Making your business a more attractive acquisition target

For business owners planning an exit, one of the most pressing considerations is how to make their business as attractive as possible, in order to draw in bidders who will come close to meeting their valuation of the company and to facilitate a profitable sale.

However, attracting buyers that will meet an owner’s own valuation of their business can be highly challenging, especially during the kind of economic uncertainty that is currently being seen in the UK and much of the rest of the world.

Economic uncertainty has a detrimental impact on M&A from a seller’s perspective, with many buyers reluctant to invest in deals and those that are more likely to target distressed acquisitions or push hard for lower valuations.

For that reason, it is vital for business owners seeking to make a profitable exit to ensure that their company is prepared for a sale and that work has been done in earnest to make the business as attractive as possible to potential buyers.

Meticulous exit planning
The first thing that will be required when making a business more attractive pre-sale is a well planned exit strategy. Unfortunately, that means approaching the sale process meticulously and giving it the requisite time necessary: I.e. a minimum of three years and ideally up to five years.

As we’ve discussed in-depth previously, a proper sale process will require years of strategising and work. Giving the sale this much attention will mean a seller gives themselves the necessary time to build value and take steps that will help to make the business as attractive as possible.

Consulting with an exit strategist from the beginning of the sale process can help to flag up the areas in which a business requires work in order to prepare it for a sale. Many exit strategists operate using a “business attractiveness index”, which provides a list of criteria that make businesses more attractive, with a higher final score indicating that the business is attractive to potential buyers and, therefore, ready for sale while a lower score indicates the business requires work to be attractive to buyers and is not ready to come to market.

As well as helping to boost the attractiveness of a business prior to engaging in a sale process, a well-strategised exit can also help to facilitate a smoother, higher-value sale by demonstrating to buyers that work has been done to make the business sale-ready, that the owner is serious about their exit strategy and that everything is in place for them to step in. In a market tinged with so much uncertainty, this kind of reassurance will be hugely attractive to buyers and will positively impact their valuation accordingly.

Scale up
A scaled up business is a more attractive business, therefore, scaling up should be at the core of any strategy to make a business more tempting to buyers pre-sale. In an earlier piece on scaling up a six-figure-turnover business, we identified the key reason why: as well as being bigger and, as a result, likely more profitable, scaled-up companies are easier to transfer.

In the current climate, buyers will want acquisitions to deliver value quickly and part of their due diligence process will be looking at how quickly they can begin to turn a profit from their investment. With that in mind, the crucial consideration will be post-deal integration and how long it is going to take for the new acquisition to become a fully incorporated part of their operation.

When a business is scaled up, it is likely to have the systems in place that can facilitate a smooth transition: a predictable revenue model; productisation; a strong leadership team; solid foot/online traffic and process documentation.

Such features, explored in-depth in our insight on scaling up a six-figure business, will make a business more resilient, easier to transfer to a new owner, easier to integrate and, ultimately, able to attract a higher sale multiple.

Grow market share and diversify
Resilience will be the key for companies seeking to maintain growth during the current downturn and accelerate this growth during a subsequent recovery. The best way to achieve resilience is to have a business with a strong market share in its specific industry, and/or with diverse sources of revenue that make it less vulnerable to economic shocks and more well-positioned to capitalise on growth opportunities.

It may sound counterintuitive to target M&A-centred growth at a time when a business is preparing to be sold, but it’s a simple fact that acquisitions are one of the quickest and most efficient methods of attaining growth, diversification and the economies of scale, especially in the midst of an economic downturn.

One thing that many owners will be wary of when taking the helm at a new company is the fragility of client relationships. Particularly at smaller firms, clients may have a close, long-standing relationship with the previous owner built on years of co-operation and a trust and understanding that has built up during that time.

An ownership transition, then, can naturally cause concerns for clients and it is not uncommon for them to use this as an opportunity to re-evaluate their contract with the business and potentially seek a different supplier. Buyers will, of course, attempt to maintain these relationships, but will also be wary that clients are guaranteed to remain with the firm post-sale.

If the target company is overly reliant on just a few clients – for example, if one client is responsible for 40 per cent of the firm’s revenue – then buyers will be seriously put off as any disruption in this regard would be highly damaging to their post-integration growth strategy.

