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Posted: 31.01.2020

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Based on over 200 deals and 30 years experience, this countdown of articles crystallises the complex transaction of selling your business into ten golden rules. You will only sell your business once and have one chance to get it right!
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#Six

MIND THE GAP

This might appear a very obvious golden rule but it is critical, at a very early stage, to be crystal clear on what any offer really means to you. Understandably, the first number that appears in any offer letter will be the highest it could possibly be – do not be seduced by clever wording

You need to clearly understand the gap between headline consideration and the actual cash you will receive on completion. Cash on completion is the only amount you can be guaranteed of receiving (subject to any warranty claims), as any other form of consideration will have an element of risk attached to it, to a lesser or greater extent

Deferred consideration, earn-outs, retained or rolled over stakes are obvious “gaps” which clearly need a detailed review, but there are some common but less well-understood adjustments that are often made to the headline price

Basis of Offer

Nearly every offer letter is based on being ‘debt-free and cash-free, subject to a normal level of working capital’ and it is important to understand the implications of this apparently straightforward statement. In short, any debt will be deducted from your consideration but you will get the benefit of any surplus cash

From the outset, you need to be crystal clear on what any offer really means to you – the devil is in the detail

Debt

Debt is a reasonably well-understood term and clearly includes loans, overdrafts and usually asset-based lending, but what about other items such as corporation tax, deferred tax and “debt-like” items? Debt-like items can include property dilapidation provisions, capital creditors, extended payment terms, underinvestment in capital expenditure and warranty provisions

Cash

Cash is clearly just cash but may not all fall within the strict definition of surplus cash. For example, a buyer is likely to want to deduct payments in advance from customers or deferred income/revenue from your actual cash balances

Deferred income/revenue is a very common issue when dealing with managed service businesses which operate on a subscription model. Many will involve annual payments in advance and a buyer will seek to time-apportion those payments and argue that the amount relating to the period post-completion is not yours and therefore not included in the price – this should be resisted

Net Working Capital Adjustment

Debt and cash are typically fixed as at the time of completion but due to timing (of say tax payments, payroll runs, etc), they may be at an usually high or low level. There is a well-established “in principle” mechanism to normalise these balances called the “net working capital adjustment”

The principle behind this adjustment is that, when a business is sold, it is delivered to the buyer with a normal level of working capital, typically defined as stock and debtors less creditors (although the definition needs clarifying, especially when dealing with overseas buyers). Keeping it simple, a normal level of working capital is typically measured by reference to the average over the last 12 months (a typical trading cycle) and to the extent that is different to actual working capital on completion, an adjustment is made (which can be either way)

A good corporate finance adviser will look beyond the headline price alone and immediately prepare a schedule reconciling headline price to cash on completion and assess the reasonableness of those estimated potential adjustments. This will also flush out any areas for clarification and negotiation

An offer that appears too good to be true often is… the devil is in the detail

Thinking of selling in the next five years or simply want an informal chat over a coffee then the team at Provantage Corporate Finance would love to hear from you

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