The growing demands of modern dealmaking

This year, Q1 deal volume was 50% higher than the same period last year and deal value was 96% higher. Dealmaking in the Thames Valley is buoyant and steadily growing – isn’t it?  The Business Magazine and BCMS Corporate, the UK's market leader in the sale of privately owned companies, invited some experienced dealmakers to gather at the Madejski Stadium, Reading to discuss.

How is the deals market at the moment?

Steve Anstey of dealmaker BCMS agreed that the Thames Valley was vibrant. “Our 2015 first half was over 40% up on 2014, and if anything, the market is now accelerating for us with dealflows and completions increasing. I expect us to be ahead of the market by the end of the year. That’s growth across all sectors too, although manufacturing and engineering have been very strong for us, along with wholesale and distribution, plus healthcare.”

RBS banker Chris Roberts: “The market has been improving since 2013-14, but the number of deals we’ve done this year, from SMEs to corporates, has already eclipsed 2014.”  Corporate activity had continued to grow from around 2010, but in the past 12-18 months there has been a noticeable up-tick in SME deals.

Private equity specialist David Rolfe highlighted “very busy dealmaking in 2014,“ and felt the second half of 2015 would be stronger than the first for NVM Private Equity “... which is a bold statement, bearing in mind the fantastic first half stats just quoted, but we are seeing a more activity now than we did earlier this year.”

Greg Norman of BGF (Business Growth Fund), supported by five main bank groups – Barclays, HSBC, Lloyds, RBS and Standard Chartered – has up to £2.5 billion available to help SMEs through long-term equity investments. “We are involved with around 100 portfolio companies. We did 33 deals nationally last year and we have completed 21 so far this year, so we are set to do more this year. We assist all sectors except regulated financial services and property development, and tend to do technology deals locally, and healthcare has been good for us nationally.”

Legal adviser Leon Arnold: “We have a nice perspective of the UK deals market because we have a number of offices around the country – and it’s busy.”  Henman Freeth’s Oxford office was reporting Thames Valley activity as “ahead of budget, with a lot of transactions set to close in the coming quarter.”  Birmingham, Leeds and London were also activity hotspots. “We are busier than last year, which was a very busy year for us. We are looking to recruit.”

Andy Hunt of BCMS added: “We are regularly doing a lot of deals and that’s consistent across all sizes of business and sectors.”

Finance adviser Charles Thorburn: “Two years ago 85% of inquiries were about growth capital refinancing, whereas now 60-70% are corporate transactions, which confirms what everyone has been saying about the market.

Anstey: “Our offer accepted pipeline is back to pre-credit crunch levels in volume terms which has to be an optimistic market indicator.”

Rolfe: “We have got good visibility of a steady low-growth market environment, where I believe there will still be enough going on to keep us all busy.”

Is the market evolving as activity has grown?

Roberts explained that the 2008 downturn had led many owner-managers to put off their plans to sell and exit. Instead they stayed on to bring their businesses through the recessionary times. “Now, they are seeing it’s a good time to exit because of positive macro-economics including low interest rates.

“But, what needs to happen more is adequate preparation for a sale, such as building a suitable management team so that when the owner-manager exits, the risk of business performance deteriorating is reduced.”

Arnold agreed, but added that some sellers were holding on to get a better price for their business. He exampled one selling client who recently received very encouraging business performance figures and then postponed his exit for 18 months. “We have almost gone full circle, from having to sell and aiming to get the best price available, to waiting to sell to get the best price, because they consider the deals undercooked.”

“Don’t buyers need to see some upside left in the business they purchase?” queried David Murray.

Business buyer Doug Lingafelter said he only looked for a certain type of acquisition – owner-managed niche businesses, with the owner seeking to retire, and opportunities to reinvigorate and restructure operations. “I don’t spend a lot of time trying to time the macro-economics. If I can find a business with underlying good products and reputation then the external factors are unimportant.”

Are today’s deals now approaching their ‘sell-by date’?

