In the second of our three-part series on choosing the right exit strategy, we examine the key indicators to watch out for when timing your sale – such as sector bubbles, the economy and M&A market – as well as tax reliefs including Entrepreneurs Relief and forecasting. This blog is adapted from a chapter in our new book The Definitive Guide to Selling Your Business.
Time is money – so they say. And when it comes to selling a business, it’s certainly a crucial factor. Get the timing right and you’ll significantly increase the value of the sale, get the timing wrong and you may not sell at all.
Despite this, working out the perfect time to exit a business is almost impossible. After all, even the most sophisticated algorithms and economic forecasters can’t see into the future – and your business may be subject to unpredictable circumstances beyond your control.
Harley Medical & PIP
In 2009, it emerged that silicone breast implants made by French company PIP were faulty. The news rocked the cosmetic surgery sector. Just a few years earlier cosmetic surgery was booming in the UK, with clinics selling at double digit multiples. Yet so catastrophic was the discovery, Harley Medical, a 30-year-old surgery with 14 clinics that fitted the implants, was forced into administration by 2012.
1) FOLLOW MARKET CONDITIONS
Fortunately, scandals such as the PIP breast implants, or the horsemeat scandal of 2013, are rare. And there are plenty of indicators we can look out for instead, the first of which is the M&A market.
Three key points to consider regarding the M&A market:
• The more buoyant the M&A market, the easier it should be to sell your business
• The more buoyant the M&A market, the higher the valuation you should achieve
• A strong economy generally means a strong M&A market and vice versa
As mentioned, another key indicator is the economy, particularly recession periods and downturns leading to a recession.
Key points to consider regarding recessions and downturns are:
• Fewer businesses perform well, with adverse effects for the M&A market
• Attractive financial projections for a business will seem less credible
• Acquisition finance (particularly bank debt) is less readily available
Generally speaking, a downturn in the M&A market hits larger companies first – with bigger deals the most at risk. While at the smaller end of the market, there should always be a solid base of deals involving retirement sales, disposals of non-core businesses and forced sales.
2) CONSIDER VALUATION BUBBLES
Dating backing centuries, sector bubbles can occur for all sorts of reasons. The important thing to remember is that eventually the bubble will burst and your business is likely to be less valuable as a result – even if your profits have grown and your business should be more valuable. So if your sector is experiencing a bubble, it’s wise to consider exiting – even if you hadn’t thought of doing so beforehand. The key to timing an exit is flexibility: so, while you may have planned to exit a few years later, if your sector is experiencing a bubble, act.
SENAD & the care home bubble
In the lead up to the Lehman’s crash of 2008, credit was cheap with banks providing acquisition finance at very high multiples of EBITDA. As a result, many sectors experienced a bubble, including care homes businesses. Concerned that this particular bubble was about to burst, we advised the shareholders of SENAD (which operates special education schools and homes) to bring forward its sale by six months. As a result, SENAD achieved the last double digit profits multiple for a care home business before the stock market crash.
3) REMEMBER THE VALUE OF CRITICAL MASS
While staying flexible is important, so too is growing your business to its optimum size for selling (which doesn’t mean as large as possible, as the buyer needs to grow the business too). Remember that as your business grows in size, not only will it become more valuable thanks to its growing profits, but it will usually be given a higher valuation multiple on those profits. On average, profit multiples on company sales increase with the size of the deal. So the bigger the business, the better its risk profile and earnings quality.
As your company grows in size, it will typically:
• Be less dependent on key people, so able to attract better management
• Have a healthier spread of customers
• Have a stronger market position and brand name
• Be less vulnerable to attack from competitors
4) HAVE A DECENT TRADING HISTORY & GROWTH FORECAST
Ideally, you want a three-year track record (or more) of rising revenue and profits to show a potential purchaser. Selling a company whose turnover or profits are flat-lining or declining is difficult, so it’s important you sell when your business is on an upward curve. As already mentioned, this doesn’t mean selling when your business is peaking. The old adage “leave something on the table” should certainly be heeded when it comes to selling a business.
