale, enabling them to realise maximum value.
At PKFSC, since the pandemic we have successfully completed a number of sales of owner-manager businesses at high values – the common theme being that these were solid businesses in resilient sectors that were carefully prepared for sale.
How do you prepare your business for sale in this environment?
In tough economic conditions, potential purchasers look for resilient, recession-proof businesses that are likely to feature relatively low risks, sales price elasticity, and decent margins. Businesses that can demonstrate these qualities will command a premium on their valuation compared to their less resilient competitors.
At PKFSC, we see many businesses that are reaping efficiency and productivity gains from changes made during the pandemic – whether this be from home-working, reduced headcount, automation, more cost-effective routes to market or other reasons. The most sought-after businesses have management that recognise that, in a high inflationary environment, efficiency gains can be quickly wiped out by poor cost management and margin degradation and have structured the business to protect against this.
The Consumer Price Index is currently at 10.5% and, although that seems to be easing slightly, the spectre of un-capped energy costs and future wage increases is a concern.
It is paramount for businesses to have systems in place to monitor costs, enabling managers to make effective strategic decisions and to position the business to enable sales prices to be increased, with no or minimal falls in volume, when required.
Josh Gurton, Corporate Finance Senior Executive at PKF Smith Cooper
Effective margin management is important to most potential purchasers, with due diligence likely to focus on margin consistency. For exiting shareholders to realise the highest value for their business, being able to demonstrate the ability to pass on cost increases allows purchasers to get comfortable with the maintainability of the financial performance of the business.
In competitive industries where the product or service is not differentiated from others, such as consumer retail, passing cost increases to customers may not always be possible – but managers can deploy strategies to mitigate margin degradation by, for instance, focussing the sales mix on higher margin products or targeting products and customers with greater price elasticity.
What about working capital?
Transactions typically take place on a cash-free, debt-free basis, meaning that the business will be acquired on the assumption that there is no cash or debt at deal completion; except for sufficient cash being left in the business as working capital to cover the usual operational cycles – what we call “normalised working capital”. In preparing a business for sale, managers can begin to implement strategies that reduce the amount of normalised working capital, thereby maximising the “free cash” that can be extracted to the seller on completion.
As economic conditions tighten, customers may delay payment, so cash management and credit control need to become an increasingly important focus. Ensuring that cash is collected on time and stock is managed effectively over a sustained period provides purchasers with more confidence in the low level and sustainability of normalised working capital. This strategy becomes even more beneficial as interest rates increase, making working capital facilities more expensive.
How can businesses differentiate themselves?
Over recent years, there has been a considerable shift towards investing in businesses that show good Environmental, Social and Governance (ESG) credentials. This trend is illustrated by the number of private equity operators raising ‘Impact’ funds that are designed to invest in companies that are demonstrably working towards having a positive environmental impact.
Understandably, not every business is set up with the aim of improving the environment but recent investment return analysis shows that businesses that do demonstrate good ESG credentials tend to have a premium valuation, in comparison to ‘dirty’ businesses. Example businesses include Foresight Solar, Gresham House Energy Storage and Harmony Energy Income – all of which experienced 25% plus share price increases in 2022.
Aside from uplifting valuation multiples, a company that improves its ESG measures is likely to reap cost savings and efficiency gains.
How can we help?
At PKF Smith Cooper we specialise in working with owner-managers to achieve their objectives; sometimes that can be achieved quickly because preparation is a short process, but often we work with businesses owners over the long-term to ensure that their business is optimally positioned and prepared so as to maximise its sale value. Being involved in a large number of transactions, we have deep and broad experience of delivering purchasers’ objectives, and can offer give unique, tailored, insightful advice to clients making strategic decisions about a potential disposal.
We believe that building a trusted relationship with clients, and becoming a seamless part of their team, is crucially important when positioning for sale. We are flexible in our level of involvement as your business progresses towards a sale – whether that be by critically reviewing regular management information, sitting-in on board meetings, or having regular catch-ups – always adding objective views and acting as an experienced sounding-board to owner-managers who are often, understandably, too busy or disinclined to evaluate value-drivers, and evaluate their business’s worth, and investigate options.
If you are looking to sell your business, contact us today to speak to Josh or another member of our expert corporate finance team.
