Business Sale Report Blog - News and views on buying and selling businesses

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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Getty Images, the market-leading stock photography vendor, is up for sale. Or, at least, it admitted it has hired Goldman Sachs to explore strategic options.

The US-based company was founded in 1995 by Jonathan Klein and Mark Getty, grandson of John Paul Getty, the philanthropist.

Having grown at a cracking pace, mainly through acquisitions, Getty is now the world’s largest supplier of video and digital pictures to ad and media agencies, posting a profit of $130.4m in 2006 on a turnover of $807m. Getty Images owns the UK-based Tony Stone Images, Image Bank and the Hulton Archive.

However, in August last year the company said it was cutting its forecasts, precipitating a slide in the stock price from $50 down to $22 last week.

The cause? The internet, which has done so well for Getty over the years, has fathered a swathe of digital image suppliers who have undercut Getty’s prices and eroded its market share. Nevertheless, the company is still expecting to post higher sales in 2007 of around $850m and is believed to be holding out for a $1.5bn sale price.

Whoever buys Getty Images, and it is thought that private equity groups Bain Capital and Kohlberg Kravis Roberts are circling, will have their work cut out holding up profits in our view, and Getty will be fortunate to achieve this price.

As an occasional Getty Images customer, we pay around £430 for use of an image for use on a website. And this only covers a licence for a 2 month period! Contrast this to most of Getty’s fast-growing competitors, where you can download and use a high resolution image, on a permanent basis, for about £5. And it’s not just the price. There is an arduous, fiddly and non-standardised order process on Getty where you need to specify exactly how and when the image is to be used, the territories it will appear in and more. Other sites have a simple pricing system across all images; the only variable is the image resolution.

Getty has been buying up some of the stronger online competitors (iStockphoto, for instance) and have an absolutely huge media bank. The average quality of its images are, I would have to admit, higher than any of its competitors. But the pricing differential cannot be sustained for long, cheaper competitors are now sprouting up everywhere, and Getty can no longer rely on the assurance of juicy corporate contract renewals from large media owners.

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