The M&A market in the UK is still experiencing significant slowdown. But, done right, it can be a vital way of generating some serious growth
It hasn’t been a great year for mergers and acquisitions (M&As) in the UK. News just last month that the number of UK firms making acquisitions – both domestic and international – had hit a record low hardly shows our M&A sector as being in the rudest health. Small- to medium-sized enterprises (SMEs) also took something of a knock this year when it was announced in April that M&As among the nation’s smaller firms had fallen by 18%. It’s understandable that confidence may still be somewhat shaken in the UK but, given the economy is gradually pulling out of recession, the low M&A activity within our borders is certainly unusual.
Trying to point to a single concrete cause of the M&A slowdown isn’t all that straightforward but there are some definite factors influencing SMEs’ abilities to acquire assets in the current environment. First of all, as has already been mentioned, confidence is king in these areas. “That’s still thin on the ground,” comments Paul Maberly, general practice partner for chartered accountants Mercer & Hole. “I think, for people to go out and buy new assets, they have to believe their order book will grow; they need to think confidence has returned and it’s not quite there.”
Another issue is the lack of capacity for debt-based lending by the banks. “There’s no bank debt for businesses to do acquisitions,” says Garret Turley, partner for Sustainable Growth Funds at venture capital (VC) firm Bridges Ventures. Regardless of the current economic picture, the large banks still have significant commercial property debts and are being forced to maintain higher capital buffers. He continues: “At the same time they’re being encouraged by the government to lend more money and these two things can’t go together: they simply don’t work.”
This means that it’s very difficult for SMEs to secure funding on a debt basis unless they have particularly strong cashflows. “Unless people are generating earnings before interest, taxes, depreciation and amortisation (EBITDA) of more than 20% turnover, they can’t fund it through debt,” explains Tim Walker, director at specialist IT service provider Taylor Made Computer Solutions.
With plenty of M&A experience of his own as a serial entrepreneur, Walker also thinks people may be misguided with regards to which benchmarks they use for healthy M&A figures. The period from the early 2000s up until 2007 was a particularly deal-hungry period and encouraged a lot of deals where the rewards didn’t match the prices people paid. “People’s valuation expectations are just not matched with what is fundable,” he says. “Unless you’ve got very strong recurring revenues – and by really strong I mean 80% plus recurring revenues – the valuations are very solidly in the four to six times EBITDA range. A lot of people think their businesses are worth ten times EBITDA, when they simply aren’t.”
However, that’s not to say finding funding for acquisitions is unachievable. “It’s possible if you’ve got access to asset-backed finance and there is VC or venture capital trust (VCT) equity available for the right deals,” explains Maberly. “That’s been driven recently by the tax breaks that were announced last year; they’ve really come into play this year, now that VCs and enterprise investment scheme (EIS) funds have actually got substantially more cash than they had 12 months ago.”
Also, as the underlying economic conditions start to ease, the freeze on UK acquisitions will almost certainly begin to thaw, a sign of which we are already beginning to see. News released at the close of June 2013 demonstrated that acquirers in Europe made some significant gains on the M&A market and it seems inevitable that this increased confidence and reward is replicated within our shores.
“We’re probably at the start of the cycle and have returned to the start of an upward trend, albeit a slow one,” says Turley. “And, as that gathers pace and confidence returns, banks will lend more money, margins will improve and there will be more reasons to grow.”
Just because an enterprise can afford to carry out an acquisition, however, it doesn’t necessarily mean it should rush out and do so. Turley feels that sometimes a deal can be driven by ego, boredom with the status quo or even trying to cover for a struggling balance sheet. He explains: “I have seen this in a couple of cases where the business looks at itself and goes, ‘Things aren’t looking so good; how do we make it look better? How do we obfuscate the message?’”
Despite this, there are clear benefits in acquisition over organic growth. “You’ve got the synergy of savings, hopefully,” comments Maberly. “You’ve got potential bulk buying, increased market clout, increased credibility in the sector. You can diversify. You can grow at a faster pace.”
But the real value comes when there is a mutual benefit for all the assets involved in the deal. “If it’s just a one-way street, it could be argued that an organic growth strategy is more appropriate,” says Turley. He recalls an acquisition he was involved in last year where the acquirer wanted access to new geographic regions, bringing in professionalised management, as well as better structures and sales practices. But, in return, it was able to reintegrate all of the knowledge and expertise its purchase had gathered and strengthen its own position in the process. He comments: “You’re definitely looking for integration rather than subsumption.”
And this integration doesn’t come at the close of a deal; it needs to be worked into your strategy from the off. “You’ve got to have a very clear plan from the outset about whether your cultures are going to match and, if not, what you’re going to do about it,” says Walker. One of the most vital areas of integration that needs to be meticulously planned is how you are going to make use of and retain key knowledge holders within the business. “You almost need to engage with and work with those key people, if you can, during the process prior to the business being acquired.”
Sometimes it can be easy for senior management to spend so much time looking at the bigger picture that they miss some of the detail. “They are very much on the high level,” explains Turley. “They will say, ‘This is our strategic vision, this is what we’re going to achieve and this is how we’re going to do it; let’s do this acquisition’.” But this means a lot of the actual work delivering that will fall to middle management and time needs to be taken to work through the details with these key members of staff. Turley continues: “You need to have that planned, nailed down to a really granular level of detail running across all aspects of processing, IT, HR, marketing, sales, whatever it is, and that is such an important bit. Without that, you’re doomed, which is why so many acquisitions fail.”
Maberly also strongly concurs with the idea that your focus needs to be as much on what happens after a purchase as anything that comes before it. “As a firm, we’ve done eight acquisitions over the last 15 years or so, and the key is actually the post-acquisition process,” he says. “Most of the celebrations happen on the day of the deal but that’s a bit premature. Really, they need to focus on what happens after the deal’s done.”
So if M&As in the UK are going to pick up and really start adding value to our enterprises again, it’s essential that SMEs know where they’re heading in the months and years after a deal is struck.