WHAT ARE YOU LOOKING FOR?

In devising profile number two at the beginning of Chapter 2 (p27) the searcher has already identified:

• the industry in which they wish to be (widget making) in which presumably they have some knowledge or experience and in respect of which they have presumably taken a view as to the current state and likely prospects of the industry
• the location (Yorkshire and Humberside) which presumably fits either where they currently live or where they are happy to move in order to acquire a business
• the scale of the business (stable turnover of £3m to £5m) which hopefully will fit the level of experience that they have, and the amount of capital they are going to be able to raise in order to enable the deal to be financed
• the business performance (currently profitable) which will provide them with a living and the return which they are seeking as part of the process
• some particular characteristics (produces own brand products and capacity for expansion) that they are seeking in a target company in this sector.

Already this straightforward exercise in defining the search has enabled the prospective buyer to focus their efforts quite precisely; they won’t be looking at distribution businesses in the West Midlands; they won’t be looking at hotels in Scotland; they won’t be looking at businesses requiring a major turnaround to achieve profitability; they won’t be attempting to bid for a listed PLC.

In other words they have quite clearly defined the key characteristics of the type of business that they would like to buy to the extent needed to commence a search for a business of this type. Chapter 5 sets out how you can go about identifying a selection of such businesses.

Simply carrying out such a search will, however, produce a list of potential targets many of which will still be irrelevant. This is because there is one critical factor missing from these search criteria and one element that has not yet been considered.

You need to add to these criteria something that on the face of it you are unlikely to be able to discover in respect of many businesses from publicly available information – namely the business’s owners must be willing to sell.

To have found a realistic target, therefore, you must have found a business that both:

• meets your criteria; and
• is or may be for sale.

So in this chapter we will consider who sellers are, what motivates them and why a business may or may not be for sale, as well as the specific issues around family businesses.

WHO ARE SELLERS?

Different types of people sell businesses. The person or people you’re ultimately dealing with might be any of the following:

• The owner manager, who may have founded and built the business from scratch. They may well have a variety of personal issues that are of importance to them in any sale apart from price: ranging from pride in the business and wanting to secure its future going forwards; through wanting to ensure that key employees are looked after; to a desire to have an ongoing role in advising the business in the future. And if these considerations are significant they may have the ability to take their time and be very choosy in who they sell the business to.
• The owner’s executor, who is dealing with winding up their estate and is simply under a duty to get the best price for the business.
• The corporate owner, who has decided that a business unit simply doesn’t fit with their current corporate strategy and is therefore disposing of it in order to focus on the rest of the business.
• The financial owner, such as a venture capitalist, who is looking to realise their investments as part of their normal business cycle, and who may even be driven by a timetable under which a fund has to be closed by a particular date.
• The insolvency practitioner, who has been appointed as receiver or administrator of a business and who will be looking to achieve the best sale possible, usually within a tight timescale, but on the basis of giving no warranties or representations as to the business whatsoever.

Each type of seller will therefore have their own objectives, timescales and key considerations in mind. It would be a mistake to think that the approach to dealing with an owner manager who wants to retire should be the same as the approach to dealing with a venture capitalist, who is looking to exit the business as a normal part of portfolio management. It is too simplistic to think that both will want the maximum sales proceeds as the be all and end all.

Particularly when looking to buy businesses that are not currently formally for sale, you will find it important to understand the psychology and motivation of the seller or potential seller, so as to be able to construct a deal that they will be willing to accept.

WHY DO SELLERS SELL?

You might reasonably ask if a business is doing well, so that it is generating profits for its owner and has good prospects, why on earth would an owner want to sell? And does this mean that businesses are only for sale if there’s a problem?

Well thankfully not, there are many reasons that business owners choose to sell their business:

• A desire for retirement or to hand over succession to other family members, business partners or management.
• To acquire money to fund growth, when the opportunities available to a business are greater than can be exploited by the business based on its own financial resources.
• To become associated with a larger firm, allowing access to their developed distribution channels or their particular manufacturing or marketing strengths.
• To allow concentration on a particular area of operations without having to worry about ‘the whole shooting match’.
• To pursue other business interests as individuals, or as corporates to concentrate on or invest in the development of other businesses within the group.
• To reduce risk by ‘banking’ some or all of the cash made in building up the business, thereby reducing some of the personal risks that will come from making future business decisions.
• Because, like an executor or an insolvency practitioner, they are under some kind of duty to sell.

The principal reasons that owner managers have for selling divide into a number of personal and business requirements.

Banking the money

Often much of a business owner’s personal wealth will be tied up in the company they have created. A sale of the business therefore offers them the principal opportunity to convert this holding into cash which allows them to diversify their investment across a range of different types of asset and investments, thereby minimising their exposure to the particular business’s fortunes, and to enjoy the benefits of having created a successful business.

