There are many reasons why buying a business can be a good move for a manufacturer. However, doing the right research and due diligence is more important than ever. Manufacturing Advisor Phil Anders explains what manufacturers need to be aware of and how to get the support needed to make the right decision.
There are a whole host of reasons why a manufacturer might want to buy another manufacturing business. Buying a supplier could help to secure your supply chain or bring component manufacture in-house. Buying a key customer could help to secure your customer base and route to your end market. You could buy a business with a complementary or competing product as part of a diversification strategy to expand into new markets. You could buy a business that offers a technological solution to increase sales. Or you could buy a business for the purposes of creating additional ‘wrap-around’ services for your customers. The list goes on.
In the wake of the financial crash in 2008, lots of acquisitions took place as companies fortunate enough to be in good health bought out other firms that were failing or undercapitalised. The COVID-19 crisis has created a similar scenario, but with one big difference.
This time, the support packages put in place by the government have introduced a new level of risk for prospective buyers. In recent months there have been fewer insolvencies than we’d expect even in normal times, which means there are lots of businesses out there being artificially kept afloat. Now, more than ever, doing the right research and preparation is essential.
It’s like buying a house
So how can you make sure that the business you’re planning to buy is what it appears to be and is worth the price you’re prepared to pay?
Buying a business is analogous to buying a house. Many business purchases are agreed in principle first. This often involves discussion between the buyer and seller, and visits to the business premises. It may even extend to a simple analysis of the financial books of the business. This is akin to a house buyer looking online or visiting an estate agent, then visiting a property, having a look around and perhaps thinking about the affordability of the property, e.g. council tax and utility bills.
But before you buy a house, you should commission a survey report to identify defects and then get quotes for their rectification. You may use this information to negotiate on price or even decide not to proceed. Or, you may simply ask for a report for mortgage valuation purposes. This is unlikely to identify defects within a property, although it may help you negotiate on price – there are many stories of house purchasers being hit with big bills after buying their dream property.
No-one should buy a business without undertaking further investigation, known as due diligence. This can be undertaken in detail, like a survey report, or superficially like a mortgage valuation.
What follows is a best practice guide to due diligence when buying a business.
An introduction to due diligence
As you might expect, we strongly recommend that you:
- Adopt a detailed approach; and
- Engage a suitably experienced commercial solicitor and accountant. Your existing suppliers may have the relevant experience, or they may not, so don’t be afraid to ask them!
Solicitors and accountants who work in this field regularly are likely to have templates that they can share to gather the relevant information from the seller. The information obtained should either confirm what you already know or identify areas for further investigation, which may lead you to continue with the purchase, decide against the purchase, or renegotiate the terms.
It’s also important to be mindful of just what it is that you’re buying. Is the business owned by a sole trader, partnership or a limited company? Whilst much of what follows is relevant to all of these legal entities, it’s also the case that each has certain ‘peculiarities’ that can affect the structure of the purchase. This is another reason to use experienced professional advisors.
This guide assumes that the business you’re buying is owned by a limited company and gives a sense of the breadth of information you should ask for. It is not, however, a definitive list.
The various elements of due diligence can be categorised under one or more of the following:
There should be a thorough review and authentication of all financial information in the business. This should include, but not be limited to:
- Historical trading information (but see below!) to understand revenue and overheads and confirm to profit margins. This should include up to date management accounts to demonstrate the recent performance
- VAT, PAYE and Corporation Tax returns
- Aged debtors and creditors listings
- A list of major suppliers and customers, including terms of purchases/sales, and details of any major sales currently being negotiated
- Latest budgets and forecasts
- Stock inventory as appropriate (broken out as to raw materials, WIP and finished goods)
- Schedule of assets (buildings, plant & equipment, fixtures & fittings, etc.) detailing age, type, value (including copies of any valuation undertaken in the last 3 years), usage, etc.
- A list of all debts owed by the business including to banks, asset financiers, directors, shareholders and any other third-party funders, to include amounts owed and the borrowing terms
- Details of any and all grants received in the previous 6 years including copies of the related documentation.
