Five Key Findings in Australian MidMarket acquisitions in 2016
- The most active sectors are consumer discretionary and industrial. The two comprise of around 42% of all private and public acquisitions.
- 26% of Australian company acquisitions came from overseas buyers, with the UK and the USA being the most active buyers.
- 10% of all acquisitions undertaken by Australian acquirers were of overseas companies.
- The most commonly stated reasons for acquisitions are product expansion, diversification (51%), economies of scale (17%) and geographic expansion (17%).
- At least 10% of all transactions involved some form of earnout.
29th February 2016
Key Takeaway: Many MidMarket accountants are not sufficiently involved in business acquisition and sale transactions. As a result, accountants neglect significant fee income and undermine their own knowledge and ability to influence.
Background – A Challenging Situation
Much has been written on the squeeze on mid-markets accountant’s earnings. This has been a resulted in some fairly significant consolidation activity as well as accountants diversification into related fields such as corporate strategy, digital consulting, data analytics and real estate consulting.
With my broad experience with Australian and international midmarket mergers and acquisitions I’ve often noted how many accountants are prepared to take a backseat in the transaction rather than full engagement with strategy and negotiation.
To that end I propose through this article and a follow up webinar how the accounting profession can earn extra, well earned fee income providing essential strategic advice to help maximise the value of a transaction for their client who can either a business seller or acquirer.
The recent Exit Smart Survey Report (2015) by William Buck reported that 70% of responders saw their accountant as being the prime source of advice when preparing their business for exit. Yet the reality in so many cases the accountants role is limited to trying (inadequately) to answer the inevitable “How much do you think my business is worth?” question, providing historic accounts in a format unfriendly way to the M&A specialist or broker and offering vague input into the tax related issues at contract stage.
I want to forward three propositions.
- At the lower mid market level (say 20-200 employees) the extra fees that the accountants could command, would be relatively minor compared to the extra sale value of the business. This gulf is even greater when the accountant is working for the acquirer. So many acquisitions go badly, and the analytical skills that the accounting profession has would be of significant assistance in pre-deal diligence, pricing, structuring and negotiating an offer and post merger integration.
- Accountants have the opportunity to capitalise this through baby boomer business exits. These will increase in coming years as more head towards retirement
- Thirdly, our economy will further globalize and this will result in an increase cross-border business acquisitions in the 20-200 employee segment.
Demographers predicted the baby boomer bulge several years ago, but so far it has not come to fruition as a result of the overall instability in the Australian economy. Instead the average age of owners has simply grown older. As of June 2014 (the latest ABS stats) there were 51,688 Australian businesses employing between 20 and 200 workers. This is a significant market considering that most businesses have ageing owners (55 y/o was a statistic compiled in 2014) and don’t have succession plans that involves family members.
Coupled with this, our increasing globalisation means great sales values for Australian businesses that have a strategic value to an acquirer. I undertook a survey back in 2014 (see http://goo.gl/KZjRIx) that found that of nearly 150 Australian private company transactions with a value $1m-100m, 45% had either an overseas buyer or seller.
So those are the trends. How can the accounting profession capitalise on them? I’ve sketched a few ideas below, and leave the interesting case studies to a webinar to which all you Accounting professionals are (naturally) invited.
Action Ideas – Client Selling
Most apart from the simplest transactions have a 14 step process. Accountants can provide valued input throughout this process.
Going from left to right in the transaction process, accountant input should include:
PRE-SALE PREPARATION. This can start up to 2-3 years before exit and optimises company performance in the eyes of the buyer. This process can be as simple as prescriptive processes for increasing sales, margin or reducing costs, but could extend to as dying the seller with reinvention of the business in order that it is of optimal appeal to a strategic buyer. The “exit planning” profession with its roots in the USA is fast spreading in Australia and will capitalise on fee income not scooped up by the trusted accountant. In addition, the accountant is charged with advising their client on the financial implications of the sale. Most accountants are proactive in advising on issues such as Capital Gains implications, less so with tax structuring. Timing is as important as quantum in this advice.
