We hope that the answers provided help to make the acquisition process clearer.
The answers provided below are the opinions of Leslie James Acquisitions.
Their accuracy is not warranted and vendors and acquirers are advised to take independent professional advice on the issues discussed.
Leslie James Acquisitions can accept no liability for the opinions expressed.
Of course, there’s no “one size fits all” answer to that question.
Valuation depends on a variety of factors, not least profitability, USP and growth potential but also on other acquirer appetite related factors such as a niche or specialisation, synergy, geography, market share etc.
There is however a good guide to valuation based on current market conditions and that is to calculate EBITDA and apply a multiple to the end figure.
In the context of insurance businesses, EBITDA is essentially a simple calculation.
It is to take the current operating profit (earnings less operating expenses) and then to “add back” non-essential post acquisition expenses, the likes of:
- The salaries and benefits of departing Directors.
- Lifestyle expenses associated with the Directors.
- Office costs (if the business is to be amalgamated within the acquirer’s offices)
- Duplicated resources, possibly including Finance, Compliance etc.
The then increased profit figure is known as the “Adjusted Profit” and it is this figure to which acquirers will apply a multiple to arrive at a valuation and offer for the business.
Profitable, attractive insurance businesses are currently being acquired for around 7 to 8 times EBITDA/Adjusted Profit and sometimes up to 10 times or even more depending on synergies and the acquirer’s appetite.
In terms of multiples of earnings (commission and fee income), subject again to profitability and the other factors mentioned, a good, profitable business will be valued at up to 2.5 to 3 times earnings and for particularly attractive businesses, this could go higher, even to 3.75 times or more.
We act exclusively for insurance brokers, PMI brokers, MGAs, Loss Adjusters and IFAs.
Many businesses accumulate cash on their balance sheets.
Some of this will be necessary working capital but beyond that, there may be cash surpluses and these cash surpluses will need to be removed from the business, before or at the point of sale.
There are a number of options which vendors will want to explore and it is very important to take professional financial advice.
The options can include:
1. Asking the acquirer to purchase the cash, at par, i.e. pound for pound, with the vendor using that cash to fund the acquisition. This is likely
to be the most tax effective option for the vendor but it is not something that all acquirers will agree to.
2. Taking the cash as dividends. There is of course a limit to how much cash can be taken as dividends – the amount can’t exceed profits – and of course, there is a fairly weighty tax to pay.
3. Investing the cash into a pension scheme and taking subsequent drawdowns. HMRC approval is required for this and again, there are taxes to pay on drawdown.
4. Investing / transferring the cash as a loan into a newly created company. Again, this is subject to HMRC approval.
Whichever route you as a vendor decide upon, you will need to take professional advice from an accountant etc.
The simple answer is yes, this is highly likely.
With an earnout, an acquirer places an initial value on the business (the “EV” or “Enterprise Value”).
When that valuation is agreed between the vendor and the acquirer, the acquirer issues Heads of Terms to set out the agreed purchase and when that is signed by both parties, the acquirer proceeds to “due diligence”, which when complete, results in a Sale/Purchase agreement being settled.
In an earnout situation, the acquirer agrees to pay, on Completion (the signing of the Sale/Purchase agreement) an initial lump sum, which is usually around 60% (sometimes up to 80%) of the Enterprise Value. Beyond that, the acquirer normally agrees to pay the balance over 12 or 24 months.
In an earnout arrangement, if there is growth within the earnout period, this will usually be reflected in enhanced payments to the vendor. Of course, that works both ways, in that if business is lost, the balance payments will reduce. However, in the case of most broking businesses for example, typically experiencing annual retention rates of 90%-95% and growth by way of new business, reduced earnout payments become unlikely.
Also, most vendors will “average out” so that if there is a drop in business in the first year post acquisition but this is made up in the second year, the value of the 40% balance payment will not reduce.
When you sell your business, you will be faced with two options, although the acquirer will normally have a fairly fixed idea of how they want the sale to be structured.
Most sales are undertaken by way of a sale of shares where the acquirer takes the company and its business, lock, stock and barrel, assuming both its assets and its liabilities.
In some cases however, particularly where a vendor is only looking to sell part of its business, for example one of its books of business, the transaction will be undertaken as a goodwill or asset sale (known as a BPA).
This is a complex area where, dependent on the structure of the sale, potential liabilities will crystallise for the vendor by way of Capital Gains Tax and/or Corporation Tax and/or Stamp Duty etc. Some of these liabilities may be mitigated with advantage taken of Entrepreneur’s Relief (now known as Business Asset Disposal Relief) where, subject to limits (currently £1 million), the vendor will only pay Capital Gains Tax at a reduced rate of 10% on the proceeds.
There are advantages and disadvantages of both approaches and before a vendor makes any decisions, appropriate professional advice will need to be taken and in addition to taxation issues, consideration will also need to be given to the rights of existing employees under the provisions of TUPE (The Transfer of Undertakings (Protection of Employment) Regulations 2006) (and amendments).
