Ensuring staff are trained to "deal with deals" and "being diligent' about due diligence are two of the tips for buying a business to come from professional services firm Towers Watson after the release of data highlighting that companies carrying out mergers and acquisitions last year outperformed the market by over three percentage points.

The firm's latest Quarterly Deal Performance Monitor shows that 2009 proved to be "a reasonably good year" for companies completing a business sale – particularly for those which closed domestic deals.

Based on analysis by the UK's Cass Business School, the monitor is the only study of mergers and acquisitions that tracks performance globally. Acquirers covered in the analysis for 2009 outperformed the MSCI World Index by 3.2%, with especially strong performances recorded in the healthcare and financial services sectors.

"Our results should not only give potential acquirers greater confidence in considering deals in 2010, but also highlight some of the elements that influence deal success," commented Marco Boschetti, head of international consulting at Towers Watson, who pointed out that domestic deals present acquirers with less complex integration challenges.

Mary Cianni, a leader of Towers Watson's global M&A practice, added that prospective business buyers appear to be "playing it safe" and focusing on acquiring targets in their home market at the moment, although credit markets are beginning to open up again.

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The importance of due diligence to the success of a transaction is often underestimated. We thought it might be useful to put together a few pointers to keep in mind while running a due diligence exercise on a business you are intending to buy. A more thorough explanation of what is required is available to subscribers.

Approach the whole process with a very objective and critical eye. When you have seen a business to buy it is very easy to get carried away and marvel at your own cleverness at seeing such a good opportunity. But always remember that it is much easier to evaluate what has been presented in a memorandum of sale than to spot what has been left out.

Get the right advisors

Buying a business is a team effort and the most important members of your team are your accountant and your solicitor. Make sure that you have a good working relationship with both and they are properly instructed. If you need to appoint new advisors do so on recommendations to ensure they have the appropriate skills.

Plan it, scope it

Define the scope of the due diligence exercise and clearly mark out who is doing what and when. Work to a timeline. In order to conduct a thorough investigation you must have everything in order before the due diligence process begins. In fact, you must start your due diligence preparation and information gathering the moment you decide that you are interested in a particular business. You will need the following:

An exact step-by-step plan of the entire due diligence exercise.
All of the information and relevant items you need from the seller before you start the analysis.
A checklist of… (more available to subscribers)

Employee issues

Thorough due diligence should pick up any issues, risks and potential liabilities relating to the seller’s employees. For instance, check if there are any past or present employees litigating against the business. Other important areas to look at might be the following.
Do any of the employment contracts have unusual clauses i.e. over-the-top redundancy packages?
What are the specifics of the pension plans?
What is the bonus structure and is it rewarding performance fairly?
(more available to subscribers)

Move fast, top down

It is important to spot any issues early on so that the appropriate warranties and indemnities can be quickly put in place. As these are legal documents, which are meant to protect both the buyer and seller from things going wrong, they can be complex, expensive and take time to put together. Focus on major issues first.

Communication is vital

The flow of communication between the buyer and his/her solicitors is of paramount importance, for if they do not work closely together, the process can quite simply fail. The buyers must communicate the key issues of concern to their solicitors; they should not just assume that all areas are of equal importance, and that everything will be dealt with in good time. Continually monitor the activity of the solicitors and accountants carrying out your diligence and make sure they are giving you regular feedback.

Don’t forget the culture

Funny how the lack of understanding of the target’s company culture is one of the main reasons for failed acquisitions, yet this has been notoriously ignored in the due diligence process. Don’t make the same mistake. This is usually one for the purchaser’s management to consider, rather than delegating to legal or financial advisers. Map out the management styles of your business and the target business. In the report we look more closely at the culture of a business.

Collect information, then analyse

Don’t let any of your advisers analyse whilst collecting the information. These are two distinct activities within the due diligence process. First find out where the required information is, then collect the information, recording its source and noting whether it is fact or hearsay. Then start an objective analysis.
Finally, make sure you differentiate between fact and opinion. Information that is presented as fact should be signed off by the target company’s directors.

Don’t panic, take your time

A focused but comprehensive approach is better than taking shortcuts in order to reduce costs. Often the buyer discovers that ‘thin areas’ of diligence need to be covered again in more detail, ultimately consuming extra time and costs.