Lingafelter suggested that UK entrepreneurism began 30-40 years ago when people started to realise that they didn’t have to work for a large corporate or in the public sector for their whole career.

“I don’t think it’s any coincidence that the first businesses I bought were founded by people who felt they could give it a go in the late 1970s, and now find themselves hitting retirement age. Shouldn’t we expect that entrepreneurial startup curve to produce a real increase of SMEs coming to market about now?”

Arnold: “I’ve seen some of that, and the challenge, particularly when representing sellers who just want to get out, is in trying to defend the business valuation so that the seller gets the right deal.”

Rolfe: “Doug’s theory has logic and we have seen that happening among traditional manufacturing style businesses, although technology-led businesses have a different sale cycle that happens a lot quicker.”

Anstey: “We are not seeing a big uplift in retirement inquiries but BCMS is a company that originates dealflow very practically, through our seminar programme for instance, so we get a fairly even quantity of new business and dealflow."

He pointed out that shareholder structures at sale might not be the same as when they were set up 30-40 years ago.

“We are seeing a notable trend of split management boards with an older generation of shareholders seeking exit and a younger generation wanting to stay in the business. So, we are having to explore different transaction solutions for clients – MBOs, MBIs, growth capital deals – rather than a traditional trade sale scenario.

“Those alternatives are no more than 20% of our transactions to date, but I expect to see that growing strongly.”

Arnold: “We have a sale going through where the earn-out share doesn’t match the shareholdings, because the older shareholder is stepping away, but the younger one is staying in the business.”

Thorburn: “Isn’t it just that now is the right time to sell? Valuations are quite high, credit is still relatively cheap, the general economy is OK, so it comes down to how much debt can be taken on to purchase businesses.”

Hunt: “The media talks about the Baby-Boom generation wanting to retire and get out, but the big wave hasn’t arrived yet.”  Age was a prominent factor, but illness, lack of succession, personal commitments were also reasons for sales.

Murray added that family businesses no longer seemed to be passed down through the generations.  Hunt answered: “Often today, the children may be capable and skilled, but they just don’t want to work in them.”

Boredom was another reason to sell and exit, said Arnold. “People who have been entrepreneurs often hate it when their businesses grow and they end up as managers and paper-pushers. That’s not what they started their business to do.

“Different skillsets and more energy are required when businesses grow. Owners may enjoy the lifestyle the business provides, but eventually not the business itself. Exits can be related to age, but not always.”

Who’s most successful: serial or one-off entrepreneurs?

Rolfe: “Some of our most successful entrepreneurs have been one-offs. But, we gravitate towards serial entrepreneurs, because they have done it successfully before and that’s the best reference you can get to back them again. We would also get more comfortable taking risk with an individual or team with whom we have worked before.”

Norman suggested more experienced entrepreneurs typically run more successful businesses. “We find that many entrepreneurial people who started businesses 30 years ago, have already exited and are now on their second or third successful business. They have learnt the lessons from their first business to make the next investment even better.”

Hunt noted that ‘retirement sales’ did tend to involve successful but smaller companies, often lifestyle businesses. He exampled one

niche business owner happy to earn a healthy income from just a few days weekly work, despite being aware that the company could achieve much more.

Rolfe: “Lifestyle businesses often have the most potential for buyers, as long as there is a capable team to take that business on, since frequently the business relies on the entrepreneurial individual.”

New funding opportunities for deals

Arnold: “It’s fantastic to be able to give clients a suite of funding recommendations beyond the usual options. The challenge is to know the good ones from the bad ones, and not to give such a wide choice that the client is bamboozled by the variety.”

Rolfe: “By nature, new funding entrants are hungrier and more nimble because they have smaller teams, which they are building. They have opened the market up to more choice and have fewer layers to negotiate in getting to term-sheets. Alternative lenders are very much on our list to consider.”

Anstey: “We are not seeing deals fall over for funding reasons any more. A few years ago the choices were much narrower for companies.”  BCMS is making concerted efforts to map this new market of discretionary rather than tick-box funders, to understand it better and where appropriate to make introductions.