5) CONSIDER A PARTIAL SALE
As already demonstrated by the case of Harley Medical, history is littered with examples of business owners who have left it too late to sell and seen their business value plummet – and their own wealth disappear as a result. In many cases, it’s emotional attachment to the business that prevents the owner from selling and ultimately losing out. If you’re (rightly) concerned that all – or a lot – of your wealth is tied up with your business, but you don’t think it’s the right time to exit completely, then a partial sale to de-risk your financial position might be worth thinking about.
6) AVOID A FORCED SALE (IF AT ALL POSSIBLE)
While ill health and financial problems will always make forced sales inevitable for some, anything you can do to avoid this scenario, such as de-risking your finances with a partial sale, is strongly advised. Ultimately, the one overriding rule in timing an exit is to sell when there’s no absolute need to do so. This way you can always pull out if you’re not happy with the sale price (or for any other reason). By contrast, as with any type of sale, once the buyer knows you need to sell, they’ll use that knowledge to their advantage.
7) AIM TO SELL AFTER THE FINANCIAL YEAR-END
While it’s hard to aim for an exact date, planning your exit to time with the financial year-end is always a good idea. This way you’ll have a neat set of audited accounts that shows the business in its most recent state – reducing uncertainty over the profits on which the purchase price is based and the assets are sold. Time it this way and the purchaser’s accountants can carry out their due diligence while the audit is taking place, minimising disruption to the business and helping to maintain confidentiality. Finally, some purchasers may wish to have an input into the finalisation of the accounts. For example, they may want to create provisions for release in future periods to enhance the profits of the company in the period following the sale. By panning your exit to tie in with the financial year-end you can provide the purchaser with the opportunity to do so.
8) LOOK AT TAX RELIEFS
The current tax regime can have a significant impact on your sale, so it’s always worth looking at. Remember that to maximise the value of your sale, the important number isn’t the headline purchase price but how much is left after the tax is deducted. Tax planning is therefore an essential part of the sale process that should be addressed as early as possible.
A big one is Entrepreneurs Relief. In their election manifesto the Conservatives promised that if re-elected they would “review and reform” Entrepreneurs Relief – the tax break which currently allows business owners to pay a lower rate of 10% capital gains tax when they sell a business, compared to the normal 20% rate.
While it is not yet known what exactly “reform” will mean, it seems likely that at the very least the rules for Entrepreneurs Relief will be tightened or the relief may even be abolished. Indeed, former head of HMRC Sir Edward Troup has called for abolition, so radical reform cannot be ruled out.
What happens next? Whilst Cavendish fully expects the new Conservative administration to honour this commitment, entrepreneurs should be aware that any reform will not happen straight away (as it will need to be included in a new Government Budget and put before Parliament).
Indeed, the Chancellor has spoken of delivering a “post-Brexit Budget” in March, so it would seem there is roughly a two-month window of opportunity for entrepreneurs.
9) CONSIDER SPLITTING OWNERSHIP
It’s worth noting that if you split ownership of your shares with your spouse, and all of the pre-conditions for entrepreneurs’ relief are met, you can realise £20m in value at the concessional 10% CGT level. Thus you can realise a significant tax arbitrage by converting the income stream from your business (on which income tax is paid) into a lightly taxed capital sum through a sale of your company.
10) REMEMBER THAT EXITING TAKES TIME
Selling a business takes between six to nine months on average. That said, it could take significantly longer than nine months, though it’s unlikely to be take less than six. As for the planning and preparation period, this can start anywhere between three years to 12 months before the sale, depending on how much work needs doing to maximise the value of the business. If you’re looking to retire following the sale, remember that unless you have a sufficiently strong management team in place, the purchaser may require you to remain in the business for a year or two afterwards – so you’ll need to factor that into your retirement time-line.
As you can see, timing is a key factor when it comes to maximising the value of your exit. And while there’s no way of assuring the perfect timing, following these steps should significantly boost your chance of success.
This blog is adapted from a chapter in our new book The Definitive Guide to Selling Your Business, which you can buy here.