It is more likely than not that a sale and purchase transaction of a small or medium-sized business involves at least one party who is negotiating such a transaction for the first time. In Spain, the business for sale is often family-owned. The buyer may also be a foreign company seeking new markets, possibly taking advantage of a relative lack of sector consolidation. Many inexperienced buyers, however, continue to sign up to deals without a good knowledge of what they are taking on and from a weak negotiating position.

In any business transaction, it is crucial that, short of jeopardising the deal, as much time as possible is taken to understand the issues and to get a feel for the target business. This will be particularly important where the seller is not used to corporate transactions or does not have experienced advisers.

When considering a business acquisition, it is also important to understand how the business has been run in the past. Many buyers of small or medium-sized businesses in Spain can expect to find tight cash control, little debt and a fairly risk adverse business strategy. Very often there will be opportunities to create synergies, to open new markets, or to introduce new technology and systems, but it is not often that much can be done in the way of cost-cutting.

An essential aide to negotiating with a seller is to understand their objectives and key concerns. Both formal and informal meetings always provide an essential source of information to complement legal and financial documents. Post-deal celebratory dinners are all very well, but of greater importance are informal occasions before reaching any agreement; these are good opportunities to get to know the management team and a relaxed seller will often drop key information into a two-minute conversation over coffee.

It will still be significant challenge, however, for the buyer to assess the business’s current and future profitability. An assessment of ‘normalised’ earnings is an essential part of acquisition due diligence, especially where the acquisition price is determined by a function of profitability or cash flow. This is particularly important in the context of family-owned businesses or where there are significant related party operations. A potential buyer in Spain should also be aware that the format of financial accounts can be difficult to understand, and comes without cash flow statements, which are not required under Spanish accounting legislation.

Management accounting information of smaller businesses is often poorer than most buyers hope to receive. Furthermore, financial and administrative personnel tend to have little or no influence on the strategic direction of the business. However, a lack of clear management accounting information in many smaller companies is not only an issue of cost. It often reflects the fact that management, and owner-managers in particular, have a long-acquired in-depth knowledge of their business and seem to have an innate feel for quantitative information. Added to the fact that financial projections and budgets are often either rudimentary or non-existent, this further emphasises the need to spend quality time with management when considering an acquisition.

When analysing business performance drivers, a buyer should identify key employees and relationships. It may be that key management or employees should be tied into the business through earn-out mechanisms or other incentives. Similarly, a buyer in Spain should be aware of the possible existence of freelance workers, who, as well as being important to the business, may essentially be quasi employees: although they have no employment contract, they may be deemed under Spanish regulations to have a labour relationship and thus be eligible for significant redundancy pay.

Tax contingencies will be a key concern of most buyers. Although it is true that these may be both significant and hard to quantify, a buyer should keep an open mind and consider tax contingencies in the context of the transaction as a whole. Options to reduce inherited tax risks should be explored, such as the acquisition of a business and assets rather than a legal entity, or the establishment of an escrow account to cover future liabilities.

Ultimately, when buying a business, a commercial decision needs to be balanced against the financial, tax and legal situations of the target. A prudent buyer should always ensure they are negotiating from the best possible position by doing proper due diligence and taking time to understand not only the business, but also the seller and their objectives.

Jeff Singer
Partner – ILV SILVER

July 2007