For Australian business, intergenerational change, ageing population and succession are all top of mind at present, but these important issues may not be getting the attention they deserve.
For Australian business, intergenerational change, ageing population and succession are all top of mind at present, but these important issues may not be getting the attention they deserve. PwC’s recent Private Business Barometer revealed only 44 percent of privately owned businesses had a strategy to deal with succession, which supports the view that business owners are not currently addressing this issue. In most privately owned businesses, including family business, succession will involve some form of sale of equity, unless the decision is to pass ownership to a family member, trusted employee or simply shut the doors. Given that for most private business owners, the majority of their wealth sits within the business, passing it on or closure won’t necessarily release the cash required to fund retirement. However, in the current climate where business confidence is shaky, finding a buyer for your private business may not be a simple process. Unlike in the boom times, buyers are not queuing up to purchase every available business; we are in a phase where finding a buyer is difficult and getting a good price is a challenge. Maximising the chance of a successful sale requires planning and time. In fact it may be a process that commences with a lead-time of several years before the business goes on the market, meaning planning is important. An early consideration for business owners of unaudited businesses is whether to conduct an audit prior to sale. Businesses that are subject to audit often get a better price than those which are not as it provides independent evidence of the financial results. It is wise to have at least two years’ audited accounts for a potential purchaser to review – that way the usual first year audit qualification is dealt with before the sale process begins. A review of staff, key contracts, equipment, and business practice is also necessary. Potential buyers want to see that the business has all the component parts in place. Buyers want to know that they can successfully run the business when current ownership moves on. They also expect that there will be a management team intact for sufficient time to allow them to fully understand the business post-purchase. A standard question in any sale process involves contracts the business holds. Are the premises secured for a suitable period? Is rent reasonable? What supply contracts are in place and what is the nature of those contracts? Are there customer contracts? How long do they last? Will a change of ownership cause a risk to these contractual arrangements continuing? Potential purchasers may also have concerns if no formal arrangements with customers and suppliers are in place or if contract terms are unfavourable. Another key issue is customer and supplier concentration. Put simply, this is where the business earns the vast majority of its revenue from one customer or has only one supplier for a critical aspect of the business. Specifically, over-reliance on one customer may be seen as a real risk and could significantly detract from value, even if the contract is highly profitable. The quality of the business assets, computers, equipment etc, will also be a consideration. If the assets are old a purchaser will factor this into the purchase price due to the potential need for replacement. Often with privately owned businesses it is not uncommon for the “operating manual” to be in the owner’s head. Given the owner will be departing, understanding how this knowledge will be transferred is vital. Documenting the business systems and empowering key staff are ways to assist the buyer gain confidence on how the business runs. Addressing each of these aspects takes time and planning, with any shortfall directly impacting the price. The prospects of a successful sale are enhanced by appointing appropriate advisors. Sometimes this is not the longstanding accountant or lawyer, but a specialist in the transactions area. The nature of that advisor will depend on the business’ scale (e.g. a business broker for the smaller size business, through to major investment bank or advisory firm for the larger scale transaction). The advisor will usually be actively involved in preparing the sale materials, such as teaser style sale documents and investment memorandum in larger scale transactions. They should also play a major role in supporting the business through due diligence, which is the period the proposed purchaser has to assess the business and decide on whether to proceed to purchase. It is important to understand the key role due diligence plays in the sale process. For larger transactions it is usually a formal process, but in any transaction there is always a time when the potential purchaser can ask questions about the businesses operations, people, finances, etc. A seller doesn’t want to be surprised by questions raised during the due diligence process as this may send warning signs to the purchaser and could impact the price. Careful planning and an experienced transactions advisor are effective ways to avoid being unprepared. When selling a business you may hear the term ‘normalised earnings’, which is the earnings after adjusting for unusual and non-core business income and expenses. In due diligence these items are usually closely scrutinised to determine whether the adjustments are reasonable and whether there have been omissions. Interest and depreciation are also normally removed to determine the Earnings before Interest Depreciation and Amortisation (EBITDA) which is the usual base upon which the selling price is determined. Another issue is understanding what the purchase price actually means. The business will be sold as a going concern so it is able to trade as normal from day one, therefore the price paid factors in all of the assets and liabilities necessary to run it including goodwill, staff, fixed assets, stock and the necessary working capital. This means a purchaser will not be entitled to surplus assets of the business in the price. Excess cash and property, not necessary to operate the business, don’t fall within the purchase price. These assets, if included in the sale, should be factored in over and above the purchase price. Another point to remember is that it’s usual for bank or other finance debt to be paid out at settlement by the seller. This is an advantage to the purchaser and is why the price is usually based on EBITDA, as the purchasers will have their own way of financing the purchase. Owner loans are also generally paid out as well and the purchaser should get a credit for the after tax leave entitlements. As a final word on the purchase price it is vital to understand the tax consequences of a sale transaction. Stamp Duty, GST, Income and Capital Gains Tax can all impact the purchase price and the final proceeds the owner actually receives. The process of selling a business is complex whether the business is small or large, and often is a once in a lifetime event. Planning and good advice are essential to ensure the best outcome is achieved. Michael Browne is a Partner at PwC pwc.com.au