Andrew Rose, Director of Vantis Corporate Finance, provides expert comment on how to steer your business through a merger or acquisition
There comes a time when many a professional services firm has to consider seriously a merger or an acquisition to ensure the ongoing development of the business.
Professional service firms, be they lawyers, chartered surveyors, accountants or similar, will at some stage receive unsolicited approaches which can be assessed at the time on a reactive basis. In this article I intend to focus on the steps which need to be taken to manage your business through a merger or an acquisition on a proactive basis. If the objective is, as it surely must be, to achieve the best possible deal, then it is essential that senior partners of the practice seriously commit to preparing the business in advance for such a merger or acquisition.
The reasons why a professional services firm reaches the point that a merger or acquisition becomes an appropriate next step are many and varied. We, at Vantis, have significant experience of advising such firms in this situation and have significant personal experience gained through Vantis’ own mergers and acquisitions. The most frequent reasons which we have seen for such a move are:
- For many firms client retention becomes an ever increasing problem, in the sense that as clients grow they require an ever increasing range of services and over an increasing geographical area. If you cannot provide these services you run the risk that your client will eventually transfer their business to one of your larger competitors. There are many examples, but an obvious one is where a national firm is unable to provide a standard service to a client operating on an international basis.
- Staff retention is an equally key issue for all professional firms; people are a professional firm’s key asset. Lose them and your business can be irreparably harmed. International and large national professional services firms have the ability to offer varied career paths to satisfy and retain key employees. It is not always so easy within small and medium sized firms. The key question for such firms is how to incentivise employees to stay. Let’s take a small practice with a small number of key employees and look at the career options for these staff. On the basis that they are ambitious then there will come a time when they will demand to be made a partner or else they will leave. The dilemma for the existing partners is, do they dilute their profit share and retain the employee, or do they let that person go and recruit a more junior employee. In the latter situation, it can mean the partners investing a significant amount of time to train the new employee at a time when the partners are looking to spend less time on the day-to-day activities of the business. It can be a stark choice. From a merger or acquisition perspective a dilution of the profit per partner ratio can also make the business less attractive as many acquisitive firms use as a bench mark the profit to partner ratio to assess suitable targets.
- In many cases the pending retirement of the senior partners can trigger a desire for a merger or acquisition. The senior partners may well have been with the firm for the majority of their careers and now the firm is faced with their pending retirement within a relatively short time scale. This may be coupled with the fact that the firm may face a succession issue as the junior partners do not have the requisite experience for managing the practice.
In all probability there will be no single reason which triggers the decision to seek a merger or an acquisition but a combination of a number of reasons. It is not an easy decision for the senior partners to make and will, in all probability, have been in the senior partners’ minds for some considerable time.
Once a decision has been made that a merger or an acquisition of the business should be explored more fully then the first step, in conjunction with your adviser, is to take a long hard look at the business and identify the key issues which need to be addressed before such a merger or acquisition is consummated. The cleaner and tidier the business, the more attractive the business becomes, which should result in a wider range of suitors to choose from and at a more attractive price!
The key to a successful merger or acquisition is preparation, preparation and preparation! I cannot overstate this as good preparation ensures control of negotiations, maintains the other party’s confidence in the integrity of the business and will ensure the best terms are achieved.
Let us now have a look at some of the issues which a business can face:
- I have already mentioned that the retention of key partners/employees may be a reason why a merger or acquisition is being considered. It is wrong to assume that the only key employees are partners. In many firms it is the “rising stars” - those that are aspiring to partnership, who are key to the firm. It is absolutely essential that their aspirations are planned for carefully, as nothing can de-motivate a person more than to see his/her career aspirations taken away. It is essential that their career opportunities will be enhanced by a merger or acquisition and this needs to be factored into the equation. It may also be appropriate to offer employees a loyalty bonus or, if possible, make provision for them to participate in either a profit or equity share scheme.
- Capital participation in the proceeds of sale or merger may well be an issue that needs to be addressed. Do not assume that the profit share for each partner will, or should, be mirrored, in the split of the equity pot. The partnership agreement may well detail such apportionments but in many cases this is not the case, and the desires of all the partners will have to be managed to avoid the green eyed monster from disrupting negotiations.
- Tax is a matter that needs careful consideration if the tax consequences of a merger or sale are to be minimised. In particular we are seeing more and more professional services partnerships restructuring themselves as Limited Liability Partnerships (LLP). Prior to the introduction of these vehicles in 2001, the only limited liability vehicle available was a company limited either by shares or guarantee. An LLP offers a number of advantages over a limited company. These are primarily tax-related and include the following:
- A single level of taxation: partners are taxed directly on their share of profits and capital gains of the business. Compare this to a company, with corporation tax on the profits and gains, and further tax suffered on drawing these profits out of the limited company. This is particularly valuable for professional services businesses which often receive an earn-out in the form of extra equity which, if taxed directly in the hands of the shareholders, may attract a very low tax rate (e.g. 10% under the new Entrepreneurs' Relief).
- Flexibility: changes in partnership share can be effected tax-free if there is no adjustment through the partners' capital or current accounts. Hence partnerships have traditionally been used for professional services firms which see incoming and outgoing partners on a regular basis.
- Dissolution: We recently saw an LLP structure used in a merger of businesses, where flexibility was required to be retained for a possible later de-merger. Bringing the businesses together under a limited company would have required more complex arrangements to effect a subsequent demerger..
Care is required if restructuring an existing business into an LLP, because this can trigger tax liabilities. As ever, appropriate advice should be obtained.
Having worked in the accountancy world for many years, I have come to realise that “culture and fit” do mean something to employees, especially when the firm you are working for is being taken over. This is a matter which needs to be considered and will greatly assist when profiling potential merger or acquisition candidates to determine an appropriate and suitable fit.
In conjunction with identifying and managing these issues in the preparatory stage, it is important to identify suitable merger or acquisitive candidates. Such companies can be categorised as follows:
- Merger partners of equal size;
- International or large national firms;
- Foreign firms with no UK presence.
Profiles of these companies can be prepared based on publicly available information, which can identify their service lines, financial strength and their track record of merger and acquisition activity.
This split can be refined, but quickly allows the appeal of such firms to be determined and highlights whether they have the potential to satisfy the issues which have triggered this process. In addition we, as advisers, would also be looking to have a no-names conversation with these companies’ decision makers so that discussions can be limited to a number of potentially interested parties. This can reduce the scope for leakage and rumour spreading which can quickly unsettle employees.
The additional benefit of undertaking the above profiling of potential merger or acquisition candidates, and conducting no-names discussions with them, is that you will pretty soon get an idea of the price and consideration structure they will agree to i.e. how much consideration is paid at completion and how they would seek to structure any deferred consideration based on pre-agreed targets.
All of the above helps to ensure that the next stage of the process, entering into meaningful negotiations, will be undertaken in a minimal timescale and with unnecessary hurdles to overcome.
We, at Vantis, are in a unique position to advise professional service firms as many of us have been directly involved in Vantis’ own mergers and acquisitions and have also advised many similar professional services firms.
If you would like more information please contact Andrew Rose or complete and submit the enquiry form below.