[EP 263] Navigating Business Transactions: 2023 Market Trends in Business Asset Sales and Share Sales

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Richard:

Yeah. Joanna, I, I’m really wondering, um, what you are seeing in the market, uh, in terms of, um, the number of transactions that are done as, as business asset sales versus share sales. Uh, I think I’m seeing and hearing in the market that there is a, a slight increase in the number of transactions that, uh, are done under a share sale.

Um, and was keen to sort of have a bit of a chat to you about your, your thoughts around how to sort of protect everyone in that. Um, in that process in terms of ensuring that everyone involved understands the difference in value of, you know, typically as a broker, you would, appraise the value of a business based on a transfer of business assets.

Uh, whereas a share sale will, you know, still have that, that value as its basis, but, We’ll be, we’ll be a different number by the time it gets to be a share sale. And just to make sure, firstly, from a value point of view, and then from the point of view of where liability sits, et cetera.

Obviously, if you acquire an entity, you acquire all its history, uh, warts and all. And, uh, and therefore again, from a legal point of view, it’s really important that everyone has their eyes open with respect to, uh, what happens and how liability is as described. You know, pre and post-transaction, that sort of thing.

Are you seeing the same in the market? 

Joanna:

Yeah. Look, we wouldn’t say that we’re seeing more share sales than we have in the past, but we have always seen a lot of share sales.  And it depends on the market that you’re talking about. So in like the sub one to $2 million market still.

Predominantly business sales for good reason because there’s the complexity that you talk about with share sale, which is this extra body of risk that a buyer is taking on. Um, but in that $2 million-plus market, we’ve always had a, um, a large proportion of that market B share sales, and still, still the same, the over, uh, overriding reason for that.

So, so there can be. Buy-side driving reasons, sell-side driving reasons. The sell side, driving reasons are often, um, the reason for it in that sort of, in that, um, say that two to $20 million market and, and then, so far, for that smaller end of the, um, of that mid-market, it’s driven by tax considerations in particular for, for the sell side, because there can be big tax differences for sellers in a share sale versus a business sale.

Um, from a buyer side perspective, the driver for, um, buyers who are particularly after share sale versus business sale is, um, ease of transition of the value in the business. So that might be, um, there might be components of value, like, for example, client, um, client contracts, um, client panels that, um, uh, you, you know, the, the seller, uh, might have or other.

Um, other elements of value in a business that can potentially leak if you have to transfer the assets one by one, which is what a business sale, um, is all about. So, we find sophisticated buyers actually aren’t particularly concerned about share sales. It’s, it’s more, um, buyers who have, um, uh, I guess who themselves aren’t.

Um, uh, aren’t used to buying a business or perhaps dealing with advisors who have less exposure to this area, who are more concerned about share sales than the sophisticated buyers or the larger buyers. But having said that, there is no, um, it’s really important to understand. One of the things that I’ve realized, you know, in the last year or so is that, um, brokers perhaps don’t quite understand the complexity jump that happens with a share sale.

Over and above a business sale. And it, there really is a complexity jump. Unfortunately, that sort of can lead to longer negotiation period when, once you’re in contract, because we have more complex contracts generally, um, when we are in A C S L, we have, um, more, uh, a more stringent regime of, uh, warranties.

Uh, we’ve got more warranties, and then we’ve got you, you know, um, More scary sounding warranties as well in, in a share sale environment. But the reason for that is because a buyer is protecting itself against those skeletons that it’s, it’s buying and, and, you know, some of those driving things are tax or, um, you, you know, um, I guess dispute and litigation risk.

Richard:

Yeah. That sort of lower end of the market, um, where the, the sort of the bottom end of where the share sales, um, click in. Janet, are you seeing a, a, um, Uh, rep and warranty insurance being used in, uh, in completing transactions at that end of the market? I know the larger deals, it’s, it’s been a fixture for a long time, but, uh, are you seeing it applied to, to smaller deals in the, let’s say the two to $10 million range?

Joanna:

Yeah, absolutely. We absolutely are. This is new, we’ve got, um, an insurance sister company of Aspect Legal that, that does this type of insurance transaction liability insurance. Actually, you perhaps didn’t even know that in asking the question, but there you go. 

Richard:

It was a late plug for you, but I’ll, I’ll take it. Yeah. 

Joanna:

Well, thank you. Thank you. Anyway. Yeah, yeah, yeah. No, no. It’s, um, one of the reasons we have that is because I think it’s really important to, um, uh, this type of insurance isn’t for everyone. It’s not necessarily necessary for all deals, but we have certain deals where sellers are particularly risk-averse or buyers with particular concerns.

And this type of insurance can be beneficial, um, in, in those sorts of situations. But it’s, as you rightly point out, it’s, um, it has been. A feature of the mid-market deals for a long period of time. There’s nothing new there. And but mostly in those mid-market deals, you’re talking about a very large premium.

You know, I, I was talking to a broker, uh, just last week and they were talking about the last deal that they did, the, the, um, premium was $150,000. So that’s, that’s a lot to add onto any transaction. Um, but, but, um, and usually that’s buy side. So buyers will take out that. That insurance, the, the, the, the Ss m e products, um, that our insurance, uh, sister business deals in, um, deals.

It, it’s just the sell side. It’s not buy-side insurance. But that’s not to say that a buyer can’t, um, Uh, can’t sort of negotiate to have the seller take out the insurance and it still acts as, um, you know, effectively security for them in terms of having funding backing the warranties, which is of course, uh, you know, can be of concern to a buyer in relation to the protection under the warranties.

