By Richard Firth, Partner, Park Place Corporate Finance
A number of recent reports have confirmed that both M&A volumes and business valuation multiples have fallen over the last 18 months. For instance, both the Argos Index ® and MarktoMarket’s sub £250m index cite a 24% fall in business valuations since the record highs reported in 2021.
These record high valuations followed a sustained period of favourable conditions for shareholders buoyed by a decade of cheap finance and the resultant influx of cash flows into private equity funds.
To wait or not to wait?
The fall in headline valuations, and a recent revival in speculation over Capital Gains Tax increases, pose a conundrum for private company shareholders considering realising value. If other timing factors are seemingly right – encouraging business performance, apparent buyer appetite and shareholder desires/needs – are business valuations likely to rebound?
Whilst each sector and indeed business will have its own drivers and relevant factors, valuation multiples are now more in line with historical averages and so it is unlikely we will see a significant resurgence in the near term.
Take for example, the case for a typical private equity-backed buyout. Financial returns from such deals are directly linked to the financial engineering that comes with leverage. As more of a company’s cash flows are absorbed by higher interest rates, debt serviceability is constrained and so the appropriate leverage multiple drops. If a PE house can raise less debt, its ability to benefit from financial engineering is curtailed. A buy-out that may have supported 4x leverage may now be more suited to 2.5x-3x. This loss of deal funding limits PE’s ability to bid up for businesses and so softens market valuations generally, be it trade or PE.
Whilst a fall in interest rates is largely expected to follow, this is modest in the context of the decade of cheap finance driven by exceptional economic circumstances.
Specific areas for unlocking value
The importance of taking advantage of other value opportunities becomes increasingly important and understanding deal mechanics beyond headline price becomes paramount for would-be sellers and their team of advisors.
The more technical and contestable elements of agreeing purchase price, such as the negotiation of the equity bridge – i.e. the gap between the headline offer and the actual share price – and agreement of completion mechanics, are easily overlooked. However, sellers who neglect to fully prepare for and engage with these topics risk leaving significant value on the table.
At Park Place we regularly see 5-10% of shareholder value up for reasoned debate between buyer and seller via different interpretations of cash and debt-like items, working capital normalisation and the approach to recognising taxes. Whilst the basic principles and mechanics behind such calculations are tried and tested, there remains a high degree of subjectivity and the specifics vary from business to business.
A series of mini price haggles
Just as revenue is often referred to as vanity and profit sanity, the same can be said of headline price and shareholder proceeds – at the end of the day it matters little how the bottom line has been reached, but that is ultimately the amount of value realised, not the headline price.
Whilst there are obvious debt items to be deducted from headline price, the treatment of items such as lease costs, dilapidations and deferred income is far less clear. Equally, assets such as tax credits, recent significant spend on capital expenditure and deposits can lead to meaningful increases against headline price. The same can be said of working capital adjustments – such as the treatment of aged debtors, creditors and stock – and the normalisation reference period – i.e. the decision to refer to a period which is backwards, forwards-looking or a hybrid of the two?
The breadth of views and direct transfer of value between buyer and seller on such points creates fertile ground for extreme, partisan positions and resultant buyer vs seller negotiations. The fact that the detail of the equity bridge is often only truly flushed out in later stages of the SPA often means that such transaction issues coincide with the more keenly fought battles in the SPA leading to increased tension and fragility in the deal process.
The devil truly is in the detail and knowing where to look for and how to handle cash/debt and net working capital matters is fundamental to a successful outcome. As a minimum, an experienced and aligned advisory team provides a strong defence against opportunistic behaviour but invariably will also lead to a more favourable position for clients and increased deal certainty for the advisory teams.
For specialist advice please contact richardfirth@ppcf.co.uk
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