Roberts: “Compared to pre and post-recession periods, bank lending appetite is now very well balanced between encouraging growth while at the same time managing risk.” Improved credit analysis and the building of knowledge of the customer’s business that proceeds the issue of indicative term-sheets gives clients more confidence that “... following a clean due-diligence exercise, we will deliver on those terms.”

Thorburn: “The landscape has changed a lot and we now tend to deal with alternative lenders more than the ‘high street’. Most people come to us after they have tried to get funding from those traditional sources, which 10 years ago would have had around 95% of the lending market.”

He highlighted the rise of challenger banks, crowd-funding, asset-based and credit funding and revealed that London now also has more than 200 niche-lending banks, which most people wouldn’t know about because they have no branch networks or widespread marketing. “This all gives borrowers more options and puts pressure on the big guys to sharpen up.”

The need for informed funding advice

“Could more choice mean more confusion?”  Murray asked.

Thorburn claimed that many clients did not need more funding but simply more informed advice about the sorts of funding available. Most large corporates would have knowledgeable in-house teams, but smaller companies often relied on their banks or accountants for advice.

Roberts suggested that many SME bracket (£2 million-£25m turnover) deals that didn’t progress or failed to complete, can often be attributed to the lack of a suitable corporate finance adviser. “Too often the management team or the company’s accountant, seek to navigate through the deal process, without the right level of support or transaction knowledge that a corporate finance adviser can provide.”

Arnold said funding advisers had a duty to know and explain all the options to clients but it was easy for advisers “to gravitate to those lenders that they know best, which means that a client might be missing out on the best solution.”

Roberts agreed that finding the right funding was vital. He pointed out that timing and preparation could also be key factors in a deal. Traditional banks might loan funds but be delayed fully assessing business plans and financial accounts, whereas alternative online peer-to-peer lenders might agree a loan quicker, but at a limited debt quantum and much higher cost to the borrower.

Norman felt BGF’s funding from the ‘high street’ banks helped client confidence and awareness of “where the money is coming from”.

Arnold added that preparation of suitable financial data and business plans was something too few companies had ready when required within the deal process.

Thorburn noted that while alternative options such as crowdfunding had “revolutionised funding in general and particularly in the zero to £1m lending space” there were still funding deficiency pockets in the market.

Rolfe felt peer-to-peer funding was a refreshing market addition to offer another alternative to high-net-worth individuals for equity investment up to £1m. It can allow businesses to manage their affairs without needing to also manage a single individual who as the funder may exert unwanted influence over the business.

Quoting personal experience, Lingafelter mentioned “... the frustration of ‘high street’ banks having zero interest in actually understanding the quality of the deal I was bringing to them ...”  He had previously brought a similar deal to them, ultimately supported by a 10-year term loan, which he had paid off in three years. “As a new loan it should have been a no-brainer, yet they were only interested in ticking boxes from the security standpoint.”

Murray and Lingafelter also pointed out it was important to be talking to the right lending decision-maker within a prospective bank, or gaining assistance from the right specialist adviser.

Things have improved, commented Roberts. Better communication nowadays between banks and their customers was providing greater understanding of business needs and deal opportunities.

Thorburn agreed, highlighting shorter decision-making processes and more emphasis on local relationship banking.

The rise of boutiques and crowdfunders

The role of boutiques and specialist dealmaking advisers has been increasing in importance in recent years, helping to make the market more nimble, noted Murray.

(Boutiques derive at least 70% of income from dealmaking fees, and gained around 30% of global M&A fees last year, according to Thomson Reuters Deals Intelligence.)

Anstey: “Advisory is a very interesting space,” he agreed, exampling one firm that had increased its debt advisory team from six to 120 staff within the past few years. “There is real confusion in the market because of the greater choices available today, and SMEs are not aware or able to navigate this range of choice.”

Roberts: “We would never expect an entrepreneur to be an expert in every single business environment or discipline, or necessarily to have a high level of deals expertise within their business.”