The danger in this case is where the owner thinks that they can get a good capital value for their business and has unrealistic expectations as to what someone will pay.

Reduction of risk

Often in the early days of a business, despite the legal status of limited liability, the owner has found that they have had to put up personal security in order to obtain bank funding, or even have had to give personal guarantees in order to obtain certain supplies, ranging from property leases all the way down to a photocopier. The effect of these personal guarantees is that the owner is liable for the debts of the company in the event of its failure, and such personal guarantees given in the early days of business have often never been fully removed.

In addition, the responsibilities of directors grow ever more onerous with every piece of legislation. There is a risk that in the event of insolvency the directors may face the prospect of potentially being made personally liable for the company’s trading losses. It makes sense therefore for owner managers at some point to seek to reduce their exposure to such risks by selling the business to someone who is willing to run it.

Health concerns or retirement

The above points are particularly relevant when an owner manager decides it is time to retire or their health starts to fail. In fact, many businesses are sold not because of any financial considerations, but principally through some change in the owner’s life. On the other hand, many entrepreneurial business owner managers seem to thrive on the activity and mental challenge of running their own business well into their seventies and later.

Boredom

Entrepreneurs and owner managers are human, and they do get bored. Those who are highly entrepreneurial may find that once they have established a business they sooner or later become bored with running the same thing and wish to move on to new projects, while others become bored with living under the continual pressure, and decide they wish to pursue other interests, retire, or occasionally, seek to hand on the administrative and managerial aspects to others in order to concentrate on the particular aspects that they love.

That the owner is a serial entrepreneur looking to move on to the next project may on the face of it appear to be a good sign about the business as it does not necessarily indicate that there is any problem with the business.

However, if the founder is bored you need to consider whether their attention to running the business has lapsed, as if so it may have suffered as a result. Serial entrepreneurs who are always looking for the next big thing tend to be poor ongoing managers and completer finishers so there may therefore be loose ends and risk issues in the business to think about.

By contrast, some serial entrepreneurs who are used to creating new businesses and selling them to move on to their next project become very adept at tidying up their creations for the sale in order to maximise the funding available. In this case be warned, as you will be dealing with a very professional seller who is good at presenting the business in the best light.

Money to grow

The faster a business is growing, the greater will be its demand for working capital to meet its expanding trading, together with investment capital to support it in exploiting new opportunities. For this type of company, achieving a sale of part of the owner’s interest to an outside investor can be the route to acquiring the capital needed to take advantage of the opportunities that arise, but this will naturally involve some form of loss of control of the business in return for the external capital introduced. In these circumstances the owner has to decide whether the opportunities offered by this extra money compensate for the restrictions on their independence.

Looming problems

Undoubtedly some business owners sell because they can see trouble coming in that either:

• The market is disappearing, which is very bad news. This can be because customers have gone away as tastes have changed; or because new products or services provide them with a better value solution to their needs. In either case the business must follow its customers to meet their new requirements or face extinction.
• Or the customers are still there to be supplied with what the business does but other people are supplying them. This can be because new competitors have entered the market taking away the company’s market share; or existing competitors have become more effective by better differentiating their products or reducing their costs so as to undercut the company’s prices.

It is important to be able to identify any looming problems that the business has and to understand the implications. If you buy a business that is about to get into difficulties you are likely to find that you have overpaid and to end up having to deal with a business turnaround rather than a simple purchase.

WHY SELLERS DON’T SELL

While on the subject of sellers and their motivation, it is worth looking at what motives will work against a sale. These can be divided into three groups of factors:

• those such as a desire to pass the business on to the next generation of the family, which can mean that a business is simply never for sale to a third-party
• those which mean that the owner is reluctant to sell the business but which give you an opportunity to persuade them. These may actually work to your advantage in that they reduce the competition to buy the business but they may also recur later in the process and cause the seller to pull out
• those that only arise during the process.

It’s important to be able to identify as quickly as possible whether the people you are dealing with are going to be serious in going through with selling or not. Once you get into the due diligence phase you will start to rack up real costs and you don’t want to then find that the seller ceases to be interested in the deal or gets cold feet, which is a waste of money and time. As far as possible you need to have weeded these out early in your screening.

Therefore from the outset you need to be looking for the things that might cause a deal to fail so as to judge the time, effort and money you put into pursuing any particular target.

Issues that might lead to the owner being reluctant to sell in the first place, and which can also resurface during the deal and cause it to fail, include the following:

Emotional attachment

Whatever their reasons for selling, business owners need to decide that they are serious about selling their business, as it is not a decision that should be taken lightly. After all, once the business is sold, it is sold. In addition, the process will take up an enormous amount of their time and effort and will cause significant amounts of disruption to the business as and when customers, competitors, employees and suppliers find out that it is being sold.