Similarly, a company might have a large portfolio of clients, with none accounting for too large a percentage of revenue, but the base may be narrow in terms of the industries that clients are coming from. This may be concerning to potential buyers during downturns and recessions, when specific sectors are likely to be adversely affected (e.g. the wave of construction insolvencies being seen amid the current downturn).

In order to ensure that a business is attractive to buyers, owners should seek to build a resilient client base with strong recurring revenue. That could mean a significant market share in one particular industry, or a diversified operation that is not reliant on one particular client or sector for revenue, ensuring that the business is insulated from economic shocks and that, during the disruption of an ownership transition, the loss of one or two clients will not have a crippling effect on the company’s revenue streams.

Strengthen client relationships and lay the groundwork for the sale
Of course, buyers will find the business more attractive if they know that client relationships are solid and stable and that clients are prepared for the business to be sold and won’t be shocked by a sudden change of ownership.

During an ownership transition, the thing that will put clients most at ease is openness and transparency. If clients are unaware that the business is being sold until shortly before or even after the deal completes, they are likely to feel blindsided and may be forced to reassess their relationship with the business.

Potential bidders are likely to want to know if clients are aware that the business is being sold and have been kept abreast of proceedings. If this isn’t the case then buyers may be put off from the deal due to the likelihood that a valuable relationship could suffer significant damage during the transition.

Sellers should let clients know that they are looking to dispose of the business during the process and reassure them that they are seeking a buyer that will maintain the same level of service post-transition and that the maximum effort is being made in advance to ensure that the post-deal integration process is smooth and that there is as little disruption as possible.

Once clients are reassured that the sale process is being handled in the proper way, sellers could potentially seek to lock in important client relationships by negotiating new contracts, something that would make the company significantly more attractive to potential buyers, demonstrating the long-term stability and growth potential of the business and reassuring them that vital relationships will not be lost once the acquisition has been completed.

Sellers could also seek to make their business more attractive to buyers by incorporating suggestions for upselling to existing clients and strategies for approaching new clients into a business plan for the possible future of the company.

Detailed financial history and extensive forecasting
One of the key reasons why it is valuable to undertake a long preparation period when selling a business is that it enables the company to focus improving turnover and profitability – both crucial attributes that will make the business more attractive to buyers.

If a business can demonstrate growth over its last three years of financial statements then buyers will be confident that it is on an upward trajectory and that there is a strong management team and strategy in place steering the business in the right direction.

Scaling up a business, as discussed above, will help to achieve this. However, it may of course not be possible to have an immaculate financial history in the years leading up to a sale. After all, the UK has been mired in economic turmoil for several years now, something that would have been hard to predict and will have left even high growth potential businesses struggling and potentially recording losses.

Even if a business is generating a loss, it can still demonstrate growth in turnover and in key metrics like new contract wins, favourable new terms with existing clients and other developments such as pipelines of new products or acquisitions.

The key is, again, transparency. The last thing owners seeking an exit should do, even if their business has recorded a loss in recent financial statements, is attempt to conceal these things from potential buyers. The likelihood is, with caution so high among buyers in the current climate, that such dishonesty will be rooted out during the due diligence stage, potentially fatally undermining trust on the buyer’s side.

If a seller is upfront about their business’ performance and forthcoming with detailed, accurate financial statements that genuinely demonstrate the business’ performance and trajectory then trust will be built and the buyer is more likely to engage in the process. During a downturn, factors such as what percentage of a business’ revenue is recurring and how diverse or resilient its revenue streams are may ultimately prove more important to buyers seeking to gauge the health and performance of a business than profit or loss figures.

However, perhaps more important than demonstrating past profitability, buyers will be particularly impressed with a detailed, ambitious growth strategy that provides a granular breakdown on the current plans for the business and where it is heading. This should be centred around financial projections for the next 3-5 years based on metrics such as historic performance, market trends and projections for things the business has in its pipeline, such as new products or services that it is working to bring to market.

In many ways, the scaling-up process that leads up to the sale of a business could be used as a jumping off point for where the business could go post-sale. Now, of course, a new owner is likely to have their own ideas and growth strategies for where they want to take the business post-acquisition, but a growth plan developed by the outgoing owners could nonetheless be attractive.

