MBOs, MBIs and BIMBOs

Overview

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There is no single answer to the question "what is the Target business worth?"

Therefore, we normally give a range of possible values - as it will be worth a different amount to different people at different times. The fundamentals that add value are increasing profits and strong underlying assets. Losses, debts, overdrawn directors' loan accounts all detract from market value.

There are lots of valid valuation methods Purchasers use when valuing target businesses. Sophisticated Purchasers can use discounted cash flow models, or a multiple of sales, replacement cost and opportunity cost and of course the separable value of the net assets.

However, many vendors are unsophisticated in their valuation techniques. We often come across vendors with price expectations established "via the golf club bar" or by advisors that have flattered their clients with hugely optimistic valuations in order to get the sale mandate. Invariably these are round sum amounts either £1m or £2m or £5m. There is no basis whatsoever for the expectation - other than that is what the vendor wants!

Part of our skill set is to educate these vendors to what is and what isn't possible - and to how we have valued their business. This often leads to an early agreement that the gap on valuation is so large it cannot be closed - and avoids wasting time with unrealistic vendors.

For privately owned businesses, that have a value of up to £10m, the most common valuation method is the price earnings or PE ratio.

This is the method most used banks and equity providers to benchmark whether a Purchaser is overpaying for an acquisition. The price earnings ratio will be adjusted for surplus assets or debt to arrive at an overall valuation.

In order to arrive at a range of market values for your business, you need to consider:

• Profits and earnings
• Multiples
• Deal structures

Profits and earnings

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What is meant by earnings?

When buying a company you must adjust the declared profits of the business for those factors which distort - upwards and downwards the maintainable or underlying profits. Purchasers will normally use operating profit before interest and tax.

In general, your confidence will grow if adjustments to profit streams of a target business are minimised - this means you have good visibility of the returns your business delivers.

You will use average two or three year trading histories, as consistent profit performance builds confidence. This also avoids the pre-sale hockey stick in profit growth in the year before sale - normally unsustainable growth that has been artificially created prior to sale. You must ignore one-off stellar profits as unsustainable.

Multiples

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Once you have the maintainable earnings for the business, the valuation can be obtained by applying a multiple to those maintainable earnings.

Multiples vary enormously. There are several factors that can affect the multiple for your deal. Recurring business, growth - upward trends in sales, margins and profits, no customer concentration, longer term written contracts with suppliers and customers and substantial order books reduce risk for you. These factors increase the visibility, quality and sustainability of earnings, and therefore they increase the multiple of earnings.

Deal Structures

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Your deal will have at least two and maybe all three of the following types of consideration included within it:

• Cash at completion - when the ink is dry you pay this cash. Sometimes, subject to confirming certain matters, a retention may be applied - for example net assets as at the completion date. Retention monies are normally released within forty five days of completion.
  
  
• Deferred consideration - or monies that are payable to the Vendor but are paid over a period of time or on the drip.
  
  
• Contingent consideration - often termed earn outs - or monies that are payable to the Vendor are contingent upon future events - for example contingent upon gross margin in the year after sale.

In an MBO, MBI or BIMBO, the proportion of consideration that is deferred or contingent is higher than when trade buyers acquire companies. Sometimes paternalistic Vendors to want to motivate or reward their management teams by agreeing to a lower acquisition price then if the business was sold to a competitor.

Vendors can also initiate transactions, often called Vendor Initiated Management Buy-outs or VIMBOs. In these circumstances, the Vendors can provide a significant proportion of the monies required to fund the deal.