Business recovery is pretty high up on our agenda, right now. Our first step, I believe, is making sense of where we are now, then our trajectory will become clearer.
I advise people on the sale and acquisition of small to medium-sized* businesses. These are two critical activities not only for business recovery but also the financial welfare of individuals.
In this blog I start by looking at the commercial landscape and scoping out various scenarios facing business owners…
Thinking the unthinkable
If you had not considered selling your business before Covid-19 forced us all into lockdown, maybe it’s time to do so. Perhaps it was on your mind but now you may think all is lost. The same is true for buying a business – is now the wrong or right time?
Trust me, these are not negative or thoughtless suggestions – the exact opposite in fact. We all need a strategy that helps us develop and / or leave our businesses. Covid-19 has put all our plans into disarray. However, we have a duty – to our employees, our families and ourselves – to make plans for business recovery, however uncertain the future looks at the moment.
My starting point is the value of business pre Covid-19. This gives us a valuable benchmark going forwards…
The MarktoMarket (MtM) indices suggest that UK merger and acquisition (M&A) multiples trended lower in 2019 versus both 2018 and 2017. The mean EV*** / EBITDA**** multiple in 2019 across all companies sold was 9.08 times profits versus 9.99 times profits in 2018 a fall of 9.1%. A possible explanation of this was that Brexit uncertainty reduced the interest of buyers. Surprisingly, the contraction of multiples did not occur at the lower end of transaction size – it implied ‘business as usual’ for smaller companies. Moreover, across the board, the consumer sector index rose year-on-year whilst industrials, business support services, technology, media and telecoms trended lower.
So what did those smaller businesses sell for in 2019? MtM valuation indices show the following:
- In the transaction range £0 – £2.5 million representing the smallest companies in the UK the data suggests that multiples in this index increased in 2019 relative to 2018, with the mean EBITDA multiple expanding by 5.5% in 2019 versus 2018. It was 5.95 times profits (2018: 5.64 times profits and 2017: 6.52 times profits).
- In the transaction range £2.5 million to £10.0 million the mean 2019 multiple was broadly in-line with 2018 at 8.08 times profits (2018: 8.05 times profits and 2017: 8.94 times profits).
- In the next level up, £10.0 million to £50.0 million, the EV/ EBITDA was 10.49 times profits in 2019 a 30% increase.
Furthermore, the multiples from the lower range to the next level increased by 36% for 2019 (2018: 43% and 2017: 37%).
Regardless of size
On the one hand, larger businesses have systems and processes in place so they are less dependent upon the owner in the day-to-day running. On the other hand, ‘buy and build’ strategies, though risky, are likely to remain popular with many entrepreneurs because of the growth opportunities. Take for example, a smaller business with an EBITDA of £500,000. Merging it with another company could increase its value by 36% – from £4.04 million to £5.25 million – simply due to a higher multiple.
Business Recovery the valuation principles still apply
This brings me to now – mid Covid-19 lockdown at the time of writing. The way forward for business recovery isn’t clear but my experience, both as a chartered accountant and adviser, tells me the principles of valuing a business still apply. For example, having a repeat purchase model in your business has always been key to its longevity and therefore its value. This is why the top-end companies like Amazon Prime, Netflix and Microsoft are so valuable – their customers sign up to a subscription and continue to buy.
Once consumers have regained their confidence enough to buy ‘big ticket’ items such as houses and cars, the economy will start to grow and we can cautiously watch for signs of business recovery. But, economic activity cannot be switched on quite as quickly as it was switched off! The return to work will be gradual as we have seen in Europe. It means profits will not bounce back quickly and so cash flow will remain negative for some time.
Whether as a business owner you wish to exit now or trade on through this crisis is something that you need to be addressing urgently.
Maximising value and saleability
I employ a simple assessment exercise to help me understand the status of a business before the planning stage. This involves looking at the customer base and day-to-day management of the business. Also the ability of the business to generate a cash flow out of its profits. For example, the fact that a business has been trading without any liquidity or reserves during the ‘good times’ is not necessarily going to work post Covid-19. Taking on more debt or deferring payments may not be sensible but the support of grants, loans and furlough arrangements might be appropriate.
I can understand business owners not wanting to take on debt having reached a certain stage in their life. The risk of a poor credit record is not to be taken lightly. Equally, withstanding cash pressure in the short term may also be unwelcome.
Likewise there will be perfect opportunities for buyers. By all accounts there is likely to be a drop in the Country’s gross domestic product (GDP). It is possible any sector of the economy will end up with too many companies chasing less business. In these situations which I have seen before, there is a race to lower prices and so gross profit declines. That is likely to be a race to the bottom and should really be avoided. One of the responses could be to consolidate and so create economies of scale to give some protection to the gross profit.
Now really is a good time to start conversations. Any deal would need to be structured so as to ring-fence the effects of Covid-19. Buyers could make a reasonable offer to the owner of a viable business.
Business Recovery – there is light at the end of the tunnel
Notwithstanding the huge amount of uncertainty that Clearly Covid-19 signals for our economy, the rules and principles for running a successful business apply. Your circumstances and personal situation are as much a part of the equation as the cold facts surrounding value.
Making the right decision and remaining in control is key whether you plan to sell or buy a business. At the heart of every business lies people – you, your family, employees, supply chain. Business recovery is definitely possible but, as you would expect, it will take time, planning and courage.
Business Recovery Further reading
*I work with businesses whose turnover is over £1 million in the sectors such as professional services such as lawyers and accountants, distribution and manufacturing.
***EV means Enterprise Value. It is a measure of the value of a business. It includes short-term and long-term debt as wells any cash on a company’s balance sheet. In other words what a buyer pays for a company’s shares.
****EBITDA means profits before interest, corporation taxation, depreciation and amortisation. Put simply it is usually the cash generated by a business unless it is in a capital intensive industry. So, the higher the multiple created, the business will be worth more. I am going to call these profits for simplicity.
More reading, help and advice from Assynt Corporate Finance
Below you'll find links to other articles that offer help and advice about selling your business, what to look for, considerations and recommendations.
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