In partnership with the Business Sale Report Smithfield Partners Solicitors and WM ProServ LLP, accountants are offering £5000 worth of free legal or accounting Due Diligence. What is the catch? This offer is only available to the first 5 companies that apply via the Business Sale Report. To qualify you just fill in our due diligence enquiry page.

We wish you luck in finding a great investment for 2010!

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At the Business Sale Report we have undertaken a straw poll of the business brokers and other professionals in the small to mid-market M&A industry to see how they thought 2010 would be for the buying and selling of businesses. Subscribers to the report can see who said what. So here are some of the opinions of the movers and shakers in the industry:

“Investors seem to be thinking that 2010 will be an improvement on 2009. People who have access to liquidity are making tentative signs they are willing to invest in the middle of the year when the situation should be clearer. Investors who can be creative when it comes to financing a deal are in a great position.”

“At the moment there appears to be a disconnect between the real business world and how the bankers who are funding businesses are operating. Recently there have been more signs of banks lending but they are only lending to people with a good track record, and also really only looking at one project at a time. However, some banks are lending at 75% debt for equity. The February bank reporting season will be important for the confidence of M&A in 2010. Asset-based businesses and those involved in the Internet I expect to be the best M&A prospects for 2010.”

“The market in businesses valued at between £1m and £2m has seen growth so far in the last quarter. I am therefore very positive about the outlook for 2010. People are looking to sell at the moment and funding is not too difficult for the right deal.”

“I am expecting 2010 to be better than 2009 but the outlook for 2011 is more uncertain as there may be more forced sellers then and prices for businesses will fall.”

“Some businesses are happy to sell assets to strengthen balance sheets. There will always be deals to be done but I envisage more forced sellers. My advice to anyone looking to buy a business in this market is to stick with what you know, as there are good deals to be had.”

“If unemployment hits 3 million then we will be in trouble. There are simply not enough smaller businesses on the market at the moment and demand has outstripped supply for good businesses. People are desperate to buy for turnover, as they want to exit in 5-10 years. People are not coming to the market as they think they will not get a good price. If the business is a good one and there are synergies with the buyer then businesses are selling for decent money.”

“There is no appetite for acquisitions of businesses with a high premium on goodwill. The banks have a policy that they will only lend on the value of goodwill if assets of the same value are used as collateral for the loan. I cannot see a revival of fortunes for engineering businesses for 2010. However I believe that Health and Safety businesses and those involved in the medical sector will be in demand next year.”

“I expect 2010 to be better for buying businesses but we are starting from a very low base. With a low volume of private equity transactions it is hard to gauge how strong the Limited Partnerships will be going into next year, as they haven’t really been tested. An expected change in Government will no doubt cause some uncertainty for the prospects in 2010.”

So there we have it, a mixture of positive and negative sentiment on the prospects for 2010. We certainly agree that any business with a good asset base and with good contracted positive cashflow will be a good prospect. To find out who said what, you will need to subscribe to the report. We believe that 2010 will be a good opportunity for buying businesses as long as you know exactly what you are doing as mistakes will be very costly. Make sure you have done good due diligence, have a good relationship with your funding partners and be ready to move quickly.

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During a corporate transaction, such as the purchase of a business, a solvency opinion is a financial opinion issued by an M&A advisor about the likely solvency of the newly created entity. The solvency opinion is based on an analysis that includes a general review of the fair saleable value of the assets and stated value of the liabilities, the cashflow capacity of the company and the ability to meet obligations as they become due.

The opinion is often required by boards and/or lenders as additional protection in the case of a subsequent fraudulent conveyance claim. Opinions issued by third party advisors can be assurance for creditors in the case of bankruptcy. In bankruptcy the absence of an independent opinion presented to the parties involved in a given transaction can result in a lender’s loss of right to priority repayment of debt from liquidation proceeds. As such solvency opinions are mostly given where a deal is highly leveraged.

The percentage of M&A advisors who believe solvency opinions will have a direct impact on the terms or completion of a transaction over the next year has doubled since before the onset of the credit crisis, according to a study released by mergermarket in association with Houlihan Lokey. The study, conducted during the third quarter of 2009, compiles interviews of senior corporate executives, private equity practitioners and lawyers from the US and Europe regarding their recent and historical experience with solvency and related business valuation opinions.

