Getting exit ready

Guest Blog

6 months ago

Multiple signs are pointing to an increasing momentum around M&A activity. If you’ve been holding out for better conditions to sell your business, now is the time to make sure you’re exit ready. Taylor Wessing’s Emma Danks, Suzy Davis and Siobhán Langwade outline key areas of focus and practical matters

After record highs in 2021, global M&A activity in 2022 and 2023 fell significantly, both in terms of deal volumes and deal values (with different sources recording varying degrees of the proportional drop, but some reporting up to half year-over-year). Though disappointing, this is understandable given the impact of macroeconomic factors at play, including: a sharp increase in interest rates (after many years of sustained low percentages), geopolitical uncertainty and conflicts, supply chain disruption, soaring energy prices, and high inflation.

All of these factors combined to suppress market confidence, leading to a drop in multiples which resulted in valuation gaps between sellers’ expectations and what buyers were prepared to pay (particularly given the stark contrast within certain sectors to the multiples that were being achieved in 2021).

From early on last year, where sellers had the ability to exercise discretion, many were opting to wait until market conditions improved. As the year passed, expectations for when those improvements would materialise kept being pushed out. Now (at the time of writing), at the end of Q1, it doesn’t feel like we are on the precipice of a ‘floodgate’ M&A moment. But green shoots are emerging and market momentum is building:

Stabilising interest rates: though the US Fed declined to cut interest rates in March, it indicated that three rate cuts are coming this year as it expects inflation to continue cooling. Similarly, the Bank of England has indicated that there will be cuts to interest rates if inflation continues to fall – it is now at 3.4% in the UK¹, the lowest level in almost two and a half years. While we shouldn’t expect interest rates to drop back to where they were in 2021, the general consensus in the market is that we are past the peak. As the debt markets stabilise, buyers (particularly private equity sponsors) who rely on debt to part-fund transactions can put greater reliance on what the rates will be in the coming months and adjust their models accordingly.
Political change: countries making up about half of the world’s GDP are holding elections this year. The threat of a change in government within the UK has, in the past, driven deal activity because of a fear of changes to tax rates (especially to capital gains tax (CGT)) or general uncertainty as to what the future would hold. That is not the case for the current impending election (the outcome of which is generally being treated as an inevitability) and it does not seem to be driving or stunting deal activity. Labour’s statement that it has noplans to raise CGT is likely salving sellers’ jitters. The geopolitical turmoil that may ensue following the US election outcome is of greater concern – but any fallout from that is likely to be less immediate.
Supply chain re-establishment: while there are still ripples of disruption flowing as a result of the war in Ukraine, the initial shock factor has passed. The various supply chain issues have started to settle, companies have found alternative sources of goods or components, the increased costs have been passed on to customers and the spike in energy prices exacerbated as a result of Russia’s invasion has eased as markets rebalance.
Record amounts of dry powder: after several years of burgeoning fundraising rounds, private equity investors are sitting on over $2tn of dry powder² which needs to be deployed. The drop in the number of assets coming to market, and the deal-doing hesitancy of the past couple of years, means that capital is burning a hole in sponsors’ pockets.
Aged investments: private equity sponsors have held off on bringing assets to market pending improvements in market valuations and are reportedly sitting on a record 28,000 unsold companies worth more than US$3tn, globally³. The pressure to sell these aged investments and return capital to their investors is building. Furthermore, investors need to demonstrate their ability to deliver returns in order to raise further capital.
Consolidated platforms: the lower end of the market has been less suppressed over the past couple of years. Companies have taken the opportunity to ‘buy and-build’ by acquiring complementary businesses to supplement their offering. Those that have effectively consolidated and integrated operations will have increased their overall value.
Future-proofing: all businesses are looking at megatrends like AI and climate change, and working out how their models and plans need to change to future-proof their business whether organically or via acquisitions.

While we can anticipate an uptick in deal-doing activity, there is still a general hesitancy hanging over the market. Buyers have had time to reflect on the (at times, hasty) decisions they made two years ago and are likely to re-enter the market with greater caution. We can expect diligence to be more thorough, additional time taken to consider and assess the risks, and less vulnerability to getting swept up in the excitement.

That means sellers who have undertaken a fulsome vendor due diligence exercise, spent time getting their house in order and focused on, and can clearly articulate, what value their business can provide to a buyer, will be a much more attractive acquisition target for buyers. That will facilitate a much more efficient sales process and minimise the risk of process-failure.

Who’s looking to buy?

There are three types of buyer who are going to be most active in the UK market:

Private equity: private equity buyers will be, and are, looking to make acquisitions. With the stabilising of interest rates and record amounts of dry powder to deploy as discussed above, private equity buyers will be keen to put their funds to work.
Strategic corporates: trade buyers’ acquisition goals can vary, but typically include: securing new technological capabilities and integrating assets and operations with a view to realise costs or other synergies; gaining new customers, talent or intellectual property to enhance market position; expanding product lines and offerings; and/or accelerating growth in new markets. Trade buyers often make acquisitions for strategic rather than purely financial reasons, however as discussed earlier the stabilising of interest rates and the availability of aged investments will likely reignite their acquisition focus.
US buyers: US buyers will be looking at the acquisition market for reasons similar to strategic buyers. Coupled with the relative strength of the US dollar and the perceived discount at which UK targets trade relative to their US peers, this means we will see increasing amounts of US acquirers taking an interest in UK companies, in particular ahead of this year’s US election.

