Once I have decided to make an offer, how long does it take to execute a contract for sale?
Once an offer is accepted, the buyer will typically undertake relevant due-diligence to confirm the financial and legal aspects of the purchase. This due-diligence may be completed in 2-4 weeks and the sale contract typically executed within the subsequent 3-5 weeks.
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How do I select the right business to buy?
Some factors to consider include:
- Whether you intend to "work in" or "work on" the business
- Your key skills and how you intend to apply these to the business you acquire
- Specific industries you are interested in and/or wish to avoid
- Location preferences for the business
- Your budget, including initial capital outlay as well as appropriate working capital
- The cashflow you require from the business
- Whether you are seeking an established company or an early stage business and the extent of growth you are seeking from the business
How much can I borrow to buy a business?
This will depend on the buyer's specific financial circumstances and the historic performance of the business.
It also depends on the type of assets that comprise the purchase price. For example, banks may be willing to lend more against tangible plant and equipment than they would against goodwill.
In many cases, Scan will present an Information Memorandum to a leading financial institution in order to obtain guidance on possible lending parameters.
For specific business opportunities, Scancorp can relay the guidance we have been provided by the banks.
Can I realistically purchase a business under management as an investment?
Yes. For larger businesses, we typically develop our Information Memorandums on the basis of the business being operated under management. This may involve us including budget for the market relevant costs of an operational manager.
Where a business can be operated under management, we urge our buyer(s) to continue to actively oversee their investment.
Scan can provide tools and advice to assist investors to oversee the performance of their business.
What factors impact the value of a business?
While this is not an exhaustive list, some of the factors that may impact on the value of a business include:
- Business' prior performance and future forecasts, eg:
- Average profitability of prior years
- Any trend (up or down) in profitability
- Extent of confirmed future revenue (such as via existing contracts)
- Nature of the business' assets, eg:
- Quantity and proportion of: physical assets such as plant and equipment, work in progress and goodwill
- Quality of the underlying assets, including how well equipment has been maintained, how probable it is to collect the outstanding debtors, the extent of obsolete or slow moving stock etc
- Terms of current contracts such as leases
- Business Structure, eg:
- Whether the business is or practically can be operated under management
- Extent of systemisation (documented processes etc)
- Whether the current owner is offering to retain equity and/or sell via an earn-out
- Industry specific factors, eg:
- Competitive position including barriers to entry, patents, exclusive supplier arrangements and competitive landscape
- The impact of relevant recently introduced and/or proposed legislation
- The number of similar businesses for sale
What processes are used to value a business?
- Business valuations are required for events such as:
- Complete or partial sale
- Periodic bank reassessment of lending facilities
- Seeking expansion capital
There are several approaches to valuing a business. Some examples include:
- Earnings capitalisation method: considers the annual return on investment in expected future earnings. The relevant earnings to be used will depend on the type of the business and whether the business is to be operated under management. For example, equipment dependent businesses should consider EBIT (earnings before interest and tax) rather than EBITDA (earnings before interest, tax, depreciation and amortisation). A business that is intended to be operated by the buyer may use PEBIT (proprietor's earnings before interest and tax) as it is appropriate to include the owner's remuneration from the business
- Book value: is based on the company's balance sheet and is determined by subtracting the company's liabilities from its assets resulting in the owner's equity. Adjustments may then be applied to account for non-balance sheet items such as intangible assets
- Intrinsic value: considers the current market replacement cost of all plant, equipment and stock involved in generating income. Intrinsic value does not include any value for the goodwill component
- Discounted cash flow (DCF): is a valuation method whereby all future cash flows of a business are estimated and discounted to give their present values. The sum of all future cash flows is the net present value (NPV). The NPV is used as the value of the business.
The discount rate applied considers both the time value of money and the risk associated with the future cashflows. DCF methods are particularly applicable where future earnings are more appropriate and reliable than historic earnings (such as with an early stage business or a business that has recently secured major contracts).
What is EBIT, PEBIT and why do these differ from the profit declared in the business' tax return?
- There are 2 primary reasons why the EBIT (earnings before interest and tax) proposed for a business differs from its declared pre-tax profit:
- Pre-tax profit includes an allowance for interest expenses. When a business is presented for sale the profit measure most typically used is EBIT. This is because the financing arrangement of the new owner(s) will likely differ. Hence a pre-tax measure of profit and interest is used.
