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by Barrie Pearson - Wednesday, 29th August 2007

When expanding your firm, be careful to ensure that you are enhancing a potential exit, not destroying it.

Acquirers are generally not interested in buying a "mini-conglomerate" and more importantly, some entrepreneurs don't realise they have created one.

The owners of an IT business came to see me recently with what they thought was a highly saleable "IT group."

The turnover was £10m, it had excessive overheads in the form of several directors, and three divisions consisting of a retail "box shifter", a maintenance business and a small software design consultancy.

All the divisions relied upon management input from the directors and, as such, were unsuitable to be sold separately. The owners were shocked to discover that their chances of selling the business in the foreseeable future were, let's say, slim.

We were able to show them how to develop the business towards achieving an attractive sale within the medium term.

The ideal company to sell is a niche business. But as we have established, high profits do not necessarily make for a great sale.

Take a rental firm specialising in one product. The person responsible for its success and high profits - and as such the key to the whole organisation - is the owner-manager.

Quite probably, the rest of the staff are merely warehousing, despatch and admin.

Without that key person, the business would quickly perish.

Thus, no larger competitors would buy the business and the possibility of selling to a management buy-in team would be difficult.

A common hold-up is a seemingly routine Inland Revenue PAYE investigation. Why? Because such an investigation can take up to a year to resolve.

It's tempting to think that because the acquirer will insist upon comprehensive tax indemnities, he will be relaxed about the situation. Not so.

Even if a purchaser was to proceed with the acquisition, there is every likelihood that he would insist on buying only the assets and the business, rather than the share capital.

Not only does this leave you, the vendor, with the tax problems, but it invariably means you will end up paying more capital gains tax.

If you're a vendor, don't start talking to prospective purchasers until you've reached complete agreement with the Inland Revenue.

And beware significant litigation. Most acquirers will delay the sale of a business until any disputes have been resolved.

In one recent case, a company was very dependent on patent protection in the US; however, a serious challenge was mounted by a major competitor. The uncertainty would have delayed the legal completion of a deal, so the two parties had to hold fire - for a long time.

Some entrepreneurs create bonus schemes for senior executives which will be simply unacceptable to a purchaser.

Take the example of the sales and marketing director who was paid a substantial annual bonus directly related to sales, regardless of whether or not the business had made a profit.

The arrangement dated back to when he was the sales director and personally instrumental in winning orders (which was no longer the case). The purchasers informed the vendor, in no uncertain terms, that they would want to negotiate a different incentive scheme with the sales and marketing director. Otherwise, no deal.

It's also not unusual for an expanding private company to create a new subsidiary and to allow the managing director to acquire a minority equity stake.

This is fine, until the time comes to sell the group.

Purchasers usually insist on buying 100 per cent of the equity.

It will be left with the vendors to negotiate the purchase of minority shareholders in subsidiaries - and an individual shareholder can sometimes hold the vendors up to ransom.

In one recent case, nine people in five different subsidiaries hold minority equity stakes. The vendors are trying to agree a formula to buy out the minority shareholders, before talking to prospective purchasers for the whole group.

So far, they have spent several months failing to reach agreement. No wonder they turned to us for advice.

Don't think that just because you've got a great business, a great deal is inevitable. Take a long, hard look at the conditions of your company. Search for features that could hamper a sale. And if in doubt, seek advice.

Otherwise, all your hard work could be for nothing.

First published in April 1998. You can find many more of Barrie Pearson's wise words in our fully searchable archive. Just hit the Search button.

Tags: mbo, due diligence, trade sale, sale preparation,