MC Group (UK) Ltd
For the typical owners of an SME business entering into a negotiation process with a potential acquirer of their company is a daunting prospect. My purpose in writing this is to arm business owners with information to demystify the process and to give example strategies that can be utilised in the negotiation process. Though written specifically about negotiating the sale of an SME business the techniques covered are usable in many different scenarios.
Accountants and corporate finance professionals maintain that valuing a business is a simple formula driven calculation focused on return on investment. This calculation usually applies a multiple to the company’s “earnings before interest and tax” (EBIT) or “earnings before interest, tax, depreciation and amortisation” (EBITDA). Adjustments will often be applied to the EBIT/DA figures in order to demonstrate the profitability of the business under new owners. One of the main reasons for this is that it is quite normal for shareholders in SME businesses to pay themselves in the most tax efficient way possible, often a mixture of a minimal PAYE salary for tax and National Insurance purposes combined with dividends (which currently enjoy a lower tax rate).
Therefore in order to give an accurate negotiating landscape it is necessary to adjust the EBIT/DA figures to show a true level of profitability. According to generally accepted accounting practices in the UK, dividends are declared after operating profit has been stated within statutory accounts therefore they have no bearing when looking at EBIT/DA, one must therefore adjust the EBIT/DA to represent market rate salaries for Directors (disregarding any dividends paid). Unless shareholders are receiving above market rate salaries paid via the PAYE system this will often mean a reduction in the companies’ earnings. It is however equally fair to “add back” overhead amounts to the profit that would not occur should a different owner acquire the business (e.g. costs related to Motor vehicles if the role of the shareholder using the vehicle would not normally enjoy this benefit) or other “director’s whims”.
The multiple used is often calculated from price, earnings (PE) ratios calculated for publicly traded business. A PE ratio is basically the quoted share price divided by the number of issued shares. A simpler way of expressing this is “if I pay a 5x multiple then it will take me 5 years to get my money back”. Of course this is utter nonsense as it assumes there will be no growth over the 5-year period and virtually all acquirers look for businesses with significant growth prospects. It is often fair to say that multiple based calculations are disadvantageous to sellers of SME sized businesses.
Selling an SME business should be more a sales operation than an accounting practice. The value of a small, private company for a large corporate acquirer is often in the individuals involved, their client relationships and the prospects for those clients’ businesses. None of which can be truly reflected in a valuation based on an arbitrary multiple of historical earnings.
So how to answer the question “How Much Do You Want?”
The “No Notion Approach”
With many clients I have advised against answering this question. There is a school of thought that your business will be worth different things to different people so if your objective is to try and achieve the maximum value possible then any serious answer including a value, will effectively cap the amount an acquirer will be willing to pay.
In this instance the best answer is simply “I have no pre-conceived idea of the value of my business, I am speaking to a number of parties and will take guidance from the offers that I receive” in other words “I will let the market decide the value of my business”. This can be a highly effective tactic when used appropriately. In my experience using this tactic can elicit a range of valuations with a quite startling variance – typically the highest offer received is 2-2.8x the lowest offer.
Achieving the maximum value possible is the reason people pay significant sums to specialist business “sales” companies. I have worked for one of these companies and have successfully used this tactic on many occasions. The downside of this form of negotiation is that it can risk having a reduced number of potential suitors prepared to engage in negotiations. You may find that a high number of people who show early interest in looking at the details of your company decline to progress to a sit down meeting with you if you are going this route. Additionally of those who do take the time to meet you and ask many of the questions found in this book, if they know that your main objective is maximising value then a reduced number will be inclined to make you an indicative offer.
The “First To The Table Approach”
Maximising the potential value of sale is actually not always the main concern. If achieving a “fair” value within a shorter timescale is your main objective then making the first move in a negotiation can make a lot of sense. Research has shown, that the negotiator who makes the first offer, more often than not, comes out ahead. Professor Alan Galinsky of the Kellogg School of Management at Northwestern University has studied research into human judgement and has found that our perception of a particular offer’s value is influenced by any number that enters the negotiating environment. Because of the influence these numbers exert they are known as anchors, therefore first offers have a strong anchoring effect and continue to exert a strong pull throughout the negotiations.
Taking this approach does effectively cap the initial value of offers that you will receive however, in my experience you are likely to see a higher number of interested parties and are therefore more likely to create a competitive situation. In a competitive scenario there are no rules and the tangible presence of competing parties can actually drive valuations over the cap established by the first indication of acceptable value. It is worth pointing out this technique requires careful management and is not for the feint of heart!
The “No Negotiation Approach”
In the same way that your business will have a different value to different acquirers, your business may have a specific value to you. I have had clients in the past with a very clear number in mind and who were not interested in any other valuation. It is not unusual for these clients to say I want x million, not a penny more, not a penny less! In this scenario I have found the most effective negotiation technique to be completely refusing to enter into a negotiation. If the number is justifiable through an accepted valuation technique then I have attempted to justify my client’s position, if not then I have presented the business in the best light possible and basically stuck a price tag on it.
This approach when used with an unjustifiable value will typically minimise the number of potential acquirers for a business and those who do come to the table are likely to think it is a clever negotiating ploy and will still make an offer lower than the specified value. However if used with a justifiable number it can be highly effective and accelerate the sales process.
There are many other negotiation methods which accountants and corporate finance professionals can employ, these tend to be numbers driven and attempt to rationalise the process through using accepted valuation methods. The techniques above are about “selling” your business, not about reaching an agreed valuation based on comparing spreadsheets!
I strongly advise using a professional negotiator who can take a tough stance with prospective acquirers and vigorously fight your corner. Attempting to negotiate on your own behalf can create animosity which is likely to have a negative effect both during the sales process and post-acquisition.
Let me know in the comments if you have had success with any of these techniques or if you have found other approaches beneficial.