The question of how best to grow a business is asked again and again and again. Organic or acquisitive – either way the intended end-result is the same: the greater efficiencies and profitability that come through economies of scale and increased market clout.
Of course, there’s nothing wrong with organic growth, it’s just that it takes time. It’s an option that Nick Dixon, director at Veriteva and a long-term buyer and seller of businesses in print, says firms should consider because “if acquisition is the focus there are a whole multitude of factors to consider… culture, financials, personnel, client overlap, market dynamics to name just a few.”
Even so, acquisition offers benefits which may be enough to sway any investor looking for a good return.
In essence, acquisition offers immediate cashflow as the target is already trading; brand recognition because the target has existing marketing, advertising, client contracts, trained employees and third-party relationships and is known within its trade sector; financing because a lender can see historical performance; trained employees – one of the most valuable assets in any business are employees that know the job; existing systems and infrastructure, which may need integration but which mean that the target is already running; and management which is invaluable in making introductions.
In contrast, setting up a new unit from scratch takes time, resources and finance that many firms struggle to provide.
So how should firms acquire?
Aim at a target
One obvious question is how should a firm identify a likely candidate?
Paul Holohan, chief executive of Richmond Capital Partners, a mergers and acquisitions specialist, reckons that the first step is to be clear on strategy: “Ask yourself why you are doing it and compare acquisition to alternative strategies. If you reach the conclusion that acquisition is the most appropriate approach then you need to develop a profile of the ideal target.”
Once they have created a profile, buyers should conduct market research and create a list of potential targets. Alternatively, as Paul Taylor, partner in the corporate department of law firm Fox Williams, suggests, a finance firm could be appointed to list targets. It’s an easier option, if expensive: “Particularly if you are looking for a domestic UK acquisition, the list of targets will often feature competitors of whom you are probably already aware. As such, paying a large finder fee may not be necessary if you know the market well and know of shareholders who may be interested in a disposal.”
Andrew Scrimgeour, former owner and chairman of label maker AJS Group, echoes this. He also recommends using a corporate adviser, but adds acquirers should know the potential targets’ “strengths and weaknesses and their likely receptiveness to an approach.”
Scrimgeour says that a good law firm experienced in mergers and acquisition is a “must have”. He advises firms to consider the reasons for the transaction: “Are your objectives to grow turnover, market share, gain economies of scale? What about geographic expansion, product range, acquisition of key staff or building scale to make you more saleable?” He emphatically advises against the pursuit of a target just to massage an ego.
David Sharpe, director at Pierce Group, a business advisery firm, takes a different tack and suggests that acquirers should consider what their offering is missing: “Print has several strands and so the key for an ambitious acquirer would be to identify and target the missing links in the business product portfolio.” He says that by doing this “the basket of goods is expanded and the cross-selling opportunities become significant.” He points to the example of Calderprint, a well-established trade printer which acquired Whitney Woods, which is in pop-up promotional products.
The first approach
Firms on the acquisition trail need to be cautious about how they hunt for a target. Scrimgeour says that if the owners are already known acquirers can approach, sensitively – “many owners can be flattered but some may be threatened.” Alternatively, an adviser can make a professional approach or suppliers with the right connections can open doors.
But how should you make an approach? Taylor says: “A direct telephone call to gauge the level of interest would normally be the most appropriate channel of communication. They can only say ‘no’ and if there is interest, a non-disclosure agreement can be put in place to facilitate further negotiations.”
For some, the secrecy of the approach is very important and using a third party to make the initial contact can be useful. Pierce Group, for example, make contact but without mentioning a buyer’s identity – “the fact the letter comes from a reputable corporate financier with pedigree lends credibility,” says Sharpe.
And ‘letter’ is the key word as far as Holohan is concerned. “An email is an absolute no. The best method is a letter to the major shareholder personally signed. Even better is a letter from your adviser – as long as the adviser is known and respected in the industry.”
He adds that research has shown that response rates are better through a trusted adviser. Contrary to Taylor, Holohan says that telephone calls can be interpreted as lacking in sensitivity and can be risky.
But while professional advisers can help, Dixon says that an initial approach doesn’t have to be either formal or complex: “An approach may be just as simple as picking up the phone and meeting for a coffee.”
Types of acquisition
According to Holohan, the most common reason for an acquisition in the printing industry in recent years is that of rationalisation of costs over two sites. “It gives an excellent opportunity to reduce costs and create one successful business,” he says, adding that the strategy could be driven by physical needs – a lease could be expiring on the existing property or premises may now have been outgrown. “In this situation, you may be looking to relocate to the target’s premises.”
The reality is that each situation is different, which is why Dixon says the purchase “very much depends upon how the target company is structured, who the ultimate owners are, and what type of owners are involved. Family, private equity, or is it a disparate shareholding?”