Ben A. Buettell, managing director and head of Houlihan Lokey’s solvency opinion practice. “In the transactions that are coming to market, buyers and lenders are taking a closer look at the valuations of assets and liabilities on a pre-and post-transaction basis. The study’s findings are in line with our observations that professionals are responding to ongoing market complexities and the growing concern that solvency opinions are more likely to be challenged in the future by spending more time on these valuation issues.”

The report has highlighted key differences between the use of solvency opinions in Europe and North America. In North America two thirds of respondents reported that they had been involved in a transaction that included a solvency opinion compared to just one third in Europe. However, it is in Europe that there is the expectation of wider use of the solvency opinions in major transactions. The study also concluded that distressed asset sales would play a more important part in driving demand for solvency opinions due to the much closer scrutiny surrounding these transactions today.

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Now that the ‘easy-credit’ party is over and businesses are facing uncertainty in the face of a faltering UK economy, there will likely be extraordinary opportunities for entrepreneurs to buy distressed businesses.

Recent figures released by the Insolvency Service reveal just how difficult the situation has become for some businesses. Between April and June this year, there were 3,560 liquidations, up 12 percent on the first three months of the year and a 15 percent increase on the second quarter last year. It also looks like the third quarter of this year will show a similar, if not higher, increase. Receiverships, often initiated by the high street banks and involving businesses that are at least three years old, have also more than doubled.

The Business Sale Report’s own figures show there were 2084 Administrative Appointments recorded throughout England and Wales in the first eight months of the year. This represents a 51% increase over the same period last year (1379). The industries most affected are property and construction. Other sectors suffering are those reliant on household discretionary spending including retail of white goods, furniture and leisure-based industries including travel, pubs and clubs.

Before venturing further, it is necessary to understand exactly what a distressed business is. The Insolvency Act 1986 (Section 123) sets out two primary forms of validation. The cashflow test. Where the business is unable to pay debts as they fall due; and the balance sheet test. The value of the business’ assets is less than its liabilities, taking into account its contingent liabilities and prospective liabilities. Obviously the degree of seriousness determines whether the business is liquidated or put into administration or receivership.

So why buy a distressed business?

Only buy a struggling business if you understand exactly why the business is currently in trouble, you know how to turn it around, and you have an exit strategy.

The one important myth to dispel is that the purchase of a troubled business is a bargain. The old adage that “if it looks too good to be true, it usually is” applies here.

Print film in a digital world�. many industries have a lifecycle that ultimately come to an end. If the product or service is no longer required at a level of need that enables you and your competitors to make a reasonable profit, why take on that struggling business and try to beat the odds?
Profitable investing in a distressed company is no different than investing in other types of business. It requires selecting a business, that once stabilised, has a demonstrable demand for its product or service going forward, for at least long enough to maximise your return on investment prior to or at your intended exit.
So you must do your research. Why is the business in trouble? Careful due diligence is absolutely critical in connection with a distressed business due to, amongst other things, the likelihood of limited or complete lack of recourse once the business has been bought.

So here are the important questions to ask:

• Is the business overburdened with debt?
• Are there any significant liabilities such as an adverse judgement or product liability claim?
• Are any tax losses available?
• Has the business lost key management?
• Are the company’s problems merely due to poor delivery or execution?

The ability to maintain the value of contracts going forward is essential. There may be restrictions on assigning contracts. Insolvency status may invalidate them and previous non-performance of contracts may incur penalties.

One of the main reasons that entrepreneurs buy businesses is the belief that they will be able to run the business better. So a buyer needs to be sure that they have what it takes to achieve this. The business may have been run poorly only because management time was taken up by a problem in the recent past so the current management are not incompetent, just distracted.

Of course, when buying a distressed business, ‘time is of the essence’, so it is important that you have a full team assembled so that you can go in and get all the information that is required quickly.
An entrepreneur has two possible methods of buying distressed businesses: either he or she can buy it to prevent it going officially insolvent, or else wait until the business is declared insolvent and buy it from the insolvency practitioner. There are advantages and disadvantages of both methods. We published an article on how to buy a business out of insolvency in the “September 2007″ edition, which you can access here. Here we will look at more general aspects of buying a troubled business.

