ANYONE regularly involved in M&A activity will have often deliberated over the valuation of privately owned businesses. After all, valuations are used to facilitate change whether for succession, an exit route, merger or acquisition.
These valuations are based not simply on the profit generated by the company, as other factors such as market position and intellectual property often play a decisive role in the underlying value of a business.
When two parties enter into price n
egotiations, there will almost inevitably be a gap between how much the buyer is willing to pay for the business and the vendor's price expectations.
What is perhaps surprising, however, is that the "value vacuum" can be so significant that talks between a willing buyer and a willing seller can end before they have really started.
In the recent experience of Anderson Anderson & Brown (AAB), many proposed transactions have not proceeded because vendors have unrealistic price expectations from the outset. In some cases, this is not a major problem because the principals are happy to continue running their own businesses, but in other scenarios, in which the vendors are keen to exit, it can make the difference between disposing of the business at a fair price and not being able to dispose of it at all.
If a private business owner is considering selling their business, they will pose the question which is utmost in their minds to their closest allies: "How much is my business worth?" The only guarantee is that there will be little consistency amongst the responses, which in itself is not surprising because business valuations are highly subjective.
The grave danger for vendors is if they receive advice from people they trust, but are uneducated in the specifics.
The harsh reality is that an "off-the-cuff" remark at the local pub on a Friday night may just leave a lasting impression in the vendor's mind and turn out to be a deal-breaker. The advice for vendors, of course, is to consult an experienced corporate finance adviser who will be prepared to challenge their value expectations.
That does not mean that an agreement will be reached between the buyer and the seller, but it does increase the chances of a fair price being agreed between the two parties.
AAB have completed a significant number of transactions this year involving oil and gas service companies, and this reflects the high degree of confidence that currently resides in the industry, but this does have a knock-on effect in terms of vendors' price expectations.
The problem with this, of course, is that the historical trading performance of these businesses does not often support the value expectations, and hence some potential purchasers find it difficult to raise the level of funding required to complete the transaction.
This does not apply to trade buyers who can derive significant benefits from the acquisition of highly complementary businesses and are willing and able to pay strategic premiums.
However, a common feature among smaller service outfits is that many, over a number of years, have been run as "lifestyle" businesses and as such are of no real interest to trade buyers.
Conversely, these lifestyle businesses typically have strong cashflows which support the MBO and MBI business models in which debt finance is prevalent, and this presents opportunities for MBO and MBI teams if the vendors' price expectations are realistic.
However, we have witnessed a distinct lack of MBO/MBI-type opportunities in 2006, and this would seem to suggest that vendors are holding out for the "big-ticket" sale to the trade player.
Overall, the fundamentals of the M&A market are looking good, with increasing levels of confidence and hungry trade buyers with cash to spend, but the warning to owners of smaller service companies is that they may not achieve their exit objective if they have unrealistic price expectations and get sucked into the "value vacuum".
• Mike Brown is head of the corporate finance division of Anderson, Anderson & Brown
The full article contains 689 words and appears in The Scotsman newspaper.