- For smaller businesses, numerous adjustments are usually required to quarantine the owner's specific financial situation from that of the business. Other items that may be adjusted from the reported profit include one-time non-recurring events.
Therefore, to calculate the reasonable price for a business, we first calculate its "suggested adjusted EBIT". This is often a complex process and involves:
- Establishing a meaningful timeframe for historical review
- Analysing the income tax returns of the business
- Analysing financial statements prepared by the business' accountant
- Identifying, quarantining and justifying any non-recurring events (eg prior lease expenses that are not relevant post consolidation)
- Where the business includes a freehold property, ensuring commercial lease rates have been accounted for
- Identifying discretionary business expenses (such as donations) that a new owner could potentially take as profit
- Adding back interest expenses, as these are subject to the financial structure specific to the new owner
- Adjusting forecast profitability expectations based on certain or extremely probable events (such as increasing profit to account for the gain of a major contract or reducing profit associated with closing down a particular product line)
- Adding back any remuneration received by the owner(s)
- At this stage, we have the "suggested adjusted PEBIT" ie the proprietor's earnings before interest and tax
- Most of the businesses marketed by Scan are presented as if they were operated under management. When this is the case, we deduct a market relevant management salary from PEBIT to arrive at the "suggested adjusted EBIT"
What is involved in due-diligence?
Due-diligence is intended to assess the validity of the representations made during the sales process. This involves a review of relevant commercial information such as financial and legal review.
The following is a subset of some of the likely objectives to be achieved during due-diligence:
- Verify corporate position, eg:
- Confirm current ownership/share structure and whether any third-parties are required to consent to the sale.
- Identify any encumbrances over the company's shares
- Investigate any related party transactions
Verify financial representations, eg:
- Confirm the "suggested adjusted EBIT" such as by analysing the appropriateness of the "add-backs"
- Confirm Work in Progress (WIP), trade debtors and creditors
- Identify provisions such as for staff leave entitlements
Verify commercial arrangements, eg
Review key contracts and documented arrangements (completed or under negotiation) such as:
- Contracts with customers and suppliers
- Purchase and service agreements
- Licence agreements
- Guarantees or indemnities
- Finance and operating leases
- Identify any material non-documented arrangements
- Identify any breaches of contracts
- Review key contracts and documented arrangements (completed or under negotiation) such as:
- Verify company's regulatory position, eg:
- Determine whether the company requires any licences or authorisations to carry out its business
- Confirm all authorisations are in place and are fully paid-up
- Identify pending changes to legislation and assess the potential impacts on the business
- Review relevant tangible property, eg:
- Verify valuations of key assets such as plant and equipment
- Develop pre-settlement balance sheet
- Undertake stock-take
- Review relevant Intellectual Property, eg:
Identify all IP required by the company such as:
- Patents, trademarks and copyrights
- Business names
- Domain names
- Where IP is owned by the company, confirm adequacy, currency and assignability of protection
- Where IP is not owned by the company, confirm all relevant licenses are in place and whether IP infringements are likely to occur
- Identify all IP required by the company such as:
- Verify company's employment arrangements, eg:
- Review currency and appropriateness of employment contracts
- Confirm the company is complying with all federal and state employment legislation
- Review staff remuneration including base salary in addition to allowances
- Review company's insurance arrangements, eg:
- Assess adequacy of insurance coverage
- Assess currency of insurance policies
- Identify any previous, current and pending claims
- Review disputes and/or litigation, eg:
- Identify any current, pending or threatened claims against the company
- Identify any current disputes
- Whether the business is a franchise - as there are specific processes that may be applicable
- The size of the business - as businesses with high EBIT may be desirable to private equity and investor groups
- The industry the business operates within - as companies within certain sectors often register their interest in acquiring smaller businesses within that sector
- Whether the owner wishes the business to be "silently sold"
- In general terms, the following marketing approaches may be employed:
- Search of Scancorp's database of registered investors
- Investigation of Scancorp's referral network for interested buyers
- Identification of potential strategic acquirers, such as suppliers, customers and accumulators within that sector
- International conferences and promotion where a business may be attractive to foreign investment
- Running of Expression of Interest (EOI) programs to obtain potential offers
- Advertising on Scan Corp's website
- Advertising on 3rd party business sale websites
- Print advertising such as local and national media