Anstey viewed some alternative funding as truly disruptive. “Crowdfunding is at the small end of the market currently, but I can see this type of funding model becoming more sophisticated and moving up the food chain in the next few years and into the conventional lending territory. As an advisory company, we (BCMS) will certainly be aiming to be ahead of that curve and understanding this space much better.”

Norman: “The crowdfunding equity platform worries me personally as people are putting money in that will be tied up long-term, and may not understand the decisions they are making,  and often don’t take a portfolio risk. I do wonder what will happen to public perception and confidence if there is a wobble in that market.”

Rolfe tended to agree. “There is little doubt that a wobble will happen in a crowdfunded business at some point, and at that time they often need a partner who can bring more than just money to assist and that is where the model may break down as a disparate set of silent shareholders will add little or no value.

Norman and Rolfe suggested the current crowdfunding ceiling was around £2m, unless there were celebrity attachments or tangible rewards (eg a free beer at ‘BrewDog’ outlets), which attracted more investors.

Thorburn pointed out that investors rarely put significant funds into crowdfunding. “It’s more of a speculative punt-basis investment, although you can get tax benefits.  It’s also a fantastic marketing tool for many businesses.”

However, investors should remember that crowdfunding is merely a brokerage platform, with the risks being borne solely by investors, and the valuations being marketed to attract.

Hunt highlighted that, unlike crowdfunding, trade and PE-supported transactions brought additional skillsets into dealmaking as well as finance.

Are we seeing more foreign investors?

Anstey: “About 30% of our deals are to foreign buyers, which is surprising with a lot of our deals being in the SME space. The USA is clearly out in front, but we are seeing more European interest, particularly French and German. Maybe they see the UK as a safe haven at the moment.”

Arnold echoed Anstey’s view, although noting a slight percentage decrease in foreign involvements this year versus domestic transactions against high activity in 2014.

Norman said much of the foreign investment was more about trade acquisition and building platforms to grow in the UK, rather than direct investment.

Rolfe added it wasn’t surprising that NVM’s exits have had a heavy bias towards international  buyers a number of which gave us the impression that. “It’s cheaper to buy in the UK than the US.”

Deal values and multiples

Roberts suggested valuation multiples for a typical trading business could be five to six times EBITDA, but tech companies could be 10 times, mainly because of their opportunity for rapid global scalability.

Rolfe countered that 10 times multiple this year could be four to five times next year, but added: “There are businesses with certain growth journey trajectories with which you can comfort yourself that those high multiples are a fair price.”

“It can be very dependent upon the individual company you are looking at and how niche the business is,” explained Hunt, while exampling an agricultural concern that had been offered 14 times EBITDA, surprisingly high for that sector, but merited for the particular deal.

Norman mentioned multiples “higher than 14” in specific areas of tech, for scaleable companies already achieving significant (100% plus) revenue growth per year.  However, he warned:  “Valuation multiples are very subjective.”

Arnold felt the media and sector markets in general helped stoke expectation by publicising the high multiples involved in deals, but not the average multiple levels, often leading to disappointment for clients involved in ‘normal’ deals.

Roberts highlighted an MBO process where the seller had not had the benefit of advisory support. “It was a lot more difficult to structure a deal, purely because of the vendor’s multiple expectation.”

Hunt: “The difficulty is that so many people view deals as all about multiples and everyone’s expectations are based on what they’ve heard or read. But, every business is completely unique and you can’t compare one with another. That’s another reason why we often get a massive spread of offers.”

Does due diligence help or hinder deal valuation?

The Roundtable view was that DD had become more robust and was a vital component of deals today, particularly in confirming true values and pricing within deals.

Arnold: “There is a common perception that people sign heads-of-terms on a deal and then DD knocks the valuation back and back. We don’t actually see that very often.”

Rolfe: “DD should be very much confirmatory, not a tool to reduce the price. In fact, it is in everyone’s interest for DD to confirm the price, because if it begins to undermine pricing, it raises the question of whether the business is what you thought you were getting, which can lead to questioning the deal rationale.”