How to find a distressed business.

A proportion of businesses up for sale are in some form of stress, as financial problems are often the catalyst that prompts the management to seek a sale. In addition to the listings here, you may consider contacting businesses via a trade association membership list, appropriate when a whole industry is in trouble i.e. estate agencies.
Specialist intermediaries are particularly useful if they also have considerable turnaround expertise. If you are known to them, you will usually be treated as an important buyer prospect, particularly if you have previously demonstrated the ability to act decisively and close a transaction in an efficient and timely manner.
Investors should be prepared to sift through many bad opportunities, and also accept that, for the good ones, there may well be a competitive bidding environment. If this happens, what, then, is the right price to bid? The “value” of a distressed company is often difficult to ascertain. The right price is going to be different for every bidder, because no two bidders:

• plan to run the business in the same way
• will effect a turnaround and stabilize the business in the same manner
• know how the business will integrate with the other businesses they hold.
• have the same cost of capital structure.
• have the same growth plans.
• share the same exit strategy.

In the current climate, where lending is drying up, the cost of capital is a key factor. Entrepreneurs who have large amounts of cash and do not wish to be highly leveraged are at a definite advantage at the moment.

So buying a distressed business can often have distinct advantages over alternatives. Start-ups always require more investment, in time and money, than is typically budgeted for. Moreover, there is often little or no track record of acceptability of the product or service. Profitable businesses have few reasons to sell other than to generate fast cash in excess of the net present value of the anticipated stream of the future cash. At the moment there are many owners of profitable businesses who are holding out for stretched multiples. So entrepreneurs who are keen to rapidly expand their portfolio of businesses interests would be advised to take a serious look at distressed businesses.
Another opportunity that cash rich entrepreneurs can exploit is the possibility that businesses might be divesting assets and divisions in order to improve their liquidity. According to Michael Garstka, a partner at Bain & Company, asset values are lower than they have been for a long time. “The downturn provides opportunities not just to acquire direct competitors, but also potentially key parts of your distribution networks or even choke points in your industry’s supplier chain.”

It is generally true that it is advantageous for the acquirer of a private company to purchase the assets not equity of the business for two main reasons – the tax advantages; and the fact that you will not be inheriting all the liabilities of the business. However, some assets still have liabilities attached to them such as contaminated land clean-up costs. Also, a purchaser may find him/herself exposed to intellectual property disputes on products. The entrepreneur will no doubt be under pressure from the seller to buy the entire company, but each situation is different and it is down to smart negotiation and good advice on structuring any deal.

In conclusion, if you have got what it takes to turn around a failing business, have cash in the bank or the ability to raise finance on good terms, then you are in a winning position. Cash is king. There are more failing businesses to choose from and fewer serious buyers in the market. This all leads to the prospect of rich pickings for a smart investor who is in a strong position in the market when the economy eventually picks up.

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For those big, powerful and wise enough, the latest trend in due diligence strategy is… don�t bother.

Last week Warren Buffett addressed MBA students at IMD, the Swiss business school. He was there to talk about a deal he struck two years ago where Berkshire Hathaway paid $4bn for 80% of Iscar, a metal tools manufacturer.

Mr Buffett admitted that he never bothered with due diligence except where there were environmental concerns.

He said that he could tell within minutes of talks commencing if a deal was going to occur. �The deal should be so obvious to you. If you have to carry the calculation out to five decimal places, like pi, it can�t be a good deal�.

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Buying a business is not like buying a car. Get it wrong with a business and it is likely to seriously hurt your wallet. So how can you tell if you are looking at one where the wheels might fall off? Nick Pritchard from Transaxman ltd has helped us put together a few examples of what to look out for and how to assess the true profitability of a businesses. Remember that the seller knows a lot more about the business than the buyer.

There are a number of indications that a business is in difficulties. Such as reduced recruitment and training activity, delay of planned maintenance, missing a major trade show, closure of product or quality development teams and reduced investment in tooling or software. When companies are prepared for sale, if the business is in some difficulty, they may simply cease any forward expenditure or investment. Continued investment in a business is essential in ensuring growing profits. This is often the reason that the best businesses to buy are the ones that are not actually being marketed for sale.

