Managing Partner RSM Poland
What helps and hinders the decision to take over a company?
At a certain stage of life of a company the owners may be considering its selling off. This may be due to a difficult market situation, synergies stemming from the merger with another entity, the age of the owners or their new plans for the future and the many diverse factors. Not every company, however, is in the position to be taken over. Well, maybe this is too strong a statement – any company is capable of being acquired, however, the price is not always attractive to the seller. Often one can hear about companies being bought “for a dime” and it does not always apply to companies in debt. Why is it that some companies change their owners under good conditions and others are never taken over?
The organisation of a company, as much as the industry in which it operates, affects the possibility of a takeover at a fair price. But this is not merely the case of these two.
Let’s imagine a situation where the potential subject of transaction is a manufacturing and service company – we shall call it an ABC company – which is a general partnership managed by its two cofounders / partners for 30 years. The company employs 80 people, generates revenues of PLN 80 m and PLN 10 m EBITDA annually. On the basis of these data, one might come to a conclusion that this is quite interesting a company and estimate that the price equalling 6 times EBITDA, i.e. PLN 60 m, is a good starting point for further negotiations.
A potential buyer contacts the ABC company, receiving from the controlling department general financial information and an offer for the amount of PLN 60 m as the price of the ABC company. The potential buyer accepts it as it is a fair price and a starting point for further negotiations.
After a closer look at the organisation and the ABC company's financial standing it turns out, however, that:
- The company is located in buildings which are a private property of the owners who take advantage of the rent. They live next door so the arrangement is perfect for them – they waste no time comuting to the place and are always available. Most employees live within a few kilometres’ radius from the company’s headquarters. Currently the company uses 100% of the available space and there is no possibility for expansion because in recent years the whole area was transformed into a typical residential area and the said company is one of the last manufacturing plants there.
- the owners actively manage the company's affairs. They have devoted their entire lives, working six days a week, 10 hours a day. The company does not have any other managers.
- The company is a general partnership, therefore, the remuneration of partners and their two assisting sons is not recognised amongst the company’s expenses.
- The company’s key client is responsible for generating 35% of its revenues and 45% of profits, cooperation with him/her lasts from the beginning of the company, and the owners of both companies know each other since their school days.
After such analysis, the potential buyer changes his/her mind and suggests a different amount - the owners reject the offer as unfavourable and break off the negotiations.
From the perspective of the sellers the case is, in fact, simple. The company has PLN 10 m EBITDA, the rate of 6 times EBITDA as the price of the company is justified by other market transactions in the same industry, an offer below that would indicate a buyer’s frivolous approach. But would it really?
From the perspective of a buyer, however, the matter is as follows:
- reported EBITDA is PLN 10 m.
- there is a need for adjustment of the remuneration of two hard-working shareholders and two of their sons. The buyer has estimated the adjustment at PLN 750 thousand.
- It reduces EBITDA to PLN 9.25 m.
- The buyer has taken into account that after the takeover of the company he/she will want to increase its production by at least 50% – the current location does not allow for it. The costs of relocating the company equal PLN 1 m. In addition, please note that the seller will not be pleased to accept the decision to relocate, as he/she will lose the rent (and as far as we know, at present there is no other option for the use of this space).
- Relocation may also cause employee turnover, as they will have to commute to work by cars or public transport (40-50 minutes one way instead of a few minutes’ walk as it is currently). The buyer has estimated the costs associated with the turnover at PLN 1 m.
- The buyer has also spotted the risk of losing the key client which he/she has estimated at 40%. Therefore, he/she has adjusted EBITDA by 60% of the part generated due to the cooperation with the key client, i.e., of the amount of PLN 4.5 m. The adjustment was, therefore, PLN 1.8 m.
Based on the above findings, the buyer has made a takeover bid for the amount calculated as follows:
- reported EBITDA: PLN 10 m.
- reduced by the adjustments in the amount of PLN 2.55 m, which included:
- PLN 0.75 m – adjustment for the undeclared salaries of partners and members and their families,
- PLN 1.8 m – adjustment due to the risk of losing the key client.
- goodwill, calculated as 6 times EBITDA, has amounted, therefore, to 6 * (PLN 10 m-PLN 2.55 m) = PLN 44.7 m.
- In addition, the goodwill has been reduced by the adjustments of:
- PLN 1 m – the cost of company’s relocation,
- PLN 1 m – the cost of employees’ rotation caused by the relocation.
Ultimately, the buyer has estimated the initial value of the company to equal PLN 42.7 m, i.e. over 28% less than it has been declared in the seller’s accounts. The original offer was rejected due to the fact that the ABC company turned out to be unprepared for a takeover.
From the perspective of the transaction itself, the following issues have turned out to be a significant burden:
- Concentration - the key client, responsible for 35% of revenues and 45% of the financial result.
- Too close bonds between the company and its owner as much as its former manager:
- Lack of other managers,
- The company located on a private property of the owners,
- The fact that the owners live on the same property,
- Informal relationship between the owners and their key client
Although the issues concerning the need for relocation of a company and proper EBITDA arrangements are entirely secondary and can be established in the course of negotiations, the concentration, however, is a huge risk and binding the company with its former owner on too many levels makes it difficult for the new owner to manage the company properly after it has been taken over. The new owner would have to change the location, appoint a new management board, help his or her staff get accustomed to the new place, recruit and train new employees in the place of those for whom the changes would be too much, etc.
These are precisely the factors causing the fact that the ABC company is not a perfect company to be taken over. At least from the perspective of a potential buyer.