Funding and Transaction News

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1 Newsletter Winter 2013/14 Funding and Transaction News Confidence returns As you will gather from the tone and topics of the articles that comprise this newsletter, we are more bullish than normal about funding and transactions. This is based predominately on the magic and elusive ingredient that stimulates business activity confidence. A plethora of reports issued in recent weeks have pointed to confidence levels being at record highs. There are a number of barriers to be overcome but I do feel supremely confident that Francis Clark s Corporate Finance team and other professionals in the region have the expertise to assist in converting aspiration to realisation. My optimism for 2014 is further underpinned by: There is probably more finance available today at a lower cost than ever before. As confidence returns, this will result in more companies taking some of this up, and funders are likely to become increasingly busy, especially as the credit approval processes that they now have to undertake are more time consuming than they were historically. This will in effect result in a competitive situation to gain access to funds, probably far sooner than many realise. We started 2013 advising on an alldebt MBO where the Management team put in limited funds for their stake, and we finished on Christmas Eve raising 3.4m of equity for a start-up. These transactions show the type of deals that are possible in the current attractive funding climate; make sure that you make the most of them in 2014 if it is appropriate for your business. Andy Killick

2 Is 2014 the year of the MBO? The prospect of taking the step from management to shareholder through a management buyout (MBO) is usually a once in a lifetime opportunity. There are a wide variety of reasons for management acquiring the company they work for, such as creating the freedom to manage the business as they see fit, as well as the financial benefits that ownership can bring. Whilst the process requires careful consideration, there are several factors that mean undertaking an MBO during 2014 could be an opportune time. At present sales and acquisitions of SME businesses are completing at well below pre-financial crisis values. However, as markets gain confidence and businesses change their focus from caution to growth, expectations of current owners may increase going forward as transaction values and volumes gather pace with more buyers entering the market. In addition, if vendors have been unable to attract the interest of a trade buyer, they may be willing to receive consideration over a period of time, allowing them to benefit from the current very favourable capital gains tax regime. As we approach the election in May 2015, there is a risk that limits on entrepreneurs relief may fall leading vendors to decide that now is a good time to bank a profit. Funding MBOs is a critical factor in their success and there are misconceptions that management needs to hold significant personal wealth. Whilst this may help reduce the risk to potential funders, the most important factor for a funder is management s commitment to the deal and future of the business. In almost all cases, funders contribute the vast majority of finance, and in some cases all of it. Presently many banks appear keen to demonstrate they are open for business and are interested in propositions supported by quality management. Furthermore, equity providers are keen to invest, with many complaining there are insufficient opportunities to invest in. Consequently, funding is more readily available now than it has been for several years. The cost of obtaining and servicing funding is also significant as the business going forward may be perceived higher risk due to the additional debt. However, fees and interest rates remain at historically low levels for quality acquisitions and more money can be raised at lower overall costs. With many businesses looking at expansion they may be better placed to service debt than in recent years, thereby increasing the confidence of lenders. Finally, the overall prospects of individual businesses will be more influential than the general economy, as will the skills and experience of management. Therefore, in summary, 2014 may well be the year of the MBO with historically low valuations, high availability of funding (at low cost) and overall economic confidence on the ascent. Matthew Willmott

3 Preparing for sale the importance of the management team and other intangibles? This article addresses some of the areas to consider when preparing for a sale, as these are factors which can either impact value or give comfort as to the future performance of the business. It is important to consider this well before (at least two years) the potential sale to ensure the business can realise its maximum value. It is also important to consider these areas from the buyer s perspective. Management team A substantial proportion of the value of a typical SME can reside in the owner/management team. This tends to decrease the value of the company itself as the acquirer is unlikely to retain the exiting shareholders for any substantial period of time. Shareholder value is always maximised in a company where the shareholders are not critical to its management, and it has developed a strong second tier management team. This is a key aspect of many of our grooming exercises. Although investment in management and structures can decrease profits in the short term, the reduction in time required by, and reliance upon, the shareholders: has a significant effect on the value of the business; expands the range of potential acquirers; eases time pressures on any exit; and allows the owners more time to properly explore their exit options. The importance of the management team on value cannot be overstressed: it doesn t just add value it may make the company sellable and we have seen several examples where a company had no real external value as the management team was so dominated by the shareholders. Diversifying customer and supplier bases Over reliance on a single customer or supplier both increases the risk of a company itself (and hence depresses its value), and exposes the company to the additional risks of those customers/suppliers. It is also difficult, particularly in the current economic climate, to turn away business from your larger customers, but such concentration can prove fatal to exit plans, and such decisions must be taken in knowledge of this downside. Improving management reporting systems Having access to current financial results and future budgets and forecasts minimises the chances of any surprises during the sales process. It also ensures that the business can be presented (and valued in line) with the most recent results - important for any valuation based on profit in a growing business. The provision of accurate and timely accounting data will also help reduce costs in the disposal process, and provide assurance that adequate financial controls and systems are in place. The value that good quality financial projections can add to the sales process cannot be underestimated, both in increasing the number of buyers and exit value achieved. They focus the buyer on the future potential of the business. Finally, you should make sure your tax affairs and documentation are upto-date as this gives assurance that the acquirer will not be inheriting any unforeseen liabilities. Nick Woodmansey

