This is a thought leadership article by Corporate Finance Partner Adrian Alexander at PrimeGlobal member firm FRP Advisory, which considers the strategies open to business owners looking to exit their business during the economic crisis.
As the coronavirus pandemic continues to impact businesses across the UK, many business owners will be considering how they can secure a future for their business whilst protecting themselves from the challenges ahead.
In recent months, many businesses have been focused on resilience and recovery. Many have chosen to streamline their operations and focus their efforts on their core proposition. At the same time, a number of SME owners have found that their priorities have changed and are thinking about the options available to realize the value of their business. If realizing value or reducing future risk is a priority, or if they feel the business has achieved its current objectives and would benefit from a new owner, they should consider exploring an exit, even if the climate is uncertain.
For business owners looking to develop an exit strategy, there are several options; be that acquisition by a trusted trade buyer, full or partial sale to their management team, handing over the reins to an Employee Ownership Trust (EOT) or merging with a competitor.
Unsurprisingly, M&A activity dipped significantly during lockdown, with deal volumes slowing as many businesses focused internally on their own challenges. We’re now experiencing some recovery and activity is picking up again – albeit the landscape is different to how it was before COVID-19 and it continues to evolve.
Private equity houses have remained active during the pandemic, and still have significant funds to invest. Initially, they were focused on supporting their portfolio companies with additional investment and resource. Subsequently, they have been looking to grow their portfolio either through new investments backing strong management teams in sectors resilient to the current economic pressures, or through organic buy-and-build strategies for their portfolio companies, where they consider the risk is less given they already know and trust the management teams.
A gap is emerging between the strong demand we’re seeing for high quality businesses, and the limited appetite for any businesses that have struggled during lockdown and seen a decline in revenues. When attractive assets appear on the market, investors are quick to show an interest. Sectors such as healthcare, software and technology have proved resilient, with continuing demand for their services and products, and the multiples that strong propositions in these industries are attracting are notable. In contrast, other businesses that are less financially stable, in the worst affected sectors, are struggling to attract attention given the precarious climate.
Consideration should also be given to expected developments around Capital Gains Tax (CGT) for business owners considering an exit. It is widely believed that CGT rates will rise and the reliefs that are currently available for owners who sell their businesses could be cut further.
However, with the postponement of the Autumn Budget, a potential short-term window has opened up for owners to either sell 100 per cent of their company or consider a partial sale or ‘two step’ exit to management, which could release some value to owners at the current CGT rates and may drive M&A activity.
Another notable trend in the market is the growing popularity of Employee Ownership Trusts (EOTs), which have come to the fore in recent months, largely due to the considerable tax benefits they can bring for exiting owners. Under the EOT structure, owners sell a majority stake – 51 per cent or more – to an employee owned trust and in doing so, control will pass to the people who already have a vested interest in continuing the company’s success whilst the sellers won’t incur CGT. As with any exit option, there can be drawbacks to EOTs, with the owner having to relinquish control of the business to the new trust. If CGT rates do increase then the interest in EOT’s could well accelerate further.
Genuine mergers in the UK market – those where two entities combine to create a new, joint business – are fairly rare, particularly in the private company market. However, given the current instability, owners of companies may now consider that it could be stronger operating together rather than trying to compete in a challenging market. Considering joining forces could in time provide better value for all of the shareholders.
The circumstance of each business is different, and it’s important that owners draw on various skillsets to prepare for an exit and start the process as early as possible. When it comes to selling a business, the ‘fail to prepare, prepare to fail’ adage holds true. It’s also important business owners have a realistic view on the valuation and deal structure that can be achieved, and whether this will meet their long-term personal needs, so they are not faced with unexpected surprises further into the process. A ‘holistic’ approach to their corporate and personal ambitions has never been more important.
To attract a good level of interest, owners must above all prove that their business is resilient and that the earnings of the company are maintainable. This applies to both companies that have struggled during the last few months as well as those that have performed well. Potential buyers or investors will ask the key question ‘can these profits be sustained, or have they been impacted by a temporary pickup in activity, due to COVID?’.
This first step requires a thorough review of their corporate strategy. Once this is in place then it is important to prepare for the sale which can include carrying out a due diligence process internally. It is crucial that owners invest resources into a sale process to understand where they stand from a commercial and legal viewpoint, and avoid hasty decisions.
Paying close attention to the details and doing the groundwork properly should lead to a far better outcome. It can also pay to play the long game rather than seeking a quick exit.
There’s a lot for business owners to weigh up before deciding on the right exit route and the timing. With the challenging headwinds, business forecasting has become incredibly difficult. Vendors also need to have realistic expectations of where their business sits in the market, and whether the appetite will be there for a third-party sale or is funding available for a management buy-out. Keeping an open mind to the pressures the current climate has had on the market and the subsequent changes to business valuations and deal structures is vital. Seeking advice early can have a huge impact on the right strategy, as it will give insight into how to prepare, the steps to consider and in what order to plan, and can highlight any areas of their business they may need to focus additional time and resource on in the period leading to their exit.
FRP is a leading business advisory firm with a strong reputation for providing cross-border solutions to create, preserve, and recover value across a range of complex stressed and distressed situations. Working across the board, from multinational organisations to small enterprises, we develop effective strategies for all kinds of businesses.Learn more