PROVIDING GUIDANCE ON VALUE OF CLIENTS BUSINESS: At the moment many accountants use simple rules of thumb rather than seeking broader guidance. Unfortunately this oft quoted 4x profit is outdated and leads to unfulfilled expectations. Why not form relationships with firms of business brokers who have databases of precedent transaction? Link Corporate is one.
PRE DILIGENCE: Preparation of relevant financial performance data prior to sale. Most astute acquirers will investigate beyond standard format financials into KPI’s, sales and margins segmented by product group, geography, new versus existing clients etc.
PREPARATION OF FINANCIAL STATEMENTS: The single most common task requested of accountants, yet the process could be made so much simpler and informative. For example, providing data in Excel format eliminates data input errors while providing current financial years part actual, part forecast helps frame how the business is trending.
ADJUSTING EARNINGS: A major component of the sale process is the publishing of an Information Memorandum. The most thumbed section of this IM are the financial pages. The annual accounts may have been produced with the view to the ATO being the sole reader. Now an entirely different audience is looking for entirely different indicators. These include issues such as: separation of capital expenses and operating expenses, accounting malfeasance (income from unspecified sources, from asset sales or from financial transactions), accrual earnings consistently running ahead of cash earnings, large differences between tax income and reported incomes, and large changes in ratios of standard expense items.
SUPPORT THROUGHOUT THE TRANSACTION: With 70% of owners seeing the accountant as the prime source of advice, its not surprising that owner clients frequently seek emotional backing for the rollercoaster ride ahead. Transactions rarely take less than six months to complete and then once the transition period where the owner has to work through an incoming new owner is added it makes it a sizable time commitment. This could be further extended by an earn out period where the full payment is contingent on achievement of a performance goal.
MINIMISING DUE DILIGENCE PERIODS: Due diligence has a nasty way of lengthen the transaction timescales and reducing the deal price. The accountants assistance is essential in getting the accounts clean, for example ensuring that the add backs are verifiable and defensible, being responsive to the scrutiny’s of the acquirer and generally ensuring that the transaction proceeds smoothly.
Finally, for every seller there’s an acquirer. Again the accountancy professional often does not provide the kind of support it is worthy of, particularly regarding the framing of appropriate acquisition candidates and their financial evaluation. Too often, accountants over emphasise the negative risk elements rather than think like the commercial operators that their training has endowed them with. This will be the subject of a future blog post.
Mark Ostryn is Director of Strategic Transactions and Valuations (strategictransactions.com.au), a Sydney based company established to assist company owners and acquirers with significant transactions.
This week the repugnant Donald Trump bragged to his adoring masses at a Florida rally* that he managed to get a $20m discount from a golf course he was purchasing, after he signed the contract. Trump simply told the seller he wasn’t paying and threatened to drag him through the courts for years after.
While I hope that company sellers never have to negotiate with an acquirer with Trumps’ lack of ethics, it does highlight an extreme example of what can go wrong.
You’ve found a buyer. The transaction is progressing well. The buyer is motivated, as they see real upside in your company. You sense that settlement is in sight, then they’ll be a few months of transition and then freedom!
Hang on. In my experience more MidMarket deals have the potential to undo at the latter negotiation and structuring phase than at any other time in the transaction.
The potholes on the road to settlement can be broadly summarised as: earn out and deferred payment clauses, transfer and incentivisation of employees, agreeing on the due diligence process, managing advisors, intellectual property considerations, non competes, managing working capital, and property and leases.
However, a successful transaction relies most on maintaining empathy for the buyers needs. There’s danger when the transaction timescales stretch out, and when potentially combative legal and financial professionals working for either party start to eat away at the goodwill built between the acquirer and seller.
Sometimes egos start to take control and imagined slights pervade the thinking of both the seller and buyer. With a recent acquisition, the buyer threatened on three separate occasions simply through exasperation with a highly detail oriented sellers solicitor.
Let’s look at the key points of negotiation when structuring a deal.
EARN OUT CLAUSES
Acquirers seek to guarantee future returns or reduce risk by deferring some of the payment for sale of the company. They can stage these payments over time or establish earn outs that are triggered by pre- agreed achievement criteria.
