Increasing value from business disposals

Carl Gordon

Why should a company, owner or shareholder consider selling all or a part of a business? Some of the key factors that might lead to a decision to sell include:

• Strategic investor. Bringing a strategic investor into the business can bring significant benefits to a growing business, including additional capital to help fund expansion, industry knowledge and expertise, and heightened profile in the market.
   
• Business expansion. Significant funding may be required, in excess of that which can be raised through debt financing from a businesses’ bankers, to take the business to the next level.
   
• Succession. Private companies, particularly family owned businesses, may not have a defined transition or succession plan when the current owners seek to exit the business.
   
• Non-core assets. For a company which has grown or has changed its strategy, there may be one or more components of the business that are no longer considered to be of strategic value.

Disposal values

A seller’s accounting records need to be sufficiently transparent to attract a buyer’s full confidence

Value can be lost due to a number of reasons, the main factors leading to disposals being viewed as unsuccessful by sellers are:

• Purchase price and completion accounts disputes
• Post deal completion issues
• Losing control over the disposal timeframe
• There are surprises, i.e. buyers become aware of significant and unexpected issues during the sales process.

Having a robust and credible business valuation to support negotiations and decisions is key to the process, as is the creation of a competitive sales environment. However, good planning and preparation, and setting a realistic timeframe for the disposal, are also fundamental to helping achieve transaction value and limiting the level of disruption to the day-to-day business operations.

Sellers are typically keen to shorten disposal timeframes because too long a process can prove distracting to the business being sold and its management, leading to business under-performance and value leakages. However, aggressive timetables can limit the opportunity for the necessary planning and preparation which many sellers often need to invest in. Sellers need to recognise that disposals can take a significant period of time and need to be realistic when setting their disposal timetable.

Value leakage

A range of issues may arise that typically result in expected values not being realised. In order to minimise value leakages, sellers should consider the following:

It is often difficult for corporate sellers to limit or avoid warranty and indemnity clauses as part of the sale terms. However, the risk arising from such terms may be mitigated by carrying out sufficient pre-sale due diligence to help ensure an increased understanding of the business, by providing sufficient information and adequate disclosures to prospective purchasers, and by ensuring that warranties and indemnities are tightly drafted. It is better to spend time identifying potential issues in advance and resolving them before the sale or negotiations with the purchaser. The alternative can be a long, costly and distracting dispute process.

Completion accounts disputes

To reduce the risk of value leakage the completion accounts process needs to be very well defined and carefully drafted into the sale and purchase agreement. The seller’s lawyers and accountants need to work closely together on this aspect of the transaction, in particular in determining the accounting policies to be used and how they are applied when drafting the completion accounts.

There are many advantages to the well established completion accounts process, but there are also disadvantages. For the seller the process introduces uncertainty and the risk of price adjustment, and for the purchaser it can be an unwanted distraction in those vital weeks and months following completion when the new purchaser wants to focus on the acquired business. Sellers may avoid the need for a completion accounts process by using an agreed pre-completion ‘effective date’ balance sheet as the reference point for the transaction, as opposed to a post-completion balance sheet. For this approach to work there needs to be a robust reference date balance sheet to price the deal, and the practical ability to ring fence and protect the business’ assets from the balance sheet date to legal completion.

In Vietnam this position may be further complicated by seller’s accounting records being of poor quality and by the absence of audited financial statements. These issues can be addressed through adequate pre-deal planning, including the completion of audited financial statements, prior to the sale process commencing.

In order to mitigate this risk, sellers should perform separation planning and more detailed assessment of the impact of the disposal on the seller’s retained business prior to marketing the business. For example, planning may be required regarding the preparation and pricing of transitional services, supply and other agreements in advance. Historically many sellers have left the drafting of transitional service agreements until after the signing of the sale and purchase agreement, even after completion.

Pre-sale due diligence, provision of information

Insufficient preparation can result in an uncomfortable experience for sellers and their advisers as even small issues can cause chaos in a disposal process. It is difficult being on the back foot during sale negotiations and being faced with awkward surprises because a prospective purchaser has carried out its own extensive due diligence and developed a better understanding of the business and the value drivers.

The earlier preparatory work is carried out in the process, the more time the seller has to develop potential upsides and to address downside issues in advance of the transaction.

Another aspect of pre-sale due diligence is the use of “vendor due diligence”. This is where the seller commissions an independent due diligence assessment of the business being sold and the resulting report (the “vendor due diligence report”) is provided to potential purchasers. We are seeing, this approach being used increasingly throughout the ASPAC region in recent years.

Sellers need to recognise that disposals can take a significant period of time and need to be realistic when setting their disposals timetable.

Aggressive timetables can limit the opportunity for necessary planning and preparation, which we assess as one of the main keys to delivering a successful disposal.

Sellers are keen to shorten disposal timeframes. Long disposal processes are a distraction for the business being sold and for its management, which can often lead to underperformance of the business and value leakage. However, experience indicates that sufficient time should be built into the timetable to enable adequate pre-deal planning and preparation.

How to increase value from disposals

Key considerations:

• Perform sufficient pre-deal planning and preparation, including the preparation of audited accounts and identification of potential upsides and issues
• Prepare a compelling sales message
• Create a competitive sales process
• Provide as much information as possible to potential buyers, allowing for commercial sensitivities, to allow bidders to understand the risks and put a value on potential upsides
• Provide a useful data room clearly focused on key value drivers, commercial and legal matters and purchasers’ anticipated areas of concern
• Ensure that information provided to potential purchasers is consistent and robust
• Prepare an appropriate sales and purchase agreement
• Minimise the level of warranties and indemnities.

(The views expressed by the author do not necessarily represent those of KPMG.)