Nevertheless, if they have successfully grown a business, sooner or later they may consider selling it for the reasons already outlined. However, the prospect of a sale for an entrepreneur (who has often founded the business) can create mixed emotions. On the one hand there is the prospect of realising the value of the business that has been built and obtaining both financial freedom and freedom from the demands, risks and worries of running a business. On the other hand, letting go of their ‘baby’, which they have sweated and worried and slaved to build, can generate a strong sense of loss.

Many owner managers therefore find it harder than you might expect to decide whether or not they ought to be selling the business, even in the face of an attractive financial offer.

Loss of meaning or structure to life

Bear in mind that your business environment gives a high degree of structure to your life. For an owner manager, selling up or moving to a position of retirement will be a major change in lifestyle for which they need to have prepared. They will need to have thought through the implications for their personal life; how they will feel once they have sold up. What are they planning to do next?

And these issues can be as fundamental and personal as not wanting to face the idea of being at stuck home all day with the spouse; or fear that they will not know what to do with themselves in retirement and will simply fade away from loss of motivation; or a lack of outside interests or friends away from work.

You may think that as a buyer these are not your problems. But if the seller only really starts to consider these issues as you get near to completion and these cause an otherwise good deal to collapse, they will be. So in your process of getting to know the seller it’s always worth discreetly trying to get a background on what they’re looking to do next and forming a judgement on how well they have thought this through, how prepared they are, and so how likely they are to go through with a sale.

Loyalty to business or staff

Owner managers may feel particularly protective of their business and its good name as it has been so intimately associated with them personally, and can feel very responsible for the prospects and welfare of the managers and staff that work for them. These feelings can be so powerful as to blind an owner to the prospect of selling the business to anyone else.

This can, however, present an opportunity if you are able to get the owner to admit that they cannot be around for ever to look after the business. Your job is then to convince the owner that you are their best chance of securing their legacy. If you can do so, you may have an opportunity of buying a business that is not for sale to anybody else, from a person for whom money is not the principal consideration.

Issues that tend to arise during the sale process rather than before include the following:

Can’t afford to sell

This occurs when the sellers realise that the earnings they will be able to make in investment income from the capital sum that you are proposing to pay them, means that they will take a significant reduction in annual income.

This issue arises relatively frequently in that a business purchase at say five or seven times earnings would mean that the owner of a business generating them a profit of £100,000 a year might expect an offer of £500,000 to £700,000, which initially appears extremely attractive. However, setting aside any reduction of that capital sum required to clear mortgages or other debts, in the current investment market they may then find that it is likely to be difficult to obtain investment return of more than say 5%. This means that this amount of capital is only going to be earning them between £25,000 and £35,000 a year, representing a substantial reduction in income.

The business owner in their sixties or seventies who is seeking a retirement sale may be willing to make such a trade-off as a way of turning the capital value of their business into a secure pension income and clearance of all their liabilities such as mortgages. The younger owner manager in their thirties or forties with perhaps a young family to support and a significant working life ahead of them is likely to be much less willing to undertake this sort of transaction.

Not theirs to sell

It is not unknown for buyers to have been negotiating in the early stages with the apparent owner manager, only to discover subsequently that a key shareholder, or a wide number of small family shareholders, do not wish to sell. The result is that the individual with whom they had been dealing did not in practice have the power to deliver a sale of all shares that they wish to buy. As discussed below, this can be a particular problem in older family businesses.

As soon as you start to look at any business you should undertake a company search (see Chapter 6) and obtain a copy of the company’s annual return, which will set out the names and addresses of the shareholders’ and directors as well as the shareholders, holdings. This will enable you to establish who owns the controlling shares and whether this is the same people that you are dealing with.

Not serious sellers

Some owners take the attitude that their business ‘is always for sale’ for the right price. These people are not really interested in a sale but if someone is prepared to make them a silly offer they would consider it. Since, however, they have not seriously thought through the pros and cons of selling and committed themselves to the process, these individuals are amongst the most likely to have second thoughts as the prospect of a sale becomes real and pull out.

The problem for you as a serious buyer with a serious interest is obviously that you will be committing to expending a high degree of cost in time and cash in pursuing an offer through to a sale. Do you want to be committing this in dealing with someone who is not actually seriously interested in selling at the outset?

Dislike of you or of the sale process

A business sale can be a very personal and pressured transaction. There are times therefore when the seller simply takes such a personal dislike to the prospective purchaser – over issues such as the amount of information being required, the buyer’s attitude towards negotiating price, or simply personality — that they pull out.

Similarly the pressure of dealing simultaneously with running their business and negotiating a sale of it, a process with which they are unlikely to be familiar, can be intense on the seller and they may even blame you as the buyer for this pressure. And the longer it goes on the more difficult it is for some sellers to cope. This is one of the reasons why, once you have found a likely target and agreed a headline price, you should proceed to undertake your due diligence and move to completion as quickly as possible.