Earn out clauses are so fraught with challenges that I’ve heard some M&A professionals refer to them as unexpected bonuses rather than part of the deal. I consider this an exaggeration and believe that a decently drafted agreement, and monitored hands on post-completion commitment processes make earn outs an integral part of the deal making process.
Earns outs are one or a series of post completion payments. They are a contingent consideration payable to a seller based on the after-sale performance of the entity. This could be based on either a financial target or metric (EBITDA, revenue) or a milestone such as an external event.
For example, I have completed a deal that pays the seller 80% of the agreed amount upfront and the remaining 20% in four quarterly periods subject to maintenance and growth of quarterly profits. The seller is staying on and could over perform resulting in an increased earn out.
The parties agreed on EBITDA over revenue because it’s a much better indication of growing shareholder value than revenue. It encourages the business to only sell profitable products or services, and to keep operating costs down.
But using EBITDA over revenue also has its pitfalls. For example, it could encourage a short-term view of the business by reducing marketing spend or capital expenditure in order to keep such costs down. This failure to invest in growth can hurt long-term business prospects.
Written into this particular contract was a sub-section that dealt with a variety of circumstances where the seller would be protected if the circumstances changed in such a way that it made it more difficult for these EBITDA targets to be achieved.
These circumstances could include examples such as the sale of the business by the current buyer, a change in the job role for the seller, a change in the product portfolio impose by the buyer and a variety of other circumstances.
Furthermore the seller also has rights to inspect the financial records of the company and the right to veto any large expenses proposed by the buyer.
Even though the safeguards are there, even this is not an ideal situation. For example, it virtually removes the right of the buyer to do anything radical with the company and forces them to have to run the acquired business as a separate entity.
Importantly, in this instance the earn out period was short and the buyer was able to capped the upside payment to the seller at 120% of target. The seller also had an ongoing employment clause that was short enough that the buyer didn’t have to keep a malcontent on the books for too long.
As the seller was also going to stay employed within the new business, the earn out also comprised of 50% shares. This gave reassurance to the acquirer that the seller would be financial motivated to increase shareholder value.
There may be situations where the full amount has been agreed but payment is deferred.
One example is escrow. Generally, escrow is used where a part of the purchase price is set aside against adjustments or warranty claims. Such warranties are a guarantee against certain negative events not occurring else payment is deducted. They could include: incomplete litigation, contingent liabilities or asset valuations.
With one of my clients, the final purchase price was based on the assumption that a major local council customer of theirs would not cancel an ongoing contract within the next twelve months. Had the local council have done so, it would have had a detrimental effect on cash flow. So the agreement was that some of the payment would be held in a trust account until the condition was satisfied.
TRANSFER OF EMPLOYEES
One of way of ensuring that key employees transferred over and were motivated to continue performing is to grant options. Such loyalty payments, contractually paid after a specified period with pre-defined performance criteria are increasingly forming part of contracts.
The emotional buy in of the sellers’ key employees is absolutely essential to the ongoing success of the merged entity. However a challenge arises where the buyer knows before the transaction – or comes to realise after the transaction – that certain employees need to be retrenched.
Perhaps there are cost synergies such as duplication of function. Perhaps the anticipated ongoing profitability of the merged entity cannot be realised with a core of inefficient staff being removed. One of the key elements of a pre-contract negotiation may be which employees are coming over. This needs to be borne in mind considering that employee entitlements such as annual, long service and sick leave or redundancy entitlements will roll over.
Part Two: will complete this analysis covering topics such as agreeing on the due diligence process, managing advisors, intellectual property considerations, non competes, managing working capital and property and leases.
Mark Ostryn is director of Strategic Transactions & Valuations in Sydney, Australia. He can be contracted on firstname.lastname@example.org
Should your company be on the acquisition trail?
Written by Mark Ostryn, Mergers & Acquisitions Facilitator, LINK Sydney
You’re in a dynamic, fast growing industry, but achieving organic growth solely through reinvesting free cash flow, may not be the best strategy. You need to grow faster, otherwise your vision may be captured by other, better-funded competitors or new entrants. Is acquisition an option?
