Save on consulting: Case on the sale of the company to a foreign investor. How to prepare for a merger and acquisition transaction on your own?
A well-known manufacturing holding company, with a market share of 20%, wanted growth. High competition in the industry did not facilitate fair mergers. Domestic competing enterprises expressed interest in the merger, but already during the preliminary negotiations, it became clear: they did not plan to buy part of the business, but to learn internal information. The only option was to attract a foreign investor and combine competencies and expectations.
Standard steps for selling a business include the following:
- Pre-sale preparation of the enterprise. A financial analysis of the company is carried out, risks are assessed, a preliminary sale price is determined, a sale strategy is developed.
- Determining the circle of potential buyers, preparing information on all possible issues.
- Preparation of a package of investment documents: description of a business model, retrospective indicators of financial and economic activity, description of key customers …
- Conducting a road-show or attracting investors in case of placement of shares on the stock exchange (IPO).
- Checking tax, legal, financial aspects (due diligence) before concluding a contract.
Each stage is a complex set of procedures and actions, including a huge number of questions and work. Undoubtedly, it depends on the size of the enterprise, in our case we are talking about big business, with an annual turnover of more than $ 400 million.
Protection of information
Foreign investors are very cautious about buying a Russian business, do not tolerate haste. One careless movement or poorly prepared information can stop the transaction, so each stage must be worked out very carefully.
As a rule, such procedures are completely trusted by business brokers or consultants who accompany the process of buying and selling a business . The price of such services is always quite high, depending on the amount of work, the cost of the object, problems solved in the process. Not every business owner is willing to spend such substantial cash on such a procedure.
The shareholders of my company, performing most of the work by the local team, pursued the main goal – to protect the company as much as possible from leakage of information about financial and other indicators. The issue of security was given great importance. In addition, the business owner was deeply immersed in all methodological and technical issues; it was easier and faster for him to work with his employees.
Audit services: why buy them?
To start a conversation with a foreign investor, you need a common language that both parties understand. To implement the first stage – pre-sale preparation of the company – it was necessary to “translate” the financial and economic language of the Russian company into international, that is, transform the accounting statements into IFRS or GAAP.
Saving on the auditor did not make sense, on the contrary, it was safer to use the services of reputable audit companies included in the top 5 in the market. Not a single foreign company will question such a report – which means that the money spent on its preparation is not guaranteed to disappear.
What other benefits will IFRS reporting provide?
- To prepare the opening balance sheet in accordance with IFRS, it is necessary to make a market valuation of all tangible and intangible assets at the balance sheet date, which reflects their market value. This means that these data can be used for initial business valuation .
- IFRS reporting maximally reflects the real financial position and effectiveness of the company, so the owner will see a real picture of his business.
- Data on the market value of assets can be used to start negotiations with investors.
We used the asset valuation report twice – for the opening balance sheet in accordance with IFRS and a second time – to start negotiations with foreign investors.
Foreign investors viewed the creation of a partnership with our company as a real and less risky way to enter the Russian market. They saw their way as follows: the acquisition of a stake in a Russian enterprise, and subsequently the creation of a joint venture. In this case, the product should have corresponded to the specifics of the foreign investor.
Three approaches to business valuation
Of course, we prepared information for negotiations to our shareholders, considering the value of the business as a profitable approach, both costly and comparative. Each of these approaches has both strengths and weaknesses.
Let me remind you that in the assessment, in accordance with the Federal Assessment Standard No. 1, three main approaches are used:
- Comparative. This is a set of valuation methods based on obtaining the value of the valuation object by comparing the valued object with peer objects. A comparative approach is recommended when reliable and sufficient information on prices and characteristics of analogous facilities is available for analysis. In this case, both transaction prices and offer prices may apply.
- Income approach – a set of valuation methods based on determining the expected income from the use of the valuation object. This method is recommended to be used when there is reliable information that allows you to predict future income that the valuation subject is capable of generating, as well as expenses associated with the valuation subject. As part of the income approach, various methods are used based on discounting cash flows and capitalizing income.
- Cost approach – a set of methods for assessing the value of the valuation subject, based on the determination of the costs necessary for the acquisition, reproduction or replacement of the valuation subject, taking into account depreciation and obsolescence.
There was little information for a comparative approach at that time, or rather, it was completely absent. Therefore, we decided to use profitable and costly methods. The profitable approach, for all its popularity, has alerted foreign investors. They asked us a lot of questions:
- How accurately are cash flows calculated? What is the guarantee of achieving their size? How to check and compare the revenue in retrospect and the plan for the next five years?
- Why is the planning period five years?
- What risks does the discount rate include and why exactly them? Are they measured correctly?
- How sensitive is Net Present Value to changes in cash flow settings? What about a change in the discount rate?
- According to what accounting standards of accounting is cash flow calculated according to RAS or IFRS?
The list goes on and on. The problem is that there are still no practical answers to these questions that could be applied systemically. Practical foreigners suggested considering the value of the business as the market value of fixed assets and intangible assets – registered trademarks and brands, which were also valued for inclusion in the opening balance sheet. An important point: the company owned well-known brands of products, the estimated value of which included goodwill and the company’s reputation.
The difficulty was that the valuation of fixed assets was made today, but at the date of reporting under IFRS, that is, three years ago. It was agreed with investors that our company’s employees will develop a mechanism to index the market value of assets to the value at the date of the proposed transaction. Of course, the results of the impairment test were taken into account in accordance with IAS 36 “Impairment of Assets”. In accordance with this IFRS standard, it is necessary to conduct this test annually, which assesses the impairment of assets of an enterprise.
An asset impairment test is carried out annually, and its result should take into account the impact of impairment that has occurred or will occur in the near future and having adverse effects on the company, in the technical, market, economic or legal conditions in which the organization operates or in the market for which the asset is intended. For example, the emergence of new technologies and the release of more advanced types of equipment can adversely affect the value of assets. An impairment test is also performed for intangible assets and goodwill.
We developed a coefficient based on official inflation data, annual depreciation of each unit of fixed assets, their income and retirement, capital investment price indices based on average normative ratios for types and groups of fixed assets, as well as for periods of their acquisition, statistical revaluation indices for types of fixed assets and sectors of the economy and industry.
Investors for an independent assessment of this methodology invited the Russian branch of the audit company included in big-4. The result of this work was a report approved by both parties, which was subsequently adopted as the basis of the transaction price.
The project, from the start of negotiations with auditors on the joint preparation of the opening balance sheet in accordance with IFRS to due diligence, took 11.5 months.
- The minimum presence of external consultants, trust in the work of a team of internal employees – not more than 10 people with a total number of employees of about 3,000 people – adds value and quality to the process and result and saves money.
- The deep immersion of the owners in the subtleties of the process, the establishment of a rigid, but real time frame for the implementation of all stages of the project rallies and motivates the team.
- Serious internal advance preparation of the enterprise, top management, careful formation of the project team – significantly saves project implementation time and guarantees the result.
- Transformation of reporting from RAS standards to IFRS standards – takes into account the interests of investors, indicates invisible problems of the company and can be the basis for assessing the market value of assets.
- Preliminary calculation of business value in different ways: comparative, profitable, costly – prepares owners for negotiations and sets the range of future prices.