Primarily, of course, it can demonstrate the potential of the business, particularly if the growth trajectory mapped out is based upon a strong history of earnings growth. Even if they have their own plan already in mind, an insider’s perspective on where the business could go could still shine a light on ideas, growth strategies and expansion opportunities that might not yet have occurred to them.

However, it is important for these future projections to not be rose-tinted. Avoid hockey-stick projections! These will prompt the potential buyer to ask, “Well, if your forecasts are so spectacular, why are you selling now?”. They want to see solid assumptions behind an extrapolated projection of your recent growth.

Just as important, and potentially just as impressive and valuable to a new owner, will be a thorough mapping out of the potential risks that the business could face. As with potential opportunities, a view on the possible risks that the business faces could help buyers plan their growth strategies more effectively and, while it may seem counterintuitive, possibly even increase their confidence in the acquisition.

Solid leadership and a succession pathway
One thing that will be immediately alarming to a potential buyer performing due diligence on a possible target business is if the company appears to be overly reliant on an owner (or multiple figures) that is going to be leaving the business post-acquisition.

As with a future forecast identifying growth opportunities for the business, a buyer may of course come into a new acquisition with plans to bring in their own people, particularly if they have extensive experience in the same industry and a leadership team at their own business that may take over the running of the new acquisition.
However, even if a new owner plans to make changes – including to the management structure – they will still be concerned if there is an over-reliance on the outgoing owner, and their valuation of the company (or even interest in doing a deal) could be impacted accordingly.

One common method for gauging whether the business is over-reliant on its owner is for the owner to think about what would happen if they were to take some extended time off. If they were to take a three-week long holiday, or potentially an even longer period of leave for a personal matter, would the business continue to perform and be in a good state when they returned? If not, then it’s likely the business lacks other leaders and leans too heavily on its figurehead – something that would be off-putting to buyers.

On the other hand, a company with a strong management team in place, one that operates without constant, day-to-day involvement from the owner and that can step up in their absence without a significant impact on operations or revenue, will make a business far more attractive to a potential new owner.

If a potential buyer was considering making changes at the senior level of a company post-acquisition, then an especially strong management team might mean they have to make fewer changes than anticipated, or even convince them that no changes are required.

This could make the business significantly more attractive to them and potentially have a positive impact on their valuation of the company, with a strong, established management team likely to help drive a smoother post-deal integration that enables value to be unlocked quicker, while saving the new owner money that they may previously have invested in reorganising the management team or hiring new talent.

Prior to a sale, a strong management team can also help to drive initiatives that increase the business’ overall value. As we discussed in our piece on scaling-up a business past six-figure revenue, a core team with a wide breadth of expertise is the foundation of any successful scaling-up strategy, with the process of increasing a business’ value dependent on experienced figures who can offer a wealth of different perspectives and ideas.

Scott Snider, President of the Exit Planning Institute (EPI), explains the importance of a highly-skilled senior leadership team in making a business an attractive acquisition target: “A highly experienced team needs to surround the owner to get to the lucrative exit. A business owner must have a team of professionals alongside their internal team to build significant and transferable value in their business. These team members should include at the core a CPA, Financial Advisor, Attorney, and Growth Consultant. The members of the transition advisory team should also have a focus or certification in the exit planning process. As such the team will be holistically focused, share a common goal and organising principle, and a common framework and process. Allowing the team to drive the business from successful to significant.”

Get financials organised
For buyers, one of the most taxing aspects of an acquisition is the due diligence process, which is often the most time-consuming stage of a transaction and the one requiring the most work. This already heavy workload will be exacerbated further if the target company’s documents, such as financial statements, are not well organised and they or their representatives are faced with attempting to piece together a picture of the business’ prior performance.

Poorly organised finances and other documents will not only increase a buyer’s workload during the due diligence stage of an acquisition, they could also suggest a deeper disorganisation that is likely to extend to other areas of the business. This could be highly damaging to a buyer’s perception of the business and their valuation and willingness to engage in the sale process could be impacted accordingly.

For that reason, a business should have, at the very least, the last three years of documents (management accounts, profit and loss statement, cash flow statement and balance sheets) well organised and readily available for buyers who reach that stage of the process (I.e. after initial negotiations and after a non-disclosure agreement has been signed). A seller could also work with a financial adviser to prepare a summary document covering the crucial figures of the previous years’ financials, which will make it easier for buyers and their lawyers to navigate the full set of documents.

