Credit crunch: business owners, look on the bright side

The credit crunch and a downturn in the UK economy could be good news for business owners looking for opportunities to acquire businesses at attractive prices.

Market sentiment has fallen sharply since last summer and in some sectors price-earnings ratios are lower than they have been for many years. This, coupled with unclear future economic conditions, results in sellers being unable to demand high premiums for their businesses. In addition, owners are being forced to sell their businesses at a discount because they are unable to secure finance to continue trading.

The amount of activity in the mid-market is holding up, which implies that funding is available there. If you’re able to finance acquisitions, then the upside potential of deals is significantly increased. If businesses can survive a downturn, then valuations could increase measurably once market sentiment improves.

So if you have access to finance, there are opportunities, but given the economic forecasts such acquisitions may turn out to be disastrous. So what can you do to ensure you are making a good acquisition?

Good buy, farewell

More than 70% of acquisitions fail to deliver the strategic or financial benefits sought by buyers. The failure of an acquisition is almost always rooted in one or more of the following four causes: strategic errors; the price was too high; the buyer’s interests were not adequately protected in the purchase agreement; or the acquired business cannot be smoothly integrated.

It is crucial that business owners think before they act. Many buyers will take advantage of low asking prices without performing adequate due diligence up front. For would-be purchasers, due diligence is the critical process during which you have the opportunity to avoid costly mistakes. More positively, it can confirm the logic for the transaction and improve the negotiation of the price and the purchase agreement.

The broad process of due diligence can encompass legal, financial, tax, employment, commercial and IT issues, and if undertaken properly can give you the following benefits:

• A detailed understanding or what you are acquiring and what the risks are;

• An enhanced negotiating position;

• The ability to identify and avoid buying a business which will detract from your company’s value;

• Detailed analysis and forecasting of the funding requirements; and

• Improved tax efficiency of the transaction

Rising debt

The M&A boom in recent years has been driven largely by cheap debt. Although the Bank of England has reduced base rates, the cost of borrowing has risen sharply and gaining access to finance is proving more challenging. If your acquisition is highly geared, then you need to prepare detailed cash flow forecasts to help identify any funding crunch points and assess the liquidity risk of the business.

Financial due diligence in particular is designed to identify financial black holes in a business. These are arrangements or operations that give rise to risks or hidden liabilities ­ either under-accruals or off-balance sheet liabilities. If black holes are identified it allows you to either negotiate down the price and/or to include related provisions in the purchase agreement.

If you acquire a company then you acquire all the liabilities with that company, so it is often advisable to purchase just the assets of the business. However, this will have significant tax implications and these should be considered in the round.

Purchase consideration can be a combination of cash, shares and loan notes as well as other instruments. The way you structure the consideration and lock-in arrangements can impact on whether the acquisition is a success or not and also limits your exposure.

Business owners have every reason to be optimistic. The current economic uncertainty should be looked at in a positive way ­ a good acquisition, well structured and negotiated up front, with proper due diligence can prove very fruitful.

Getting it right

• Think before you act. It is one thing to be adventurous, quite another to be rash. Make sure an acquisition fits into your long-term business strategy.

• If you decide to proceed, undertake thorough due diligence of the business you plan to acquire. This will tell you if there are any nasty surprises waiting around the corner.

• Ensure there are no financial ‘black holes’. Make sure you identify any funding crunch points and assess the liquidity risk of the business.

• Decide whether you wish to purchase the company and, therefore, also acquire its liabilities, or just the business assets.

• It is important to remember that the way you structure the deal can significantly impact on whether the acquisition is a success or not.
  

David Cox is a partner at haysmacintyre