The next question to consider is whether to buy shares or the assets. Here Taylor notes that: “Given the favourable Capital Gains Tax rates and Entrepreneurs’ Relief, management shareholders will normally be looking to sell shares.” But his comment comes with a warning: as all liabilities will be inherited on a share acquisition, the acquirer will need to take extra care with its due diligence. Scrimgeour agrees and says acquirers should not underestimate the amount of due diligence. He says: “There are very important differences between acquiring the share capital and buying the assets or the book of business… seek professional counsel is my advice.”
Of course, everyone has a different perspective on what they want (or can afford) to buy. Some want elements, others want the whole business – the preferred option for Sharpe. Why? As he sees it, while there may be a duplication of resources, “if the business is broken up and sold in chunks, complications arise with restrictive covenants, tax issues for the seller, warranties (guarantees), etc.” He favours purchase by way of a share sale.
Understanding what is being bought is key. Although acquirers will usually be able to obtain warranties from shareholders, there is no substitute for extensive due diligence. Taylor says the process falls into three distinct areas – legal which will be handled by lawyers; financial and tax which will be dealt with by accountants; and commercial which falls to the acquirer. “Increasingly,” says Taylor, “online data rooms are being set up with the information being populated by the management team. If any skeletons in the cupboard are identified, these can be turned into indemnities and, as such, risk stays with the vendors.”
Dixon says that that while financial due diligence is important, “own desktop research should be done before an approach is made along with market and commercial due diligence when into a deal.”
And own research is much easier nowadays. Holohan points out that research should be a mixture of financial information in the public domain (Companies House, online databases, etc) and other information gained discreetly through industry sources. He adds, however, that “it is important to remember that financial information can be months out of date and cannot be relied upon to give an accurate view of the firm’s financial health.”
Workplace culture clash
Acquirers need to recognise that buying the assets of a firm is one thing, but a business also comes with the staff already employed and they must get along with the acquirer’s staff. There are countless examples where mergers and acquisitions have failed because of culture clash – Daimler and Chrysler, AOL and Time Warner, HP and Compaq.
Culture is something that Dixon looks closely at. While each target is different, he says: “I always view a compatibility of culture as one of the key requirements.” Sharpe takes the same perspective, noting that inevitably “there is a learning curve following acquisition in order that both firms can gain an understanding and make the necessary adjustments to working practices.” He thinks the due diligence meetings usually indicate if the businesses can adapt.
Holohan says to look at the top – board level – for clues on possible culture issues. “Leadership styles can differ immensely and cause confusion. Even worse is confusion where the former owner continues in some capacity.”
Of course, not every business bought is in rude health and if the target is in trouble the purchaser should be particularly cautious. Where a distressed target is involved creditors can apply pressure, which must be considered when arriving at a valuation.
A question to ask is what is the reason for the decline? Holohan says that while it could be the loss of a major client or a bad debt, “if there are no obvious reasons, it suggests that the target can no longer compete in the market. You may or may not be able to correct this.”
One option that Taylor suggests is to wait until the target goes into a formal insolvency process and then make an offer to the administrator or liquidator when the price should be considerably lower. But he warns: “As there will be no warranties, you would be acquiring on a ‘buyer beware’ basis.”
Alternatively, Holohan says to buy the trade and selected assets of firms in trouble “so that you are not taking full responsibility for past actions (or inaction).” He adds that a thorough analysis of three years’ accounts is essential.
Sharpe says to look out for Crown debt arrears such as PAYE and VAT – “a time to pay arrangement is crucial if a live rescue is to be completed”.
However, buying in distressed circumstances means that there’s the risk of a lack of support from existing customers due to lack of confidence in the business, and from creditors who would have suffered due to the business failure – something that Dixon has experienced, noting that it’s important to secure the supply chain when a firm is in trouble.
Similarly, Scrimgeour knows to be aware of issues as “turning a business round in print can be very difficult, especially where competition is stiff and there is sector oversupply.”
Buying involves substantial costs and many are not insignificant. Purchasers should budget for the corporate finance finder’s fee, accountants’ costs, legal fees (legal drafting, due diligence and deal completion matters), insurance warranty payments and costs allied with any associated funding. Taylor regularly sees these as “being over 10% of the purchase price depending on the size of the deal.”
Sharpe says acquirers should not ignore property and any stamp duty that is payable. And just as importantly he notes the hidden cost of TUPE “which only crystallises if there is a staff restructure following the takeover”.
And Taylor mentions one more expense that is harder to quantify – time: “Arguably the biggest cost is the huge drain on the management teams of the buyer and seller. It is important to make sure that the acquisition doesn’t become a huge distraction and the underlying business is not neglected.”