Are you exit ready?

If you have been considering a sales process, and assuming you don’t have a functioning crystal ball to tell you when the best time to sell will be, the best we can advise is to ‘be ready’. It’s a time-consuming process to collate the necessary financial, tax, commercial and legal information required for a sales process and that needs to be balanced with ensuring sufficient time is dedicated to continuing to run the business.

Legal due diligence

Here are a few of the key areas that you will need to focus on in terms of the daily business activities to get exit ready and ensure a smooth transaction process:

Commercial contracts: ensure you have formally documented, and signed, contracts with commercial counterparties (such as suppliers, customers, agents and distributors). Familiarise yourself with the termination and amendment terms, and whether they require notification to the counterparty of potential M&A transactions. Do they permit your counterparty a right of first offer or refusal if a buyer takes control of the company? Are there any material/key agreements which are coming to the end of their term or have been terminated, which would impact the company’s value?
Intellectual property, know-how, trade secrets and brands: can you evidence that the company either owns, or has the right to use, any IP necessary and/or relevant to the business? Also, confirm whether you have measures to manage and protect these assets from infringement or unwanted onward disclosure, and if not, consider whether such measures should be implemented.
Disputes: monitor, assess and manage actual and/or potential disputes and investigations to minimise their impact on the value of the business. Resolution of a dispute before the sale process begins may not be possible but it’s important to conduct a proper assessment of relevant risks and to maintain clear records of decision-making processes.
Employment: maintain good employee records, eg by regularly updating the company’s policies and employee handbook, and ensure detailed records are kept of any disciplinary and grievance procedures that are undertaken.
Contractors and self-employed workers: do you have documentation and working practices in place to reflect the correct status of any independent contractors or self-employed workers (as misclassification presents a number of risks)?
Immigration: do you have proper evidentiary records that your employees have the right to work in the jurisdiction they work in?
Options: where tax-favoured options (eg enterprise management incentives or company share option plans have been granted and will be exercised in connection with a transaction, buyers will want to see that the company has followed HMRC rules and guidance in granting such options and operating the scheme. Any failures in this respect can affect, or result in the loss of, CGT treatment and/or other tax-favourable treatment for option holders, with their option exercises instead being subject to income tax and national insurance contributions on the full gain.

Transaction-specific considerations

As well as preparing for a due diligence process, there are a number of practical matters you will need to consider in order to get a deal over the line:

Regulatory approvals: the global regulatory framework is multifaceted and becoming more extensive:
- Antitrust/competition: regulating businesses to avoid a market dominance and preserve competition has been an element of M&A for many years. There are more than 100 countries with merger rules based on turnover, market share and asset tests. Analysis will need to be undertaken to determine whether your transaction will be caught or (subject to who the buyer is) may be caught.
- Foreign direct investment (FDI) and national security: an increasing number of jurisdictions are implementing some form of FDI or national security regime, requiring transactions to be notified to regulators. Furthermore, several are now refining and adapting their requirements as their understanding of the application of the rules to transactions in practice changes.
- Regulated businesses: those businesses whose activities are regulated will typically need consent from, or a notification will be triggered to, the relevant regulatory body in the event of a transaction. This will depend on the nature of the transaction, the rules of the body and the conditions attached to the authorisation.
Shareholder communications: particularly relevant for a share sale, the timing for when to communicate the details of the transaction (and even the fact a transaction is proposed) is a delicate balancing act when there is a wide shareholder base. Enough time will need to be given to allow sellers to consider (and get advice on) the proposed terms of the sale and the negotiations will need to be sufficiently well progressed for the terms to be explained. If there are any shareholders with whom the company has not maintained contact, or with whom there has been past animosity, this can further complicate the process, both in terms of when and how to send the communications, and whether they will sign and deliver the documents necessary to implement the transaction.
External lenders/debt providers: if you have any third-party lenders, it’s likely that their consent will be required for the transaction or the transaction will trigger a repayment obligation. Buyers typically expect an unencumbered asset to be delivered by the sellers, and co-ordinating the repayment of debt, the release of security and completion of the transaction to the buyer requires careful orchestration.

Help is at hand

An M&A transaction can be complicated, time consuming and daunting if it’s an unfamiliar process. We are here to help you get exit ready. We’ve released a new ‘Exit Guide’ which distils our experience from countless deals to help companies prepare and successfully navigate an M&A sale process. To get a copy, please get in touch.

Notes

For more information contact

Emma Danks
Partner
E: e.danks@taylorwessing.com

Suzy Davis
Partner
E: s.davis@taylorwessing.com

Siobhán Langwade
Partner
E: s.langwade@taylorwessing.com

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