Whether intended as a stand-alone entity or as a launch pad for group expansion into the Spanish market, there are many advantages of buying a business over setting one up: you will save time, the business will normally have established customers, a known brand in the Spanish market, stable supplier relationships, and experienced employees; you will be in a better position to project future results as the business will have a history of performance; you may be able to bring improvements, create synergies and increase profitability.
But is the asking price too high? And are there hidden risks and liabilities that might come back to haunt you? At least with setting up a business from scratch, you know exactly where you stand.
We like to use the analogy of a fruit tree. A fruit tree grows, gives fruit (or not!) and eventually, dies. It doesn’t matter what shape the tree takes, or what type of fruit it produces, it has certain requirements for it to be able to bear good quality fruit and to continue bearing fruit. Just like a business.
To be comfortable that these requirements are fulfilled, and that the price you will be paying for a business matches its future earnings capabilities, you will need to ask some pretty searching questions.
To explore some key areas of due diligence analysis that can assist your decision-making process, let’s have a look at an Orange Tree.
Quality of Earnings’ analysis
Your tree may bear fruit, but how good is that fruit? Does it look sweet and juicy, or is it bitter and dry?
– Due diligence procedures will analyse the true profitability of your target business, taking a sceptical view of the profit figure reported by the seller. Potential adjustments to profit can be highly significant to the buyer: a €1 drop in the reported profit of your target business can often mean a renegotiation of your purchase price by €4, €5 or more.
At ILV SILVER, we use our experience of Spanish accounting policies and practices, in addition to well-aimed questioning; if we believe further analysis is required, we roll our sleeves up and get into the detail.
Profitability analysis and asset review
How strong are the branches that bear the fruit? Can the branches grow and produce even more fruit in the future? Procedures typically performed by ILV SILVER include:
– An analysis of the profitability by business line. What are the key profit-generators? Which business lines are under-performing?
– A review of the balance sheet of your target business and review the sustainability of its assets (its ‘income-generating units’). Do they need to be replaced? What capital expenditure will be required in the future?
– A review of the employees of the business. What is the employment cost history? Are there any key employees?
The results of these procedures will help you decide if any pruning may be required post-acquisition: do the least profitable branches need to be cut away for the business as a whole to flourish?
Identifying potential show-stoppers and assistance with price negotiation
The fruit tree may appear firmly-rooted, but is it? Can you really tell if the tree’s roots will be strong enough to nourish future yields?
– Due diligence analysis may unearth tax, legal, labour or accounting obligations that may not, at first, be visible. What areas of weakness does the business have? How might these affect future earnings growth? Are there any tax liabilities? Does the business have legal title to its assets? What liabilities come with the employees?
– A good due diligence review will help you value the business and negotiate the price. Does the trading history reflect strong customer and supplier relationships, and a well-known brand name? What should the value of goodwill be? Are the projections realistic?
At ILV SILVER we can help you to decide if the business’s foundations are strong enough to provide for future growth, or if the tree might fall down at any moment.