Other documents that are likely to be reviewed in due diligence will include corporate structure and records, banking details, contracts with clients, a detailed breakdown of the company’s assets and intellectual property, insurance policy documents and certificates, the relevant compliance and consent requirements for the firm’s industry, employment records, tax documents, ESG-related reports such as environmental audits, property information, employee benefits etc.

Sellers engaging in a full three to five year sale process should begin preparing for due diligence right from the off. Getting all the relevant documents organised and ready to be looked over by potential buyers who get far enough along in the process will ensure a smoother, quicker due diligence stage. This will also impress upon buyers that the business is well organised and approaching its sale with the utmost seriousness.

Reasons for selling
Obviously, buyers will be able to build their own idea of a business’ performance and growth trajectory during the due diligence phase, but one thing they may take particular interest in is why the owner is selling as this may point to deeper issues within the business.

Ultimately, the reasons behind selling should potentially be the very first step in the process and one that determines whether or not the timing is right. If a business is underperforming, the economy is weak and projections for the company are not strong, then owners may naturally be tempted to seek an exit if they feel they are not up to the task.

However, selling when desperate is a bad idea and attempting to offload an underperforming business while clearly looking for a swift exit will not attract the type of buyer that is likely to meet an owner’s valuation of the company.

Of course, buyers will know that the owner wants to exit the business – otherwise they wouldn’t be undertaking a sale process – but desperation to get out will point to a struggling, directionless business and paint a highly unattractive picture.

Buyers will need to feel that an owner is selling for a legitimate reason, and sellers can ensure they preserve the attractiveness of their business by selling when the timing is right and when they have a good reason for exiting the firm and passing the reins on to someone else.

Retirement, of course, is a legitimate reason for selling and, if a seller initiates the exit process years in advance when retirement is still some way off, this could dispel the perception that an ageing owner is desperate to get out and stop working as soon as possible. Framing a retirement sale as a process attempting to find a younger owner ready to take the business into a new growth phase could be one method that helps to both attract buyers and preserve value.

Overall, a business will be most attractive to buyers if it is an opportunity for growth and this is a particularly effective way of defining reasons for selling. Perhaps the best time to sell is when the business is poised to enter a new phase of growth or has the potential for considerable expansion but requires new investment from a well-capitalised buyer to do so. Although, as mentioned above, sellers will need to ensure that their projections are built on solid data and a thorough examination of the business’ growth prospects, as well as wider economic/social factors and potential risks.

If the sale process is complete with a business plan outlining positive financial projections, growth strategies and areas in which the business could expand or diversify, then owners will be able demonstrate to potential buyers that they are selling in order to unlock the business’ potential and increased profitability.

Flexibility on deal structure
The M&A environment is tight right now and even well-capitalised buyers will be more reticent about deploying their funds into costly acquisitions. While it is true that the best deals are usually done during recessions and downturns, it is also true that buyers will be tightening their due diligence even further and placing an even greater emphasis on targeting those deals that will quickly generate significant value.

Two main factors are seen as major barriers to dealmaking in the current climate for both buyers and sellers: tighter financing conditions and valuation gaps. Given the uncertainty that continues to grip the economy, as well as other economic issues such as inflation and soaring costs, valuations for UK firms have fallen considerably.

Traditional lenders such as banks have tightened their financing conditions and, although private equity firms remain keen to deploy funds for M&A buyers, competition for this kind of backing will be fierce and not all buyers will be able to access it.

The knock-on effect here is that sellers may struggle to find buyers willing to meet their valuation of their business or, even if buyers are willing to pay a higher valuation, may find it hard to differentiate themselves from other similar firms that are on the market.

In order to make businesses more attractive during times when buyers are either less motivated to pursue high-value deals or are struggling to access the requisite financing (or perhaps both), sellers can offer flexibility on the financial or operational structure of the deal that might make it more accessible to buyers and potentially enable them to unlock a higher ultimate valuation.

