Don Glossop, who founded advisory firm Andon Frères, reports on how sellers are adjusting to painful new realities – to the benefit of buyers – and why he’s optimistic about the sector’s prospects for the rest of 2009, despite the wider economic gloom.

Adam Bannister: What were the striking features of the marketplace in 2008?

Don Glossop: Well, it’s been an uncertain market. Following the Chancellor’s announcement in late 2007 regarding changes to capital gains tax, there was a surge in companies coming onto the market as people tried to get deals done before 5 April.

I expected a fairly quiet second quarter, which it was, and the market generally takes a summer holiday anyway.

In recent months there has been activity, and I haven’t seen any major downturn yet, although it's a cautious market at the moment.

There will always be a market for someone wanting to buy profitable companies

 

I’d say that people are thinking about things for longer before deciding to sell or buy a business.

We were around during the last economic downturn and property slump, and I felt it didn’t impact overly on sales and acquisitions in the SME marketplace. There will always be a market for someone wanting to buy profitable companies.

AB: And do you see the market entering a new phase in 2009?

DG: I think it will be uncertain still, but there will be activity and deals to be done.

Perhaps the more marginal deals will struggle – for example companies in difficulties, those bought out of receivership or where transactions are highly geared, requiring heavy borrowings – but that is probably no bad thing.

AB: What makes you say that?

DG: Sometimes vendors’ valuations are too bullish and not achievable, so hopefully we’ll enter a more realistic period of valuations.

I don’t think that means value calculations are going to change; the same principles will always apply in that return on investment is what counts.

But the anticipated difficulty in raising funds will hopefully see vendors being more realistic in their expectations.

AB: If sellers are lowering their expectations, does it make it a good time to buy a business?

DG: Yes, although I’ve always felt that this marketplace provides a great opportunity for companies to achieve rapid growth through acquisitions rather than organic growth. I'm a great a believer in buy-and-build strategies.

AB: Will earn-outs become more common to help credit-starved buyers meet the price?

DG: We’ve always seen an element of deferred consideration or earn-outs in transactions and I would expect this to continue.

For example, a company may be on the market for, say, £3mn, and the reality is that, on the strength of an information pack, one or two meetings with the vendor and a review of some accounts, the purchaser has to decide in principle whether to commit to spending £3m on a business – that’s a big risk.

Due diligence can only ever be limited, so the buyer will want to mitigate his risk by having an earn-out linked to future performance.

AB: What are the most important factors in closing deals?

DG: Vendor valuation expectations and managing those expectations. Sellers must come to terms with return on investment being the key factor in determining value.

Also, the buyer and the seller must be flexible, keeping discussions going and compromising to get a mutually acceptable deal.

AB: How should you prepare a business for sale to maximise the price and sale prospects?

DG: It depends on the company: some are ready for market straightaway but others need quite a bit of pre-sale planning.

Some businesses aren’t strong management-wise and generally owner-managed businesses need more support.

Others have experienced management teams, with well-prepared business plans, good profits and strong cash flows, and are therefore well placed.

Key factors in preparing for sale are: having good second-tier management, reducing the business’s dependence on vendors, having a solid business plan and financial budgets, being prudent with spending and generally striving to improve profitability.

Some businesses have a history of trying to reduce profits to save corporation tax, but this is a false economy in the lead up to sale as it has a disproportionate impact on the sale value.

AB: How do you value mid-market businesses?

DG: In general terms, we use a multiple of sustainable profitability. In the mid market this isn't always the same as reported profitability because company owners manage their businesses differently.

Some take large salaries, pay their family and put lifestyle expenses through the business, making the profit look low; others may take no salary and pay themselves dividends, so the profit looks high.

There may also be non-recurring or exceptional expenditure in a particular year, interest payments or amortisations, etcetera. You therefore have to normalise the accounts so the purchaser knows the sustainable profitability he can expect to inherit.

There are a number of other considerations for valuing businesses – for example, supporting net asset value in the balance sheet, the size of the forward-order book or the extent of any recurring or contracted revenues.

AB: Tell me about an interesting deal you’ve done...

DG: A good illustration of our range was a management buyout we did about 15 years ago of a fledgling, niche technology business from a major regional company.

After advising on the MBO we provided consultancy support and advice for around 10 years, before advising on a £4m sale.

AB: If you could give one piece of advice to a mid-market seller or buyer, what would it be?

DG: For the seller, the timing of, and reasons for, the sale needs to be right. It's vital to make the right decisions, maximise the opportunity and take proper advice.

For the buyer, it's important not to borrow too much money to fund the transaction.

Invariably, acquisitions aren’t straightforward, and if the business has borrowed up to the hilt there is no headroom if anything goes wrong. Companies often fail not because they aren’t profitable, but because they run out of money.

AB: And what are your hopes for the rest of the year?

DG: This country has a habit of talking itself into downturns and recessions, which isn’t helped by media negativity. We need to be more positive about the outlook.

My hopes are that the banking system stabilises and that government promises of supporting the SME marketplace actually materialise. Overall, I’m optimistic that things should begin to recover next year, though probably not until the second half.