Surviving Due Diligence

First Published July 2013

Although the term “Due Diligence” (DD) applies to any investigation prior to signing a contract & can even apply to a duty of care process, it is most commonly used in respect of the evaluation carried out by a potential purchaser, before an acquisition or significant investment.

 

It takes many forms but is normally carried out by the purchaser directly, by reporting accountants & or by the purchaser’s solicitors. There may well be the need to involve other professionals, possibly including IT consultants, property professionals, environmentalists & or an almost endless list of possibilities, depending on the complexity of the businesses. Professionals in each speciality are often employed by both parties, asking the questions, providing responses, evaluating answers & asking follow up questions.

 

The process is costly, almost always invasive & normally stressful for both parties to the transaction. Not only is it true that most potential transactions fail, it is also true that most transactions fail during due diligence. Getting it right, which means effective & quick, is important to both sides.

 

Top Tips for a Successful Outcome

 

Sellers need to prepare early. Preparing your business for sale not only includes profit & value maximisation but also includes preparing the responses & marshalling the data for those questions which it is possible to anticipate. You can’t predict everything, but you can predict the obvious & can prepare the data, trace the supporting documents & explain the anomalies before the DD process has started, thereby reducing time scales, reducing stress levels, impressing & supporting the purchaser’s confidence levels & improving the likelihood of success.

 

There is no such thing as a “light touch” due diligence. At some point in almost every transaction, the purchaser will tell the seller that they have instructed the professionals to carry out a “light touch” DD. But it never happens. Even if the purchaser actually does ask for a light touch, the professionals involved have to worry about their professional negligence insurance & will place pressure on the purchaser to allow them to carry out an extensive investigation & however well intentioned, most purchasers will follow the strong advice given by their advisers.

 

Choose your professional advisors carefully. This tip is important for both purchasers & sellers. Almost every professional adviser will claim that they are experienced in DD work, although many aren’t. Always ask questions & seek examples of previous work. Expect a firm to have specialist partners & if they don’t, wonder how much DD work they get involved in. Meet the other members of the team, as it is they that are doing most of the work & interfacing with the other parties in the transaction. As well as ensuring that the advisers are experienced in DD, ensure that they are not too big for the scale of this transaction – you will save money & improve the likelihood of a successful outcome.

 

Respond quickly, respond accurately & document everything. Not only does the DD process help the purchaser to maintain (or even improve) confidence that they are doing the right deal at the right price, the answers will have a direct impact on the wording of the Share Purchase Agreement & in particular, the warranties & indemnities. Wherever possible, you should also take notes & then confirm all conversations with a written record.

 

Manage the professionals. Again, this is equally important for both purchasers & sellers. If properly chosen, the professionals firms should be experts in their field, but are unlikely to be experts in your field. Equally, the professional people that are asking the questions & possibly preparing the responses are likely to be more junior & less experienced than you might expect. Many of the questions will reflect their lack of experience & lack of understanding, as will many of the answers. Even when the questions are “sensible” & the answers accurate, there is lots of opportunity for the professionals to misunderstand the responses or misinterpret the implications. Both purchasers & sellers need to keep a close eye on their respective advisers, to anticipate “ill advised” questions, clumsy answers & mistakes in interpretation. Check everything & don’t allow the often understandable mistakes to get in the way of the transaction.

 

Love the other side. Every sales process that involves an extended gap between agreement & completion suffers from a phenomenon called “buyer remorse.” Well known to both new car sales personnel & estate agents, the purchaser begins to regret the decision to buy & these feeling of remorse are exaggerated by the length of the time scale involved. With a company sale, the room for buyer remorse is exaggerated by the extended time scales, by the DD process & by any changing circumstances, whether it be the target, the purchaser,  the market or the economy that is changing. Whilst the purchaser is experiencing “buyer remorse”, the seller may well be experiencing “seller remorse”, a phenomenon that probably only occurs with sales of personal property, be it a house or a business. When you add in the particular invasive issues around DD exaggerated by the commitment to fulfil the DD process whilst continuing to manage a business, it is little wonder that seller remorse is such an important issue in every transaction. The solution is for both sides to meet often, empathise with the other’s issues & look to resolve problems before they become barriers.