So you have seen a great business and you are doing due diligence. Don’t let the vendor pull the wool over your eyes! There was one well documented fraud where everything seemed hunky dory, but the vendors had hired in a number of temporary staff to make the factory look busier while the potential buyers were looking around.

Arriving at the adjusted net profit

There are essentially two main types of adjustments that need to be made:

* Allowances for non-recurring items, such as a grant or a big debt
* Items shown as costs that are really a distribution to the current owners.

For example, distributions to owners might be special pension contributions, or expenses that are a consequence of the life style of the shareholders, as well as the usual salaries and benefits in kind. In one instance a US business was in the process of buying a company in South Wales, unfortunately the vendor had forgotten that he had put his Cardiff Arms Park debenture through the company – Once the purchaser understood the importance of being able to take customers to the match, the vendor had to buy his own tickets.

Where a company occupies its own freehold property it may also be necessary to adjust the trading results for a notional rent charge, if the property is worth substantially more than its book value.

Standardising earnings
The purpose of restating results is to show what the earnings of the business would have been on a standardised basis, as a guide to the future earnings. The valuation exercise is done therefore to establish how much a theoretical buyer would be prepared to pay as a capital sum in exchange for the right to receive those future earnings.

Earnings for this purpose would be trading profits before interest but after a notional taxation charge. This recognises that the value of the business may be different from the value of the equity, as the latter value will depend on how the business has been financed. Where businesses have accumulated cash reserves it should be remembered that these funds represent past earnings which have not been distributed.

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The importance of due diligence to the success of a transaction is often underestimated. I thought it might be useful to put together a few pointers to keep in mind while running a due diligence exercise on a business you are intending to buy. It is not a checklist � there are a few good due diligence checklists around � there is a good booklet available to subscribers of the Business Sale Report entitled �Due Diligence – over 1000 Key Questions to Evaluate Any Business For Sale�. You can download an extract here.

Plan it, scope it
Define the scope of the due diligence exercise and clearly mark out who is doing what, when. Work to a timeline. Don�t waste time on areas that are not likely to cause any real issues or have any effect on the final sale agreement.

Employee issues
Thorough due diligence should pick up any issues, risks and potential liabilities relating to the seller�s employees. For instance, check if there are any past or present employees litigating against the business. Do any of the employment contracts have unusual clauses i.e. over-the-top redundancy packages? What are the specifics of the pension plans?

Move fast, top down
It is important to spot any issues early on so that the appropriate warranties and indemnities can be quickly put in place. Focus on major issues first. As with any aspect of due diligence, the late uncovering of issues which lead to changed warranties and indemnities at an advanced stage can reduce strength of the negotiating hand and, (i.e. in the case of pensions) in some cases, even scupper the deal.

Communication is vital
The flow of communication between the buyer and his/her solicitors is of paramount importance, for if they do not work closely together, the process can quite simply fail.
Buyers must communicate the key issues of concern to the solicitors; they should not just assume that all areas are of equal importance, and that everything will be dealt with in good time. The solicitor must be told what the key commercial reasons are for the purchase, which areas are high-risk and which areas should be prioritised.
Continually monitor the activity of the solicitors and accountants carrying out your diligence and make sure they are giving you regular feedback.

Don�t forget the culture
Funny how the lack of understanding of the target�s company culture is one of the main reasons for failed acquisitions, yet has been notoriously ignored in the due diligence process. Don�t make the same mistake. This is usually one for the purchaser�s management to consider, rather than delegating to legal or financial advisers. Map out the management styles of your business and the target business. Look at the core values of each and analyse the differences. How do the communication structures and styles differ? Look at the dispute policies.

Collect information, then analyse
Don�t let any of your advisers analyse whilst collecting the information. These are two distinct activities within the due diligence process. First find out where the required information is, then collect the information, recording its source and noting whether it is fact or hearsay. Then start an objective analysis.

Don�t panic, take your time
A focused but comprehensive approach is better than taking shortcuts in order to reduce costs. Often the buyer discovers that �thin areas� of diligence need to be covered again in more detail. It will end up taking more time overall and costing more money.

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