The analysis of historical financial information is crucial in order satisfy yourself that the business has traded as it appears to have done. Ideally, you want to be able to see accountant-prepared financial information but be aware that the rules relating to audits are such that many businesses with a turnover below £10.2 million qualify for an exemption. Therefore, you may, or may not, be able to rely on the recent annual accounts.
Legal matters relating to the business should be reviewed. As a minimum, the following should be obtained:
- The company’s memorandum and articles of association
- A list of recent (last 3 years) and current directors and shareholders, and copies of any contracts, loans or arrangements between them and the company
- Copies of any distribution agreements, purchase agreements, sales agreements, quotes, warranties (received and given), supply contracts and a major supplier and customer invoices and purchase orders
- Evidence of any intellectual property rights claimed to be owned by the company, whether formally registered (e.g. a trademark) or claimed (e.g. a recipe)
- Copies of any and all agreements pertaining to assets, for example, copies of leases, rental agreements and land registry documentation
- Evidence of compliance with any and all regulatory matters including Health & Safety, and/or licences, permits and certificates required to conduct business
- Evidence of joint venture agreements and/or partnerships, as applicable
- Details of any contractual provisions that can be triggered by the change of ownership or control of the company
- Details of any material changes within the business over the past 3 years
- Details of any breaches or termination of any contract by any person to which the company is party
- Details of acquisitions and/or disposals of companies, businesses or material fixed assets since incorporation
- Copies of insurance policies
- Information relating to all IT matters including data protection compliance, the rights and usage of software, and maintenance and support agreements.
Areas to consider in HR include, but are not limited to:
- Request an organisational chart. Identify who the key employees are and their responsibilities
- Obtain and review all contracts of employment and external contractor agreements, to include salaries, benefits, insurance, overtime commitments, pension commitments, as well as disciplinary, sickness and maternity records as applicable.
- Check all payroll employee tax forms
- Details of any pension schemes operated by the company and details of active members and pensioners (both active and deferred)
- Obtain copies of the accident book, all HR policies and procedures and staff handbook
- Copies of directors’ service agreements and appointments of non-executive directors
- Details of any job evaluation study, investigations by external bodies (e.g. Commission for Racial Equality and Health & Safety Executive, etc.), industrial tribunal awards or staff consultative committee meeting minutes.
Any other considerations
Due diligence has to be a very thorough process in order to provide you, the buyer, with a detailed overview of the business you are looking to purchase. It should help you determine whether the asking price is reasonable, and it will form the basis of the legal agreement that the solicitors will draw up between you and the seller, including, where appropriate, legal clauses to provide you with protection in the event of a problem. It is imperative to have experienced legal and professional advice for this process.
Although we have covered the main legal, financial and regulatory matters above, it’s also worth commenting that as a prospective purchaser there will be matters that you may wish to review and judge for yourself. Such matters include:
- Understanding how the business is structured; its products, production and sales processes
- Researching competitors and the scale of market opportunity locally, nationally and internationally
- How technology and buyer trends may affect the industry
- How this business fits with your own. Does it, for example, extend your current offering, open up new markets, provide you with a cheaper source of parts, etc.
All of these elements can be better analysed with the information that your professional advisors obtain and check on your behalf. But ultimately, the decision to buy and the price to be paid rests with you, so satisfying yourself about the above points is also a crucial stage in the buying process.
How we can help
Our Manufacturing Team can support you in the process of acquiring a business with an initial review of the business case and financials. To take you to the next step, SME manufacturers can also access grant funding through our Manufacturing Growth Fund, to procure the professional services needed to make the right decisions – whether that’s accountants, solicitors or industry specialists.
Grants of up to £9,000 are available to eligible manufacturers for projects valued up to £24,999. To find out more, get in touch with an advisor today.
Phil Anders, Manufacturing Advisor
Phil has over 20 years experience, supporting business growth for small and medium manufacturing enterprises.
Formerly delivering the Manufacturing Advisory Service (MAS), Phil is well versed in working with manufacturers to identify growth opportunities and implementing operational improvement plans. A Six Sigma Green belt, Phil is a lean manufacturing expert with specialisms in continuous improvement, waste minimisation and quality management.
To view Phil's full profile including technical capabilities and industry experience, please click here.