From a financial standpoint, offering seller financing or potentially structuring a portion of the deal consideration as an earnout can entice buyers with a lower upfront fee, while potentially meaning that a higher overall valuation can be put on the deal. Of course, the drawback here is that the seller can take on a considerable amount of risk if the business doesn’t perform post-acquisition, which could limit the deferred amount that is payable, meaning that sellers should seek to negotiate favourable terms for themselves, while only pursuing this kind of deal structure if they are confident in the future of the business and the competence of the incoming ownership.

Operationally, buyers may also be more attracted to a deal if, for instance, the outgoing owner agrees to continue with the business for a pre-agreed period after the acquisition, something that can considerably ease the post-deal transition period and enable the new owner to more quickly get to grips with running the company.

The ESG element
As we discussed in another recent insight, one of the main themes defining M&A over recent years has been ESG. ESG is becoming a major factor in M&A in numerous different ways and it is one of the key factors that owners can use to increase their attractiveness to potential buyers.

Firstly, strong ESG performance is associated with higher multiples, meaning that a company with solid ESG credentials is likely to attract a higher sale price when it is acquired. Deloitte research that assessed M&A deals based on the target firm’s Refinitiv ESG score found that firm’s with a 10-point higher ESG score, on average, attracted a 1.2x higher EV/EBITDA multiple, while companies that improved their ESG score by 10 points saw a 1.8x increase in their EV/EBITDA multiple.

Research has often found that investing in ESG can create long-term value, generate higher returns and insulate the investor from volatility and long-term risks, all while boosting its brand perception. This has resulted in buyers placing an increasing emphasis on acquiring firms that help to boost their ESG credentials.

Returning to the issue of funding, amid tight financing conditions, buyers that put ESG at the core of their acquisition strategy are more likely to attract the capital required to conduct deals, with ESG also a hugely important consideration for lenders such as banks and private equity firms. According to a 2021 PwC study, 72 per cent of private equity firms say they screen potential investments for ESG opportunities and risks at the pre-acquisition stage.

Simply put, a business with strong ESG credentials is one that is far more attractive to buyers in the current marketplace and one that will attract a significantly higher valuation than a counterpart whose credentials are comparatively lacking.

Summing up: The 4 C’s
At the heart of increasing a business’ value and, thus making it more attractive to potential buyers when the time comes to sell, are the Exit Planning Institute’s “4 C’s”: Human Capital; Structural Capital; Customer Capital and Social Capital.

As well as defining and summing up the main levers that owners can use to increase the value of their business, they also provide a useful overview of the steps that can be taken to increase the attractiveness of a company ahead of a successful exit, touching on many of the points discussed above.

Human Capital refers to developing a capable team that has the skill, expertise and will to lead the business, enabling the company to continue operating well with or without the owner. As discussed above, a solid leadership team will be a major attribute when selling a business, indicating a depth of knowledge, skill and expertise that goes far beyond the owner and representing a highly valuable, attractive and transferable asset to a new owner.

Structural Capital refers to the systems and processes that ensure the business runs smoothly and efficiently. These are the kinds of attributes that a business should seek to develop during a pre-sale scaling-up phase, things such as productisation, process documentation and a predictable revenue model.

Customer Capital means developing a solid, loyal customer or client base that is committed to working with the firm. While some new owners will prepare for the eventuality that some clients might move on once a business changes hands, having a strong, diverse and stable client base that is in the loop about the sale process will be extremely attractive to buyers.

Social Capital means that a company has a strong culture defined by a shared vision and values. This is something that owners preparing for a sale can build while improving the ESG credentials of their business, by instilling social values, goals and standards in their business. This could be achieved by setting environmental related goals, establishing a set of governance standards for the senior team or even by engaging in regular philanthropic work. Whatever it is, the evidence is clear that companies that make a concerted effort to improve their ESG credentials generate higher valuations and are more attractive to buyers, a trend that is only likely to grow stronger over the coming years.

While the 4 C’s are perhaps an overly simplistic method of outlining how owners can improve the attractiveness of their business, they do provide a useful framework for building the kind of attributes that buyers often look for.

Aside from taking these kinds of steps, ones that will materially improve a business’ value, make it easier to transfer and more attractive to buyers, owners also need to recognise the uncertain times that we are living in, ensure they are transparent and, when the right kind of buyer comes along, flexible and co-operative about achieving a successful sale.

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