In selling your limited company business, it’s not always a straightforward case of selling 100% of your shares.
There are often other deal structures you might consider and we may be able to arrange.
Minority / Majority Sales
In this scenario, an acquirer may agree / offer to purchase a minority stake (up to 49%), leaving the vendor with the majority. This is an opportunity for a vendor to ‘take cash off the table’ but to retain ‘skin in the game’, the idea being that the acquirer’s involvement in the business can help that business to expand at a faster rate. If that added growth is achieved over a period of time, perhaps around 5 years, the vendor can then sell their majority to the acquirer at a higher rate than would have been the case on day one.
Alternatively, the acquirer may purchase a majority stake (say 80%), leaving the vendor with a minority stake, which can grow in value with the acquirer’s involvement. Again, if it does grow, the vendor exits further down the line with higher overall sale proceeds.
Both scenarios may particularly suit vendors who are not yet ready for retirement and who are keen to remain involved with the acquirer, earning a salary with a ‘pension’ (their remaining stake) ready for their future retirement.
With some deals, the acquirer will offer the vendor to roll-in some of the sale proceeds of their 100% sale into the acquirer’s equity, typically to a maximum of 10% to 15%.
Again, this is more suited to vendors not immediately looking to retire.
This option can be highly valuable for a vendor.
For example, where a private equity backed acquirer will routinely pay 7-8 times EBITDA for a commercial broker, that Private Equity house will look, at the end of their lifecycle, often after around 5 years, to either undergo a trade sale or a sale to another Private Equity house and that valuation will often be around 15 times or more EBITDA.
Therefore, the vendor’s rolled-in equity could go from a valuation of 7-8 times to 15+ times. A solid investment!
We deal with all the above structures and can find one which suits you best when it comes to selling your business.
There is a principle in M&A which is known as Multiple Arbitrage – the practice of increasing the value of a company without having made any operational or profit improvements to it.
In other words, you are arbitraging (increasing) the multiple of EBITDA (pre tax operating profit) at which the company is bought and sold.
Private equity firms use this principle regularly, to generate automatic positive returns even before realising a single synergy or cost cut.
This is something we can use on your behalf to enhance the sale price of your business.
There are broadly three methods of Multiple Arbitrage used, as follows:
1. Merging add-ons to grow size
The larger of two identical companies usually sells at a higher multiple because it is simply larger.
For example, where most good, solid commercial/corporate brokers will trade at up to around 8-10x EBITDA, the large consolidators are currently trading at around 15x to 18x EBITDA.
The acquisition of your business at 8x EBITDA gives the consolidator an immediate paper profit of up to 10x your business’s EBITDA (18x less 8x).
Also, the more you grow your business, particularly by acquisition, the larger your business and its EBITDA gets, which tends by itself to push up the EBITDA multiples available when you exit.
Using large company examples, if companies with £25M in EBITDA sell at 8x earnings. a company with a £100M EBITDA can hypothetically acquire a £25M EBITDA company for £200M and automatically be able to sell that company, as part of its whole, for perhaps twice that, at £400M.
Since the acquirer did nothing to change the operational workings or profitability of the acquired business, this is multiple arbitrage.
2. Assumed profitability growth
Assumed profitability growth is another driver of company and industry valuation multiples.
Take for example an insurance broker trading solely in personal lines but where those personal lines clients are the owners of SME businesses.
If a group of buyers believe that they can exploit the client base for commercial business (which generally achieves higher multiples valuations), then they may be willing to pay more per share for a business with this future capability.
Thus, a buyer could purchase the personal lines broker for say 4-6x EBITDA, tweak the strategy and business plan to become a commercial and personal lines broker, and flip it back into the market as a commercial broker play at 8-10x EBITDA.
3. Rolling a private company into a public one
If a public company trading at 20x earnings buys a small private company for 10x earnings, the earnings of the latter automatically trade at 20x as part of the whole entity, given that the transaction is small enough not to be scrutinised.
When the public company reports earnings the first time after making the acquisition, the tranche of its earnings from the acquisition naturally trades at the same multiple as the whole entity, 20x instead of 10x, completing the arbitrage.
The Moral Of The Story
Being aware of multiple arbitrage and keeping it in mind when doing a deal can benefit all parties in a negotiation.
As a buyer, you may be able to identify multiple arbitrage candidates to solidify a stronger IRR.
If you have confidence in the spread and think it is priced correctly, there are few reasons you should not pursue the arbitrage.
On the flip side, a sell-side advisor can push for a higher purchase price for their client.
Knowing that a potential buyer may be looking at your sale as an arbitrage opportunity allows you greater leverage when negotiating a selling price.
This is where using a business broker such as ourselves provides a greater opportunity for a negotiation for a higher valuation to be obtained.
Contact me today in strict confidence to see how I can help you.