 

Hang Tough. Most transactions experience problems & any issues are exaggerated when they are applied to family businesses where the emotional attachments are that much greater. By keeping the focus on the end result, a business that has been professionally prepared for sale & which is fully supported through DD will come through & realise real value for the vendor & for the purchaser

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Bob Drew is a Commercial FD with over 30 years’ experience in business. Having bought several businesses & sold a few, Bob has lived through a significant Exit when a large family business was sold to a private equity firm. The above Tips are borne of experience – they are not lifted from a text book.

Exit Planning Top Tips

First Published May 2013

1] Focus on your desires and objectives. For many entrepreneurs, this means balancing your wishes for yourself, for your family, for your employees, for your business and in many cases, for your customers and/or suppliers. This is a tough call and will probably take considerable time. Various people might need to be consulted, not least your professional advisers who may be able to help shape your thoughts and aspirations. The team at FD eXcel have considerable experience with exit planning and will be able to test your aspirations and assist you in clarifying your thoughts.

2] Start Now! The earlier you start, the better placed you will be in achieving your aspirations. It’s a long process and the sooner you start the earlier you will be ready. Whether it’s a sale or a transfer within the family, every exit specialist will tell you that companies that plan early are more likely to complete and more likely to achieve a higher price and/or a more tax efficient solution. The FD eXcel team are happy to engage early.

3] The Plan is critical. Why will the business grow? Why will it not decline when you leave? Why do you win in the market? In short the business needs a business plan that explains where it currently sits in the market, where it is going, how it is run, what threats it sees and what opportunities it will exploit…. A key part in establishing the value is a solid financial plan but this is underwritten by a quality business plan that explains the key assumptions. Too often there are numbers and tables with no plan and with no plan they are just numbers & tables… The FD eXcel team are experienced in working on business plans and formulating business strategies. These sessions in themselves can add considerable value to a business.

4] Timing is everything. Economic performance and company profitability tend to follow cycles and the trick is to time a transaction so that you hit the top of the curve. But you are often not in control of events. The 2008 banking crash brought many a well-planned exit to a halt, either by damaging value or by the impact on funding. And even without a global economic crisis, the right buyer might appear at the wrong time or an unforeseen health issue might undermine the best laid of plans. The team at FD eXcel appreciate the constraints on time and will be able to react at speed and are equally aware of the need, at times, to apply the brakes.

5] Clear out the skeletons. Every business over a few years old is likely to have issues that have not been attended to. Have you complied with all planning permissions and building regulations? What about the Health and Safety legislation? And are you up-to date with all of your tax compliance? Whatever the issue, it WILL surface during due diligence! The FD eXcel team will help you identify these issues and will assist you in resolving problems and or introducing you to the appropriate experts.

6] View your business from the perspective of the other side. The negotiation euphoria is often followed by what the psychologists call “buyer remorse”. They worry that they have paid too much, about “black holes”, about future prospects, about losing staff and about post acquisition implementation? They just worry! But if you can see the world from their perspective, you can take steps to mitigate your purchasers concerns, before they become issues. The FD eXcel team have been on both sides of the fence, have suffered the buyer remorse and are well qualified to predict the areas of concern.

7] Pay down debt. Your business is likely to be valued on a debt free basis and the price is then likely to be reduced by any outstanding debt. And your buyer’s advisers are likely to value debt far more aggressively than you. The FD eXcel team can help you identify debt and if instructed early enough can help pay down or restructure debt before it becomes an issue within a valuation.

8] Generate competition. Easier said than done, but having multiple potential exit plans not only improves prices but also tends to shorten timescales between offer and completion. The FD eXcel team have many strategic connections and will be able to assist in your search for multiple suitors.

9] Choose your advisors. You probably have long term relationships with advisers that have served you well. But an exit is a particular transaction which requires a level of expertise and experience that is outside the remit of many advisers, whatever they may claim. The team at FD eXcel have “been there and done it” from where they have built a wide network of connections, all of which have significant experience within their particular areas of expertise.

10] Prepare a plan B. The stark truth is that most transactions fail. And the impact of failure can be devastating upon a business, if not planned for and managed. Clearly the FD eXcel team would prefer to see a transaction through to completion but they will also help plan for failure and assist in managing that event if the situation arises.  