4 Due diligence through the looking glass Starting with the end in mind, what is expected from a due diligence exercise is a report that focuses on the client s key issues (be they buyer, funder or vendor). Below I look briefly at one aspect essential to all due diligence assignments, communication, and then touch on an area that has been the focus of attention in most due diligence assignments I have been involved in recently - the financial projections. Communication The due diligence process should start with a meeting with the purchaser or funder to fully understand their motivations for entering into the transaction and, specifically, their assessment of key areas (e.g. IP ownership or customer contracts) and perceived risk areas. For vendor due diligence we look to put ourselves in the shoes of the buyer. The information gleaned at this meeting combined with initial research on the target enables us to set out a framework for the assignment. This will then allow a tailored due diligence information request to be prepared and agreed with the client before being issued. This will also ensure the report appropriately addresses the key areas and implications of any findings. This clear communication is essential to ensure any issues are properly understood. We structure our reports in a tabular format, highlighting the key matters in an executive summary which: summarises the key issues identified (in order of priority); describes the implications of any findings to the client; and where practical, provides suggested actions to mitigate the risks. Projections: here and now Unsurprisingly, in most cases a buyer or funder will be interested in the future prospects of the business they are acquiring or investing in. Whilst history can be a guide to the future, our work in this area will include a review of the projections and budgeting procedures. We have found it is not uncommon for owner-managed businesses to lack structure and reliable projections/ budgetary information. At best, this can delay the due diligence process, at worst, it can have a significant impact on the likelihood of a transaction progressing. A due diligence investigation into the projections will include reviewing the: Underlying assumptions are these reasonable for the business and justifiable? Accuracy of historical forecasting were previous years projections in line with the actual results, and are the reasons for variance understood? Mathematical accuracy are there any mathematical errors in the projections? As we have said in previous articles in Funding and Transaction News, there are other benefits in businesses producing projections and monitoring performance against these we would advise owner managers to consider directing resource to this area, even if they do not think they will be entering into a transaction just yet. In some instances, there are even subsidies available to assist businesses getting these in place. Nick Tippett M&A a view from the front lines: five themes for 2013 into 2014? (A synopsis of an article written for the WMN Deals Review January 2014) I collated the views of leading Corporate Finance Advisors of themes from Distilling this to five themes, some of which are interrelated, gives an indication of what 2014 might bring: 1. Increased deal volumes Overall, according to the majority of the local advisors, there seems to be a consistent theme about a significant improvement in business confidence built on the recent economic news. This is then feeding through to increasing volumes and pipelines for deals for From Francis Clark s perspective, we also see 2014 as having the potential for significantly increased deal volumes, based on the number of potential exits needed for the plethora of deals completed in that have been unable to exit in their more normal 5 to 7 year time-frame. 2. Increased availability of deal funding We continue to see more sources of debt and equity finance as well as wider availability of funds from traditional banks and equity funders. 3. More realistic vendor and purchaser expectations Vendors are perhaps tired of waiting and feel growth from here will be steady but is unlikely to be spectacular, so they might as well look at exit now in other words things have recovered enough to explore options. We are now seeing realistic expectations from purchasers and vendors, although deferred terms are still a significant part of this. 4. Due diligence to the fore When compared to the pre-crash M&A market of 2007/8, deals are still taking longer to complete as the trend for detailed and comprehensive due diligence by buyers continues. This is generally accepted as the new normal by sellers in our experience and is driving some innovative deal structures. The caution still in the market, which is unsurprising given the events of the last six years, is seeing more time spent on due diligence and, indeed in some transactions, clients reluctant to commence work on the acquisition or investment documents until the due diligence is largely completed. 5. Need for good advice and focus on key issues As one advisor summed up: it has never been more important for advisors to assist their clients to take a commercial stance on non-key issues to move the deal forward. It is also vital that all advisors work collaboratively together to ensure completion does occur and in a timely manner. Mark Greaves