FAMILY BUSINESSES

Family businesses differ significantly from non-family businesses and if you’ve not worked in a family-owned business it can be difficult to appreciate what is going on.

In any business of any size there will tend to be two groups of stakeholders: those who work in the business, the employees; and those who own the business; the shareholders. This gives rise to three distinct interest groups as in the middle there are the owner managers, who both own shares in the business and work within it.

Looking at the financial interests of these three groups of stakeholders, it is evident that they will have very different concerns in respect of the sale of the business:

• employees are likely to be focused on security of employment
• external shareholders (those who don’t work in the business) are likely to concentrate on the value to be obtained for their shares
• owner managers working within the business may well be interested in both aspects and seeking to balance the value obtained for shares against the security of a subsequent employment contract.

In a family-owned company, by contrast, there are three distinct groups of stakeholders: the owners (shareholders), the workers and the family. This gives rise to seven sub-groups of interests which can complicate the position enormously.

For example, family members who are neither shareholders nor employees have on the face of it no financial interest in any sale of the business whatsoever. Does this mean they are without influence? Unfortunately not, in that family considerations in respect of the family name or pride in what the family has achieved through the business may mean that those family members who do own shares come under significant family pressure not to undertake transactions that may undermine this ‘family heritage’.

In addition, even if family members do not have a shareholding they may still have a financial interest, either direct such as an ownership of the property, or indirect in that they are supported by the funds generated from the business. This can give them a very strong moral position when putting pressure on the actual shareholders in considering any deal.

Once you appreciate the additional layers of interest that exist within a family business then a number of things follow from it:

In whose interests?

Firstly all family-owned businesses sit somewhere on a continuum as to in whose interests the businesses is managed.

In some family-owned businesses, family interests clearly take priority over those of the business, so that for example family members are employed irrespective of their skills or competence. At the other end of the scale, some family businesses are run strictly as a business with very little room left for family sentiment.

When entering into initial discussions with a family-owned business you should try to make a judgement quickly as to where along this continuum this particular business lies, as it will give you significant guidance in how to approach the purchase.

Who actually is the owner?

Secondly you need to establish early on who actually owns the business. You may for example be dealing with a managing director who is quite clearly currently running it from day to day. However, you could quite easily find that the 50-year-old director with whom you are dealing is actually a minority shareholder and that his parents are the key shareholders, with whom you will really have to negotiate any purchase.

Failure to understand quite who has the ‘ownership’ can lead to a lot of wasted effort. Unfortunately, while this can establish the legal ownership of the shares it is not enough simply to undertake the search of the annual return at Companies House discussed above. This is because in a family situation you also need to establish who is the person who will actually make the decision, irrespective of who in the family nominally owns the shares.

The issue of ownership can be even more problematic in some old established family companies where shareholding is likely to have become extremely fragmented over a number of generations. This can lead to a significant volume of shares being held by relatives with no active involvement in the business whose agenda in terms of preserving grandad’s legacy and/or requiring a steady income stream from dividends may be very different from the shareholders involved in managing the business from day to day. This can mean that getting acceptance of your offer from sufficient numbers of shareholders to be able to purchase control may be very difficult.

WHO ARE YOU COMPETING WITH?

Finally it is worth considering who your competitors in buying a business might be.

If you are looking at buying a small lifestyle business then the competition is likely to come from other individuals.

As soon as you start to look at buying a commercial or sizeable business you may find that in addition to other individuals, the variety of corporate purchasers that you may be competing with might include:

• consolidators looking to buy a number of businesses within one industry with a view to merging their back-office administration and purchasing to obtain the benefits of economies of scale and/or to put together a business of a size that can be floated or sold to an industrial purchaser in the way that the individual businesses cannot
• slow growth companies who are looking to ‘bolt on’ turnover so as to present themselves as having higher growth
• venture capitalists looking to back an MBO, MBI or BIMBO team
• existing buy outs which have raised money for their business plan from venture capitalists based on an aggressive acquisition policy to grow the business and who therefore have cash with which to make acquisitions
• focused corporates that have sold their non-core activities to generate a cash pot with which to refocus on their core area of operations and to grow this if necessary by way of strategic acquisitions
• changing corporates looking to move into a new area of business and to avoid the learning curve of starting their own subsidiary by buying their way in.

As discussed in Chapter 8, each of the above may have specific reasons why they may be prepared to pay more for the business than you are based on its existing performance, and obviously some of the above may have deeper pockets than you when it comes to agreeing a price with the seller.

Nevertheless, as we discussed, for some sellers price is not everything and your ability to form a personal relationship with the seller and to relate to their aspirations for the business may give you the edge over some corporate or financial purchasers.