But we are looking at a much, much cheaper cost. So we are looking, you can get it down to us. Um, lowers 10 K for every mill of cover. So of course, if, if you are in a, um, and that’s for seven years cover. So if you are in, you know, um, a transaction where there’s a million dollars worth of, um, of exposure under the, um, Under the warranties, then you’re paying 10,000 for that.

Obviously, that’s a completely different cost point to our $150,000 policy. So, um, you know, I, I think it’s great for, we, we find it’s particularly useful, as I say, not needed in all deals by any stretch of the imagination, but really good where sellers have this real concern, um, about the risks that they’re taking on board.

And, you know, that can be that whole, you know, can’t sleep well at night. Um, element, you know, when sellers feel that, that they’re ex, their, their, their proceeds are exposed. Um, and, and so it’s just that I, I think it’s just a nice policy to help get over some of those hurdles in the negotiation warranties.

Richard:

Certainly sits on both sides of the transactions, doesn’t it? Uh, you know, typically at the smaller end of the market, the buyer would, uh, would see some risk in terms of being able to, um, claim. Successfully claim against a, um, you know, a warranty, uh, in, in terms of, you know, whether the money’s still there.

So it’s certainly got a valid, you know, valid place. So it’s, and it’s good to hear that it’s, um, coming down into the, um, into the, the small end. I mean, that’s what I’m seeing as well. But, you know, uh, you kind of see quite a broad, broad, broad spectrum of the market. So, yeah. Thanks. 

Joanna:

Well, it’s quiet, I think it’s exciting.

 I think it’s exciting in the market, but it’s, um, it, it’s a great mechanism as well for, you know, have those, sometimes those negotiations where a buyer wants retention or hold back and, and you know, so there’s this money that’s sitting on the table that’s frozen effectively for, you know, two years, three years, whatever the period is.

You know, this is a great way to release that, um, those funds to the seller as well. So anyway, I think it’s great. 

Richard:

And it is great development, isn’t it? It’s um, back when I was, you know, in, in my public company days, uh, the CFO roles that I’ve done, um, the transactions tended to be, you know, much larger.

And, um, a lot of the sorts of tools that we used, uh, in that, that larger, more sophisticated end of the market are finding, finding their equivalent, uh, in the, the middle market, the lower middle market, which is, which is a tremendous evolution. 

Joanna:

It is! I find it deeply. Exciting. I don’t know.

Like we, perhaps we are sitting here a bit nerdy, Richard. I don’t know, but um, yeah, 

Richard:

We’re definitely sounding like that anyway. 

Joanna:

Fabulous. 

Richard:

The only other question I had for you, Joanna, was sort of a bit of a  part of where we wandered into on the last question, which was again, around whether you’re seeing, uh, more use of at risk components in deals. I am hearing again in the market that there’s greater use of, uh, earnouts and those, those sorts of structures, uh, in deals. I, I guess it, it relates a bit to, um, you know, to access to funding, to complete deals, but also, uh, also relates to, I guess if we wind the clock back a couple of years and see what external events can, can do in terms of the risk profile of businesses.

People are, I guess, understandably looking at. Uh, potentially creating protection around the, the asset that they’re looking to acquire. So are you saying you know, more at risk components in deals? 

Joanna:

Absolutely. Absolutely. We are. Um, I would say I. More than 90% of our $2 million plus deals will have an earnout or some sort of at risk component, um, at the moment, which is astounding actually.

So almost every deal we do these days, um, will, will have a component. I mean, you know, there’s still the odd one that comes in. Um, that doesn’t, but mostly, uh, when we are talking about dealing with, with, um, sophisticated buyers, even not, um, e e even first time buyers now have found their way into the market using, um, a lot more of the, and it’s smaller deals. This is the thing that really, um, gets me. Usually it was, um, on our side, the, the larger the deal, the more likely it was that it had an at-risk component or an, you know, like an out deferred. Payment, whatever milestone, whatever, whatever it was. But, um, but I’m now seeing it, um, leak into smaller deals, um, quite a lot more than I ever had in the past.

So we used to have, you know, I feel like deal complexity has. Increased, uh, really you, you know, for the smaller deals, because there was always that complexity in larger deals. But I just feel like that, that that ex, that, uh, deal complexity for smaller deals, uh, has, you know, exponentially increased over the last few years.

Richard:

Hopefully, that’s all for good reason. It probably isn’t, as I say, my sense it’s because of a, a, a heightened perception of, you know, future risk, et cetera. Um, but I, I find, and again, just sort of seeking your thoughts, that it’s, it’s very important to work hard with all sides of a deal to ensure that when you’re structuring an earnout, that you’re, you’re creating a measure that is, Appropriate to the circumstances, uh, to which it’s gonna be applied.

Um, you know, I guess in a simple sense, looking at a revenue versus gross margin versus net margin based sort of metric and, and figuring out what is both gonna support the business, support the seller, support the buyer, uh, and, you know, be, be appropriate to the, the business at hand. Um, but it, it, it takes a lot of thought, I find. 

Joanna:

It does, it does take a lot of thought. And we, um, I’m finding that that is actually taking a much larger component of the contract negotiation these days as opposed to what it used to take, which is interesting because you used to spend the, the bulk of our time, particularly in share sales, but also in business sales over a particular transaction size in warranties and indemnities like that used to be where we’d spend.

A lot of time now, it’s almost like that bulk of time is taken out by the, the earnouts and, you know, and, and warranties, indemnities sort of sit, sit second on that, um, on that, you know, contract negotiation list. So anyway, that’s, that’s how I feel it’s sitting. 

Richard:

Oh, great. Thanks for that. 

Joanna:

Thank you for coming to the show.

It’s always a pleasure to have you, Richard.

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