Norman: “Our success rate from DD to completion is very high because we set the bar right in the first place.”  Reputations are important and people have to live with what they have promised – in the days and years after, he added.

Anstey: “Our job is about creating a choice of offers and allowing clients to view them in context. We talk about maximising deal value, but it’s also about creating confidence for our clients that they are getting the best deal possible.

“Though we represent vendors, we do a lot of thinking about de-risking the transaction for the buyer, and have just begun commercial, financial and legal pre-DD for clients to make sure we are all aware of the potential deal pitfalls. We don’t want things to be discovered that could have been managed prior to DD, then see a deal fall over.”

New trends in dealmaking

Arnold mentioned that, with UK economic growth picking up, sellers were now asking for earn-outs, and staying with their businesses as a lesser shareholder for a period to gain a return from its future growth.

Thorburn mentioned sellers requesting an earn-out option to ensure a deal is deliverable, thus demonstrating their alignment with the deal and the business’s future.

Rolfe was unaware of that scenario but said “... that would be music to my ears”  because it would confirm for the buyer that the business had genuine potential in the eyes of the seller.

Anstey said BCMS believed the motive of potential buyers had a big impact on valuations, and so it concentrated hard on building a wide range of influential buyers. “For every successful sale, we have an average of seven meetings with interested buyers, and we always seek to get multiple offers. Conventional pricing doesn’t come into it in such a scenario. It’s about the future story of what the buyer can do with the business and how well it answers their motive to buy.”

Hunt pointed out that the agricultural seller he mentioned did not take the highest offer. “An entrepreneurial seller often cares more about the company name, its staff and their future than getting money in his own back-pocket.”

Arnold exampled a seller who accepted an MBO option rather than a more valuable trade sale offer, for exactly that reason.

Rolfe: “That’s because he wants to feel able to walk down the streets where a lot of his former employees work. That’s a value he puts on the deal.”

Why do deals go wrong?

Acquisitions can fail explained Arnold if buyers do not truly understand the business they are buying – perhaps through poor due diligence or misguidance by the sellers. Or deals can go wrong because a key contract of the acquired company is lost soon after purchase.

Roberts agreed there could be several reasons why deals fell down. “We always try to get to the potential deal-breaking aspects straight away, before a lot of work will have been put in by all concerned, and we try to mitigate those risks of the transaction falling apart.”

"Are business plans crafted well enough by the deal participants?" asked Murray.

Hunt: “At BCMS, a skilled team of qualified financial analysts assist clients to prepare realistic and credible business plans.”

Arnold stressed the need for proper early preparation rather than business owners essentially ‘daydreaming’ into a sale and exit, having done no research of requirements, gained no advice or skilled assistance to help maximise the deal and get the sale away.

Banker Roberts said early engagement with potential lenders was very important, in order to ensure key risk areas of business plans were adequately covered. This could save much time and questioning when it came to later financial DD.

Rolfe suggested proven experience was key. “As a private business owner you might make one acquisition in your lifetime.”  Professional dealmakers know how to make acquisitions, have the skills, contacts, and processes in readiness to progress things successfully. “Because we buy many businesses every year, we bring a rigour to the process that gets things done, while business owners often simply see the attractive figures and glamour of the activity.”

 

Participants

Steve Anstey:  Executive director, BCMS

Leon Arnold:  Partner, head of corporate, Henmans Freeth solicitors

Greg Norman :  Investor, Business Growth Fund

Andy Hunt:  Commercial director, BCMS

Doug Lingafelter  CEO, Jacqueline Webb & Co

Chris Roberts:  Transaction director,  corporate transactions team, future Williams & Glyn team, Royal Bank of Scotland

David Rolfe:  Partner, NVM Private Equity

Charles Thorburn:  Co-founder, finance adviser CreditSquare

David Murray:  The Business Magazine managing editor and publisher, chaired the discussion