When Nash works with privately owned SMEs on a sale of their business, a common question we receive early on is, what will the offer look like? Will they buy my business and also buy my business assets(stock, debtors, plant and equipment etc)? Or is it just one number all up?
At the heart of this question, there is a difference between how sophisticated buyers and unsophisticated buyers structure offers. I will describe who these parties are shortly.
Many of our clients have had their own experience of acquiring a small business and how they structured their offers. Typically, the offer is to buy the assets of the business at book value, plus an amount of goodwill where the business is delivering strong financial returns. Naturally, based on their own experience, clients can assume that this is how an offer will be structured for their own, substantially larger business. However, with larger transactions, the structure of the offer is usually different.
In Australia, most business sales under $5m are conducted as asset sales.
The sum of a business's tangible and intangible assets are assigned a value, the total of which is the purchase price. The business itself has not been purchased, rather the assets within it that are required to run operations, are acquired. The business then continues to operate under the new owner and under a new company.
Why conduct an asset sale?
The main reason that small transactions are conducted this way is to save money on legal and tax due diligence expenses. This is so any historical liabilities will stay with the corporate entity and will not be responsibility of the new owner. A small business being acquired by an unsophisticated buyer, may have offers put forward that value the assets of the business and the goodwill they are willing to pay.
Who is an unsophisticated buyer?
Firstly, we use this term in a non-derogatory way. An unsophisticated buyer is simply a wealthy individual or a small business that has no previous experience in large corporate transactions. It is not a commentary on their skill sets, they may well be elite at managing a business. These types of buyers are typically buying businesses at lower valuations and are capital restricted.
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Who is an sophisticated buyer?
Sophisticated buyers are large corporate companies or private equity firms that have substantial experience in conducting larger transactions (usually north of $20m). These types of buyers think about acquisitions differently and these transactions are more commonly conducted as the sale of shares in a company.
What might a sophisticated buyer look for?
- The total return on capital they will make from conducting an acquisition.
- The earnings of a business
After this, they can determine a Total Enterprise Value for the business based on what they consider to be an acceptable return. For example, for a business making $4m profit before tax, a basic offer may look like “we value the business at $20m on a cash free, debt free basis and assuming a normal level of working capital”.
In the mind of sophisticated investor, they have determined that if they outlay a total of $20m of capital, $4m in pre tax profit is an acceptable return. The qualification of ‘cash free and debt free’ means the value would be adjusted down, if the company has any external debt (or up if they have cash). The qualification of ‘a normal level of working capital’ means that business needs to be delivered with sufficient working capital to operate normally post-acquisition. It is important to note that in this scenario $20m is to total price paid, there won’t be any additional payment made for the assets of the business, it’s all-inclusive.
Whilst this concept may take some time to get used to, it is important to understand. If you are selling a sizeable business for the first time, there is nothing inherently fair or unfair about either methodology of submitting an offer. A good corporate advisor will effectively explain all elements of an offer and the financial and non-financial impact on the client.
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