Think more about the blue sky opportunity to be captured and how best your own company can capture them. Once you’ve a framework, you’re better placed to determine the type of company you need to acquire. Alternatively, you may find that organic growth, or growth through collaboration and strategic alliances is less risky or more profitable.
Here’s a list of 10 questions that you should be able to provide very detailed answers to before you head down the acquisition path:
- What are your key strengths, weaknesses, opportunities and threats? In particular, what do you need to ensure your opportunities come to fruition? Also how do you mitigate against threats to your business?
- Imagine the future of your industry. How will it evolve? How will customer tastes change, how will suppliers adapt to suit those change, what shifts are likely to occur in related industries, what new direct competitors are likely to emerge, how will customer needs otherwise be satisfied and what impact (if any) will government policy, technology or the environment likely to have?
- To what extent do you and your team have the right experience, skills and attitudes to capitalise on the opportunity? Can this be improved, and what external skill sets might you need to contemplate bringing in?
- How will you make money from the opportunity? How can you best develop this opportunity in a risk- averse way, then continue to capitalise on it by building and maintaining entry barriers?
- Review your customers buying process. How does the customer make decisions, is your service a compelling purchase, how much does it cost to reduce and deliver the service, how much support is required and how easy is it to retain the customer? What additional revenues or annuity streams can be obtained to improve cash flows?
- How would you strengthen your Value Chain and ensure optimal performance from manufacturers, distributors, imports and exporters, wholesalers and retailers?
- What are the strengths and weaknesses of your current competitors, what resources do they control and how could you potential co-opt potential or actual competitors by forming alliances or otherwise collaborating?
- What are your financial projections? What cash flow issues do you have particularly pertaining to investing in capital or personnel, or customer or supplier payment terms? How might these constraints hamper your growth?
- What alternative scenarios could take place as you implement your plan? How would you cope with a best or worst case scenario where the initiative is more or less successful than anticipated?
- What is your eventual exit strategy?
Out of all these questions, perhaps the last is both the most important and the most challenging to answer. This theme will be raised in part two.
You’ve built up a sizeable business. It’s profitable and still growing, but you know there’s more to life than 65 hour weeks. You’re an “empty nester” and keen for more golf and extended vacations. You’re ready to sell. However, your financial advisor tells you that thanks to the exiting baby boomers, businesses are trading at lower multiples values than ever. You’ll need the proceeds from your business sale to fund your superannuation. Time to get out, but how do you maximise your sale value?
There may not be many participants in your industry who have the spare funds to invest in acquiring your company. The larger your company is, the less the number of participants. Many are already known to you, so there’s a likelihood that when you sell, your M&A advisor will be facilitating some kind of auction process. So what’s your action plan in the 18-24 months, before the auction process starts?
Firstly, identify these players. They may be direct competitors of yours now, or they could be interstate or overseas operators who know that buying the niche you’ve worked hard to carve out is cheaper or less risky than trying to do it themselves. But think beyond that. Which companies in related industries (or those companies in a different stage in the supply chain to your company) would also benefit from acquiring your company?
Now think about how your industry will change in the next two years and what these companies will need from your company. Perhaps it’s access to your client database, or your skilled and knowledgeable employees, or your IP, or your brand? So work on strengthening those assets. The more value an acquirer can see in such assets, the higher the price they’ll be willing to pay for your company.
Secondly, monitor and track industry developments. Competitive intelligence technology has progressed to the stage where you can set up news and company alerts on every mover in your industry. What announcements have they made? How has their website changed? What product innovations have been made in your industry and how are they impacting the market? What related industries are slowly aligning themselves with your industry? What substitute products and services are becoming available that could threaten your industry? There’s a wide range of electronic tools for sophisticated tracking. Some are free like Google Alerts, others like D&B 360 and IBISWorld are subscription based, but a sophisticated M&A company like LINK Corporate can utilise these tools on your behalf.