Everyone has a different risk profile and set of aims. As Dixon says: “An acquisition is not for the faint hearted – you should consider if you are better off focusing your energy on organic growth or taking a larger risk with an acquisition.”
In an ideal world, a transaction should be smooth with no significant identified issues and two sets of employees that rub along well together. However, we don’t live in an ideal world and printing businesses need to invest time in finding the right target and doing their homework.
Consider your reasons for buying a business. Is it to grow faster than would otherwise happen with organic growth? Is it to remove a rival? Will it fill a gap in the product and service offering? Or is it through physical necessity – to increase capacity or seek more appropriate plant and premises? If the reasons are unclear then no action should be taken.
Seek out the target but be sensitive in the approach. Consider if contacts and suppliers have inside knowledge that may be of assistance. Also look to appoint an industry trusted third-party adviser who can make discreet enquiries.
Appoint appropriate advisers to deal with legal, accountancy, tax, and employment matters. Using existing advisers may not suit as they are unlikely to have the necessary experience for “one-off” transactions such as buying a business.
Unless the acquisition is being self-financed or is a share-based deal, finance will need to be arranged. Lenders will want to see three years’ of accounts, financial projections, a solid business plan, information on the key personnel, and details of assets and liabilities.
Due diligence – the checking of facts – is central to the buying process. This needs to be undertaken properly to establish what is being bought, what the risks and liabilities are, and if the target is worth the price being asked.
Legal responsibilities to employees
Both buyer and seller should think about the impact of the acquisition on their respective employees during the early stages of negotiations. Employees involved in a business acquisition can sometimes have a significant level of protection – which in practice means that dismissing employees following an acquisition can be restricted. The cost consequences of getting something wrong can be substantial and so it is important to understand the application of the law and its practical implications.
The Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) is the key piece of legislation in the area, and if it applies, it can have consequences.
Employees immediately and automatically transfer from their existing employer to the acquiring business on the transfer of the business. The incoming employer inherits not only all of the employees but also the outgoing employer’s liabilities and obligations in respect to those employees.
There is an obligation on both the outgoing and incoming employers to inform and in some cases, consult with representatives of the employees affected by the transfer.
TUPE gives enhanced protection against unfair dismissal. This protection can cover not only the employees of the seller but also the buyer’s employees.
TUPE also applies where a change of contractors takes place in what is called a service provision change.
Bodies that need to be informed
When a company is acquired, official bodies and authorities need to be informed. The penalties for non-compliance can be serious and may lead to fines and prosecution. The changes can be reported online but if the company has no online account it will need to register first. Alternatively, paper-based notification is permitted, but it’s advisable to keep a proof of posting.
HM Revenue & Customs, the administrator and enforcer of many business-related taxes, needs to know of the establishment, cessation of trading, or change in ownership of a business. The main considerations are for VAT, PAYE Income Tax, National Insurance, self-assessment of Income Tax, and Corporation Tax. HMRC has a page that details taxing issues relevant to a business (https://www.gov.uk/browse/tax/dealing-with-hmrc) and a page where changes can be notified to it (https://www.gov.uk/tell-hmrc-changed-business-details).
For a company or partnership, notification also needs to be made to Companies House which has a page for notification (https://www.gov.uk/file-changes-to-a-company-with-companies-house).
Local authorities need to know about change of occupation if premises are vacated or if a new organisation becomes responsible for a premises’ business rates. Firms will need to contact their local authority to notify.
It’s important not to forget about utilities suppliers – gas, water, electricity and telecoms. Firms moving into ‘new’ premises should not assume that not signing a new contract with the existing supplier to the premises will offer best value.
Potential pitfalls and hazards
Key hazards to note are the threat of loss of business due to change of control, changing relationships and the possible loss of key staff following the takeover. These can be managed by having close liaison with customers and offering staff revised employment contracts that come with incentives.
A good valuation is critical. For this the acquirer would be best advised using an adviser with industry knowledge for valuations rather than the acquirer’s own accountant.
Buyers should be aware of the possibility of getting caught up in ‘deal fever’ and so bypass effective and proven processes – especially due diligence. Without this key step buyers will have no idea about the veracity of what they are being told.
Buying a business from an administrator is risky. Their job is not to help the buyer but to realise the greatest possible value for the creditors. This means that there is only a limited opportunity for due diligence and rarely will any warranties (guarantees) be provided.
The adage that ‘people buy people’ applies to staff as much as it does to the seller and customer relationship. Ignoring any potential staffing and culture issues can do more damage than any over-valuation.
Management must continue running the existing business and keep it performing. It can become very easy to be distracted by the acquisition process.
Existing contracts and arrangements will need to be honoured once/if the former management leaves.