Can growth through acquisition dramatically increase your exit price?

Before unpacking this, I would urge entrepreneurs to take good financial advice early because this can help you work out what you really need. It may also help you work out if a reliable home for your employees, or maximising price, is the priority.

Once you are clear on your desired exit value/financial plan, you can have your business valued and understand what you need to do. If the value and needs do not match up, growth through acquisition can be a solution. A larger business with stronger management, a good track record, and some international element will deliver a higher multiple than a small, domestic business reliant on its founder and a few clients.

Example: 

• Target exit value £20m, with EBITDA (earnings before interest, tax, depreciation and amortisation) at £2m.
• If your sector delivers a multiple of 5x EBITDA, you will be £10m short of your target.

If organic growth is around 5% and you need to plan your exit soon and acquisition can help.

What can an acquisition deliver?

• New territory, an established sales team, logistics, and customers (speed to market)
• Skilled workforce and equipment
• New product lines
• A complimentary business which has a higher multiple on sale – an obvious example would be a software product which compliments a manufacturer’s product

How you finance an acquisition will be important

Raising equity: introducing investor(s) will avoid debt financing costs putting pressure on working capital, but you will be sharing your ultimate exit price and control. You will need to change your constitution (usually articles of association) to make sure you can control key decisions (including when to sell – a “drag along clause”). Disruptive shareholders can be a big distraction.

Debt finance: avoids the need to manage investors and means the founder retains 100% of the equity. If you acquire a business which can be scaled quickly, this can be the most straightforward option.  Cashflow projections and forecasts (building in risk factors) are critical.

Using cash: within your business or within the target.  If the target has cash reserves, use these to help fund acquisition by releasing it as capital to sellers in a tax efficient manner.

Delayed payment: most deals today involve an element of deferred consideration, whether earn out (performance of the target post-acquisition) or deferred payment. Earn out avoids a risk of over- paying and can help close a value gap between buyer and seller.

Risk: The benefit of an acquisition can be lost if risk is assumed without protection. Deferred payment, combined with warranties and indemnities, are designed to protect buyers. Having a professional team able to support you is critical to assess this risk and design the deal to protect you as buyer and work out where you can make compromises.

Examples:

• A risk around a key customer renewing a big contract could be covered by deferred consideration or condition precedent.
• A business which relies on independent contractors who work predominantly for the target could have part time employees incorrectly characterised for tax purposes. This may need to be corrected pre deal, because the risk can be high.

Warranty and indemnity insurance is now available to cover (unidentified) risk. Buyers should, however, consider the impact of management distraction which can be caused by warranty claims.

Key people

Tying in key people is critical. Normally, sellers will only remain for one to three years, motivated by helping deliver an earn out. Key managers will typically need enhanced deals, with improved service contracts, share options, or growth shares. These need to be taken into consideration when reaching a price.

Back to the price

Why can a larger business justify a higher multiple when calculating price? Of course, that is not always the case, but these are commonly perceived benefits:

Access to larger trade buyers: with greater resources.

Private Equity value increases: PE multiples will often increase multiples as scale and sophistication of management increases (resilience and reliability).

Synergies increase: synergies are far greater for a larger business.

• Greater resilience
• Culture: less reliant on a founder.

Finally…leave space to take the value

If you buy with a view to future exit, your eventual sale multiple should be greater than your acquisition multiple.

Example: Buy a retirement sale at 3 x EBITDA and sell at 6x as part of your larger business.  

For further information or an initial discussion with our expert Corporate lawyers about growth through acquisition, please get in touch by email or call +44(0)3333 231580.