Thirdly, be flexible with the terms of the deal. When the time comes to sell, don’t be in a hurry to depart. Even if you’ve done your job correctly, and worked hard to restructure your company to lessen the dependency on you, a smart acquirer is buying on the basis of synergies – i.e. 1+1=3.
Their motivation behind the acquisition is that they can see opportunities to increase the profits of your company and the profits of their core operations. To achieve that they’ll need your expertise and experience in transitioning, in maintaining the loyalty of your key people and in ensuring that the strengths of the two sides of the merged operation flow through to the other. Consequently, you may not receive the full sale price on exchange of contract, and deferred payments may well be linked to future performance. Accept this reality and enjoy the challenge of being a pivotal person in the merged operation.
Good luck with the next few, inevitably bumpy years and remember the three key messages in a successful sale – plan ahead, monitor and track industry developments and prepared to be flexible with the deal and your eventual exit.
LINK Corporate, Sydney
0411 742 400
I’ve now updated my report on all MidMarket M&A transactions ($1m to approx $100m) that have had media coverage this year.
* There were 136 traceable transactions -around 1 per day since mid-January.
* In 45% of those transactions, one party was international.
* In 30% of those transactions, part of the sale price was deferred and based on future performance goals.
* Regarding buyer motivations, more than 20 were provided. Predominant reasons include: Geographic Extension (24%), Broaden Products & Services (19%), Access to Technology (12%) and Access to Customers (12%)
Here’s my full report. – http://goo.gl/KZjRIx
Please excuse any errors or admissions.
Please let me know if there are any other announce able transactions.
Historic financial reports form the basis of all business valuations, but there is always a wide discrepancy between the theoretical value of a business and its actual selling price. This is because there are a number of criteria, most of which are unquantifiable in a traditional modelling sense that can radically change the attractiveness of a business.
One key one is its future potential for profits, and involves likely future buyer demand, competition, changes in the value chain and a wide range of other factors. LINK’S sophisticated Valuation Tool takes into account the following weighting factors:
- Barriers to Entry
Would it be easy for a competitor to become established in this industry?
- Risk Profile of the Business
Does the business rely on a small number of clients, or relies on the owner?
- Length of Time in Operation
Is this an established business?
- Uniqueness of the Business
Does the business have a well-defined niche?
- Risk Profile of the Industry
What is the vulnerability of the industry as a whole?
- Location of the Business
Close to major markets for its products and services?
- Likely Buyer Demand
Is this business likely to attract few or many buyers at the current time?
Through LINK Corporate’s access to a wide range of company sales data, the results are then matched against comparable sale transactions in a similar industry. This gives a true “market based” indication of the value of a business. Once sellers can offer a realistic market asking price it increases the chances on a sale.
Victor Whiteley & Mark Ostryn
To arrange a business valuation, please call me on 0411 742 400
More information – http://linkcorporate.com.au/services/business-market-calculating/
Ever received an offer from an unsolicited buyer?
The most common question I’m asked by a potential seller, is “what’s my business worth?” It’s also the toughest question to answer, as it depends on the industry, size of company, its historic and future profitability and the availability of sufficient buyers to create competitive tension to drive the price up. The calculation is further complicated by the increasing use of deferred payments and future performance hurdles.
An indication of a “quality” business is the fact that they may well receive approaches from acquirers. The Sellability Score recently analysed 5,364 businesses with a $1m+ turnover that had received such overtures in the USA, UK and Australia. Their results are interesting:
|Average Multiple of Pre-Tax Profit||Characteristic|
|3.5x||Across all businesses approached|
|4.3x||Where the business had a historic profit growth rate of more than 20%|
|5.4x||For those companies to have a unique product or service for which they have a virtual monopoly|
Why so high for the latter? Look at the perspective of a large company, who can both afford and justify such multiples. They will place less value on the turnover derived from products and services that you have in common. They will argue that their economies of scale put them in a better position to sell the things that you both offer today.
Likewise, they will pay the largest premium to get access to a new product or service they can sell to their customers. Big, mature companies have customers and systems, but they sometimes lack innovation; and many choose a strategy of acquisition as a way to buy their innovation.