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This was written by Bob Drew, a Commercial FD with over 30 years’ experience in business. Bob has lived through a significant Exit when his business was sold to a private equity firm. The above Tips are borne of experience they are not lifted from a text book.

Buying Groups – Improving Sales and Profits even in a recession?

First Published April 2013

When we started our buying group, our objective was to improve our buying terms by 2%. So we were surprised when our first tender improved purchase prices by 22% on a major product group and we achieved purchase price improvements between 10% and 20% across the other product groups. Subsequent purchase rounds improved buying terms further, improved credit terms and added significant marketing support. The returns were way ahead of what we ever expected.

My company was a founder member and we were careful in selecting colleagues who shared similar aspirations and similar business views. The founding group was made up of 4 companies, 3 of which ranked within the largest 6 companies within our industrial sector. As well as sharing the rewards we invested in a central warehouse facility which allowed us to source from overseas, in shared IT and a centralised purchasing function. As a group, we marketed together, exchanged skills and tendered for national contracts. 

Ten years after it’s formation, c15% of my company’s turnover was directly or indirectly linked to the buying group.

The buying group concept can probably trace its ancestral routes back to the earliest cooperative groups in the mid 18^th century. 

Although the Rochdale Society of Equitable Partners from 1844 is often cited as the earliest successful cooperative group, “The Cooperator” newspaper was established in 1828 and the earliest records go back to the mid 1700’s and the Fenwick Weavers Society of 1761. Whereas most of these early groups concentrated on selling and or social enterprise, the cooperative concept has developed across the world in various directions, including what is described as Retailers’ Cooperatives, where commercial organisations employ economies of scale to leverage purchasing opportunities and often pool marketing and other resources.  The Best Western hotel chain is a Retailers’ Cooperative whose members are independent hotel operators and who only dropped the cooperative description in order to avoid possible legal confusions within some US states.

Traditional buying groups operate in both horizontal and vertical markets.

Horizontal groups are not industry specific and focus upon generic services that are consumed across businesses in general. Horizontal groups tend to cover purchases of utilities, office supplies, building resources, packaging and generic professional services. At the small corporate level, many horizontal groups are independently owned, where the ownership is entirely separate from the membership, whereas in the large corporate arena ownership and membership are more likely to be aligned. According to research in the US, up to 20% of the Fortune 1000 use horizontal buying groups and reportedly receive improvements in excess of 10% on products that they source through these channels.

Vertical buying groups arise where business enterprises within the same industry come together to purchase raw materials, goods for resale and other goods and services within their industrial sector. Vertical buying groups are common within the grocery trade, electronics, hardware/builders merchants, plumbing supplies, leisure and hospitality, motor components, farming, healthcare and manufacturing. Some buying groups are independently owned whereas many are owned by their members. Some of these groups are enormous. “Today’s Group” claim to be the largest buying group of its kind in the UK with buying power exceeding £5bn although most UK buying groups are significantly smaller. “Today’s Group” are owned by their members.

As well as the normal commercial issues, buying groups have unique, but related, problems in terms of ownership, governance, finance and competition law.

In the early days of any group the founding members are more likely to concentrate on the practical issues and pay scant attention to the organisation. By definition, there is likely to be mutual empathy amongst the founding partners together with a shared vision. Shares/ownership will probably be allocated equally and decisions will probably be agreed by consensus, with a genuine incentive to compromise so that the project can be taken forward. Initial funding is likely to be shared equally with an agreed objective of getting the suppliers to pay the running costs by way of rebate or improved invoice prices. And little thought is likely to be given to competition law.

As the group grows, the opportunity for disagreement increases. Decision making tends to be by ownership rather than ability and there is often a tendency for decision makers to focus on the cost to their particular organisation, as opposed to the merit of the proposition. With equal funding, smaller members might be unable to fund ambitious projects. Whereas with funding linked to purchasing, larger members might reflect upon the differences in financial contribution, which might be further distorted by differences in product mix. And what happens when there is fundamental disagreement or a significant member leaves?

The legal implications are equally interesting.

