Corporate Advisory Inisghts: Why Business Owners Are Losing Millions When Selling!

Why Mergers & Acquisitions are set to rise

The realty is M&A transactions will be on the up over the next decade, and most business owners selling their businesses will be unprepared!

Why will mergers and acquisitions be on the up?

Because we are going through one of the largest transfers of wealth over the next decade, from two major generations (Builders and Boomers) that have shaped our lives, to Gen X and Gen Y.

As the builders generation and baby boomers downsize, sell businesses, sell properties and exit the workforce, or sadly pass away. A large pool of their assets will be sold or transferred to their children and grandchildren (some are competent and some aren’t, the joys of family).

This transition of Boomers leaving the workforce is further confirmed by the increased superannuation outflows going to boomers in recent times. However, as our corporate advisory arm has seen, the reality is that for a number of business owners their business will be sold at a great discount!

Why businesses are being sold at a discount?

Whilst these generations did an amazing job at building up Australia to what it is today, their hardcore focus on working in their businesses, rather than on their business will leave them short changed!

All too often basic corporate and business hygiene factors are left neglected! Unfortunately in this world of bureaucracy, many buyers will use these hygiene factors as reasons to discount the purchase price!

What many business owners fail to recognise, is that the preparation for selling a business must take places years before the actual business goes to market!

More importantly, because we help businesses get funding to acquire other business through our private lending services and private corporate debt facilities. Any financier will want to see a number of these corporate hygiene factors in place! Essentially the more appealing your business is to a financier of a purchaser, the more money you can command!

Corporate advisory - what is poor business and corporate hygiene?

Where we are seeing businesses fall short as part of our corporate advisory services is typically with basic business hygiene factors. The below lists several things business owners are doing wrong, when it comes to this. The below is just a short list of what we have seen and should give you an idea of some of major themes that will effect your final sale price!

Poor financial health on paper

Many business owners have been creative in their tax affairs to reduce profits on paper. Whilst this strategy works well to reduce taxes whilst owing the business, it is one of the worst things that can be done when it comes time to selling a business. Any purchaser worth his or her salt, will review tax returns and not just management accounts. Therefore, if a business has reduced their profits by just $400k p.a using creative tax solutions, this could mean a $1.2M to $2M delta in the sale price offered! Based off a 3x to 5x multiple of earnings.

Wrong group structures

Some business owners have created various structures as part of their business group, to either reduce tax or protect assets. Whilst this is inherently correct during the period of running a business to reduce tax or protect assets, it adds further deal complexity, especially when there are intercompany loans involved! Ultimately any purchaser or private financier of the purchaser, will want to see things as simply and clearly as possible! The lesson here is to avoid inter company loans in the years leading up to a sale and complex structures.

Loans to directors

As part of our corporate advisory services, we have seen first hand where clients have taken excessive director loans beyond the terms of division 7A . As such, many business owners that don't do this properly are being heavily penalised when a sale of business occurs! Technically speaking those funds are still owed to the business by the director that took them, if they haven’t been repaid. In some instances directors have breached tax codes, which adds further fuel to the fire. These matters require a degree of sophistication to be handled properly, prior to any business sale as those offered through our corporate advisory services.

Loss making business arms

As part of our corporate advisory services we have seen businesses with large revenues making very slim profits, especially in the construction industry! For example, one business we reviewed and that came to us after the transaction was done, was making $50 million dollars in revenue with only $200k in profit. For them one of their business arms was making a profit of $4M whilst the other arm was making a loss of $3.8M.

This ultimately meant the business owner could only sell his business to a competitor, that understood his business arms at a very discounted price! Had the business been structured the right way from the start, he could have attracted a wider array of buyers including private equity groups, and commanded a much higher sale price!

The lesson here is to know how to structure your various business arms, and present your business in the best possible light!

Business debts and personal debts.

A number of business owners have debts where they have allowed banks to have a General security agreement (GSA) over their business. Meaning the bank has a security interest over all aspects of their business assets, if everything is contained within one SPV.

This mater only gets worse when the business owner has taken bank loans with the same bank for personal and investment assets! In these scenarios banks will typically cross collateralise a loan (take cross security), which then blurs the lines between business debts and personal debts.

In some instances, the bank can refuse to remove its GSA over a business being sold, if it feels its debt covenants will be breached, thus preventing the sale from happening.

The lesson here is to ring fence your debts, as we enable you to as part of our corporate advisory services.

Enterprise Value- business sale vs equity sale and company debts

Sale of business

Selling of a business, means the assets of the business being are being sold or the entirety of the business to a buyer. However, if a business has bank debts or debts, that have a registered security position against the SPV in use. Then legally speaking those assets within the SPV can’t be sold without the debt being cleared first!

Or if they are sold with the debt, the lender must approve the incoming party taking that debt over.

Share sale

A share sale on the other hand, means the acquirer is acquiring shares within the SPV that is holding the business. For example, units in a trust, or shares in a company that owns the business. In this instance the purchaser is acquiring shares, including all the benefits of ownership and all the known and unknown liabilities / obligations of the business. Once again, any known liabilities/ obligations could hinder the sale value of the business.

To read more about the difference click here.

Enterprise value

Regardless of which path the business is being sold, for a purchaser of a business the total cost is the price they are paying for the business, plus any debt they are taking on, less cash on hand the business has. This is typically known as the Enterprise Value (EV) of a business, and you can read more about it here.

Because a purchaser will be looking at the enterprise value of a business, which is comprised of the ratio between the price of the business and the debt the business has. It is imperative business owners minimise their debt at the point of sale, to maximise how much they receive for the business itself!

They under value ARR in their business

What is ARR? It is annual reoccurring revenue! Whilst ARR is typically reserved for SaaS businesses, many business owners undervalue the inbuilt reoccurring revenue they may already have. Typically in services outside of software, this usually comes in the form of service or product contracts that are locked in over years. The quality of these agreements, and length of them play a very large role in not just locking in revenue, but also the value of a business at its time of sale!

From our corporate advisory experience, many business owners fail to negotiate the right types of contracts with the right clauses, to maximise the future sale value of their businesses!

Key personnel

There are many different definitions as to what constitutes “key personnel” eg Austrac has a very different definition as to what we would have. When it comes to businesses being sold, key personnel aren’t just people such as the CEO, CFO, CIO or COO. It is also about employees that have specific IP or employees that have key business relationships with clients.

People buy off people, and if you can’t retain good management, or those with the knowledge to solve problems, or those that have relationships, then a business is fundamentally not worth much! Conseuqnetly, being able to retain, and have succession planning is a key component to increasing the value of your business.

We’ve seen firsthand where businesses have lost millions of dollars in their sale price, because they were unable to lock in key personnel as part of their business sale!

The lesson here is to ensure you have key personnel locked into your business prior to sale!

The above are just some of the points we cover as part of our corporate advisory services (click here to read more) and helping businesses become business exit ready!

For a confidential discussion, please don’t hesitate to contact us (here)