Get it right, and this is as good a time as any to grow your business by acquiring or merging with another company. So why is the failure rate for such deals so high and what can you do to maximise your chances of success? Growing Business investigates
When Jeremy Waud decided that it was time for his facilities management company Incentive FM to strengthen its office cleaning capabilities, the ideal partner was staring him in the face. Waud had worked with Herts-based Quality Assured Services (QAS) over a number of years, knew and respected its founder and chairman Steve Wright, and was keen to get access to its public sector clients. What’s more, Wright was ready to ally his company to a group that could go after broader facilities management contracts and provide a London office.
Risk takers and haters
The acquisition was completed in 2009, no thanks to the banks, according to Waud. “The sale consideration was £30m, of which we needed to raise £2m in cash,” he explains. “Our own bank, Barclays, was lukewarm, so we went to RBS. They were encouraging at first, then dragged their feet before offering us £250,000, which was no help at all, even when that was doubled using the government’s Enterprise Finance Guarantee (EFG) scheme.”
After much frustration, a complex deal was hammered out using invoice financing. However, Waud pulled the plug when RBS insisted on a clause giving it a veto on payments. “It put the bank into a position where it could stop us making a payment if it thought our cashflow was under pressure at some future date,” he says.
That was a deal breaker from the vendor’s point of view, so the two companies went away and came to an agreement based on a lower upfront payment, a deferred consideration plus equity. Six months down the line, the expanded group reports £20m turnover and 57% sales growth in the year to March 2010, while projecting £25m sales during the current year. Crucially, Wright is on Incentive FM’s board. “The banks were stunned that we did the deal without them, but we were delighted,” says Waud, although the experience cost him £100,000 in upfront costs.
Incentive FM’s story neatly illustrates some of the problems facing purchasers in the present market. Everyone knows it’s harder to get credit these days, yet it remains unclear how that may change under the new UK government. Prime minister David Cameron promised to review the EFG, but as it stands, the scheme can be used as another way to control lending rather than free it up.
Merger and acquisition activity has dropped this year, according to Experian Corpfin. “At the start of 2010, feedback from the corporate finance community was more optimistic and talked of a more realistic approach to valuations among vendors,” recalls Experian’s business development manager Wendy Smith. “However, the lower number of deals tells us that the market is still very fragile.
Although funding has been available where strong risk-free businesses have been involved, there is a still a funding gap. This is proving to be the key barrier to getting deals off the ground.”
Risk-free is the key phrase here. Earlier this year, Chris Steel, a director of First Flight Placements, was retained by a client to acquire an engineering-based manufacturing business with an enterprise value of £2.1m. “It was generating an adjusted EBITDA [earnings before interest, taxes, depreciation and amortisation] of around £450,000, and has excellent growth opportunities, both in the UK and overseas,” he explains.
The cash on a completion target of £1.6m was to be funded by £450,000 in equity, £350,000 invoice finance and a four-year loan of £900,000, including fees. Most banks declined the lending proposal quickly, with one offering support initially based on a 50% level of securitisation on the cashflow lend element. However, the bank’s final decision stated that this had to be fully securitised, and that the directors had to provide additional guarantees of £100,000. “In other words, the bank was unwilling to take any risk at all to facilitate the deal,” says Steel.
Extra mile due diligence
The banks’ reluctance to lend was entirely based on their perception of risk. “We have seen clients borrowing to make a string of acquisitions they couldn’t fund when the company had a lean period a year or two down the line,” says Natasha Frangos, partner at corporate finance specialists haysmacintyre.
“It’s easy to get beguiled by benefits such as cost savings or an increased customer base, and not think about the negative synergies and risks.”
Assessing the risks and avoiding nasty surprises is the job of the due diligence teams, and that should always involve visiting the target company. A good practitioner will not just be content to go over the books, the contracts, licences and employment agreements. The most beneficial information comes out of discussions with the directors, the financial controller and senior salespeople, according to Frangos. “Without personal contact, you can’t get a feel for less tangible aspects of the business, such as morale, its flexibility in changing markets and its attitude to future risk,” she says.
It follows that financial and legal due diligence isn’t a formality. Don’t view the report as something to be glanced at, posted to your bank and kept in a file, stresses Frangos. “Sit down with the due diligence team and discuss the findings and the actions that are suggested,” she advises. “To get the benefit out of the process, you need to talk through the risk areas and points that can be used in negotiation and factored into the agreement.”
As Incentive FM showed, money isn’t the only factor that can threaten an acquisition. If you’re healthy financially, this can be a good time to buy a company that is an appropriate fit and the motivation of both parties is right, says Jeremy Furniss, partner at ‘boutique’ finance firm Livingstone Partners. “What acquirers get consistently wrong, often causing them to withdraw quite late in the process, is not going through a deep enough analysis of why they are acquiring a business,” he points out. “Kissing frogs is a waste of time and money.”
Bad reasons for going on the hunt include doing it because group HQ says that this is how you must expand, or because your company is going downhill. “Solving problems in your own business is never a good enough reason for going out and buying another,” says Furniss. “Legitimate reasons for wanting to acquire a business include: organic growth not being fast enough; to achieve scale and critical mass in the market; or to gain access to critical technology.”
Conversely, Furniss recommends making sure you clearly understand precisely why the target company is on the market. “When acting for purchasers, I’ve frequently found that the sellers have been rehearsed: ‘Please pay me £10m and I promise to be just as interested in putting in the hours with that in my pocket as I was before,’” he says. “If the management team is about to retire, then that is often an absolute obstacle to getting the deal done.”
What acquirers want to hear is that the target business has been taken as far as it will go under private ownership and now wants to move to the next level as part of a bigger group with more resources, infrastructure and a strengthened management structure.