In its broadest and simplest terms, it is illegal for businesses to do anything that distorts competition and which has a negative impact on the final consumer. In most cases, the purchasing process should be OK, but there is a need for caution when buying groups look at purchasing compliance rates within their membership. And additional caution is required when members start to cooperate on marketing, selling and contracting? Which, of course, is what many buying groups actually do. And extreme caution is required in terms of restrictions on membership or on member’s activities.

Buying group membership isn’t without its challenges. Members leave with possible implications upon the financial structure. New members join who may or may not share the perceived vision. Some members are fully engaged and fully supportive, whereas other members are less so. There is a tendency for secret agendas. But it works when there is a common goal and a well constituted membership agreement.

Our group produced an agreement from day one & I was responsible for drafting and negotiating a revised agreement when our largest member left, exposing operational and financial issues with the original contract. At that time, we chose to move away from a one member one vote system and to agree a voting system of my design and based upon financial contribution. It worked because we had a mature membership.

  Buying groups are not for everybody, but where they are suitable, they can have a transformational impact. Having experienced the ups and downs of a £365m turnover buying group, we have the experience to advise and guide other buying groups along their journey to success.

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Bob Drew is a Commercial FD with over 30 years’ experience in business. Having bought several businesses & sold a few, Bob has lived through a significant Exit when a large family business was sold to a private equity firm. The above Tips are borne of experience – they are not lifted from a text book.

What does the expression "Part Time" mean to you?

First published November 2012

 "What does the expression “Part Time” mean to you? Working in an industry, it’s easy to assume that everybody understands the colloquialisms or expressions that are familiar to insiders & how many industries have been handicapped by an assumption that their customers understand the basics behind the name. Subscribers to this forum undoubtedly understand the meaning of the word BLOG, but to a whole generation the word is almost completely meaningless. So what would they make of a person who is described as a blogger? 

So what does the expression “Part Time” mean to you? Maybe a mum returning to work? Or a person looking for an easy life, leading up to, or maybe post, retirement? Or maybe a person who works full time, but for a number of different people or organisations – a sort of full time, part timer, if you will! All descriptions are surely true. 

So which is it, when you see a person described as a Part Time Finance Director? Well, it could be a mum returning to work, employed for 3 or 4 days a week for one organisation & it could also be someone at or around retirement, looking for an easy life. But these days, it is more likely to be a full time FD, working part time for a portfolio of clients. The advantages to the client are many and varied. They have access to a mature, experienced, commercial FD at a fraction of the cost of employing a full time person. Most clients will already have an established accounting function and are likely to already employ a bookkeeper and/or an accountant, possibly on a part time basis. But until they came across the concept of a portfolio part time FD, the client probably thought that they couldn’t afford their own Finance Director. And as most portfolio part time FD’s operate via their own limited company, the client is also absolved from the costs of employers NI, pensions, sick benefits, holiday leave, maternity/paternity leave and company cars. 

And what is the difference between a part time FD and an interim FD? An interim tends to work full time for one client for a period of time – often to cover for maternity or to assist a client over a major project or increase in workflow. Assignments might be a number of weeks or a number of months, but after the assignment is completed, the interim FD moves on. A portfolio part time FD, on the other hand, will work for a number of clients at the same time and assignments will tend to last for many months, often years. 

So what does a portfolio part time FD actually do? In simple terms, everything that a strategic full time FD does, but on a part time basis. Staff supervision and mentoring – often including HR, IT, purchasing, pricing and other admin functions. Risk and compliance. Cash flow management. Internal controls, KPI’s and reporting. Budgets and business plans. Relationship management with bankers, auditors, shareholders and other stakeholders. Raising finance. Mergers, acquisitions and other significant projects. Exit planning. 

These days, many experienced part time FD’s are members of a group, whereby they can share skills, experiences and resources calling on colleagues to assist as the need arises. Maybe it’s an expert on Sage, a colleague with experience with buying groups, a franchise expert or maybe a colleague with experience within the angel investor market. And how many full time FD’s can say that!"
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Bob Drew is a Commercial FD with over 30 years’ experience in business. Having bought several businesses & sold a few, Bob has lived through a significant Exit when a large family business was sold to a private equity firm. The above Tips are borne of experience – they are not lifted from a text book.