5 Holistic approach to fund raising sets Sub10 up for bright future The investment managers at the Business Growth Fund have impressed the Corporate Finance team at Francis Clark since their inception with their pragmatic approach to potential investments. It was pleasing, and maybe not surprising, therefore, that when BGF s first investment in a business in Devon and Cornwall was completed it was with a Francis Clark client: 2.5m investment in Sub10 Systems, a specialist designer, developer and vendor of class-leading millimetre wave ( mmw ) wireless solutions for mobile telecoms. We have worked with the Sub10 team from day one. During this time we have advised on many aspects of the business, in particular, adopting a holistic approach to help Sub10 raise funding from a number of sources, including grant, bank and equity. For the next stage in its development, BGF always seemed like a good fit for Sub10 and this is perhaps explained by reference to quotes from both parties post investment: Stuart Broome, co-founder and CEO of Sub10 said: Our vision is to develop the smallest, bestin-class mmw wireless solutions that are cost-effective and userfriendly. There was a real gap in the market for Sub10 s product.... The BGF investment will enable us to invest in research & development and develop our range of wireless products, recruit staff, increase sales & marketing spend, and will provide additional working capital so that we can continue to grow the business. We looked at a number of financing options but having spent time with the BGF team, we feel confident that they are the right fit for us and look forward to an extremely bright future together. Ned Dorbin, senior investment manager of BGF, said: Sub10 is a relatively young company and it is growing rapidly as a result of the work of an extremely experienced management team and their ability to carve out a niche in the expanding mmw wireless solutions market. BGF s long-term equity finance is well-suited to technology companies investment plans, especially where the company is growing like Sub10 and where the business case often works best over extended time periods. We are delighted to be investing and are also very pleased to be backing such an ambitious team and an innovative South West business. We echo Ned Dorbin and hope that this is the first of many such companies from this region in which BGF invests. Ned will be outlining BGF s offer at our forthcoming Finance in the South West and Finance in Cornwall events. David Armstrong Finance in the South West and Finance in Cornwall events Finance in the South West (26 February) is fully booked and Finance in Cornwall (13 May) is getting bookings despite invitations not having been sent out yet. These statements are testament to the popularity of the events which are aimed at disseminating information on various funding and business support initiatives potentially available to SMEs in the region. The format of these events is we think unique with the fundholders themselves making short, sharp presentations to give an overview of the fund/support they can provide. The presenters are then available for one to one questions/ networking during the morning. We are thankful to the presenters who give up their time to speak for 6 minutes. More details of the events can be found at: francisclark.co.uk/news-views/events/

6 Grants Reflections and projections After a relatively stable grants market, the upcoming period is likely to be transitory. I will touch on the second point later, but firstly it is worth reflecting on recent achievements and, in particular, the impact a grant can have on a business. In the 12 months to November 2013, the grants team assisted South West businesses in raising c 12m of grant offers. However, from a more economic perspective, the impact is more far-reaching than this figure alone; in particular it will: assist in leveraging 36 million of additional investment; create over 840 new jobs; safeguard at least 640 jobs; and impact more than 10 sectors directly. These are just the highlights and do not consider the more intangible/ linked elements of supply chain, high street spend and export potential, but it seems reasonable to conclude that the total economic impact stimulated by a grant cannot be overlooked. So, what does the future funding landscape look like? Some schemes, such as BIG (Cornwall) and the Assisted Asset Purchase Scheme (across the country) remain open. The Plymouth and South West Peninsula City Deal is due to open soon and, on a larger scale, round 6 of the Regional Growth Fund direct applications will go live in the summer. Looking further into the future the visibility is a little more cloudy. The investment programmes for the European Funding, totalling c 600m across the two Local Enterprise Partnerships in the South West, are being worked on, but in reality, whilst some schemes may open during 2014, all elements will not be fully operational until There seems to be a desire to move away from a substantially grant-focused offering to more debt and equity based schemes. An introduction of this nature makes sense and should have a longer term, revolving economic impact on the region, but only if the right mix of product and terms is developed to meet the demands and needs of the businesses in the region. Additionally, there are bound to be further government (UK and EU) guidelines which will need to be considered to ensure the products match the market. Furthermore, the on-going cost of running such schemes, particularly whilst we still live within and feel the effects of an austerityfocused public sector, has to be a factor. We will keep abreast of all developments and disseminate this information via our regular events and blogs etc. but, for now, it seems reasonable to conclude that the stimulus a grant provides can be considerable. David Bullen Please visit our website for your local office expert FRANCISCLARK.CO.UK If you would like to be added to, or deleted from our mailing list, please contact Martin Anderson martin.anderson@francisclark.co.uk or sign up online at: Francis Clark has seven offices in the South West: Exeter Plymouth Salisbury Taunton Tavistock Torquay Truro Francis Clark LLP is a limited liability partnership, registered in England and Wales with registered number OC The registered office is Sigma House, Oak View Close, Edginswell Park, Torquay TQ2 7FF where a list of members is available for inspection and at The term Partner is used to refer to a member of Francis Clark LLP or to an employee or consultant with equivalent standing and qualification. This publication is produced by Francis Clark LLP for general information only and is not intended to constitute professional advice. Specific professional advice should be obtained before acting on any of the information contained herein. Whilst Francis Clark LLP is confident of the accuracy of the information in this publication (as at the date of publication), no duty of care is assumed to any direct or indirect recipient of this publication and no liability is accepted for any omission or inaccuracy.