Introduction
There are three main types of business media:
- limited companies;
- partnerships; and
- sole traders.
All of these businesses can be acquired, although the structure of the acquisition may differ depending on the type of business.
Terminology
The business or company being purchased is often referred to in practice as ‘target>/b>’, a term which I will use throughout my posts on the topic.
Note that the purchase of a listed company is a special case, and is referred to as a takeover, rather than an acquisition.
Valuing a company
One of the biggest single investments a company can make is to buy another company. It is an investment decision and the cost of the investment needs careful consideration. Therefore, it is necessary to estimate the value of the company before the costs and benefits can be assessed.
If the company is a listed company for example, the share price will be quoted on a stock exchange and therefore it is possible to place a market value on the company. However, suppose that the company is not doing very well and the share price is depressed, the market value may not represent what someone else is prepared to pay for it. Other companies may feel that if the company was better managed they would be able to make more profit and then increase the return and hence value of the company. In addition, we have to answer the same question concerning value even if the company is not quoted and therefore there is no quoted share price available.
So how much would the potential buyer be prepared to pay for the company?
Book value
One value that can be placed on the company is the balance sheet value of the assets. However, as this is a book value it may not be the true value of the assets. Another version of this method is to value all the assets at the break-up value, i.e. how much would be left if all the assets were sold and the liabilities paid.
‘Going Concern’
The book value or break-up value often doesn’t reflect the true value of the company as it will probably be worth more as a going concern (i.e. as a money generating business) than it would if it were broken up and sold. This depends, of course, on how well the company is performing and the future prospects for the company’s products and services.
Future cash flows
If an investor buys a company, they are in effect making an investment that is expected to provide a return. In fact, if the company makes a profit, it could provide a return for a number of years into the future. A common way of viewing this is to say that the purchaser of the company is actually buying a future stream of income that is generated by the profits of the company, or future cash flows.
Viewed in this way, a common way to value a company is to take a number of years’ multiple of the future profits. If we made a bold assumption that the profits are equivalent to cash flows we can calculate the present value of a number of years’ future cash flows. This can be equated to the return that the investor will receive from the investment over a period of time, leaving aside any increase in the value of the company when it is sold.
In reality, there is no best way to accurately value a company, as there is always an element of subjective judgment, e.g. how many years are taken into account and what return is expected.
How do you acquire the business of a company limited by shares?
Such companies are owned by their shareholders who each own shares in the company. As you have learned, these shares are capable of being transferred from one person to another. As a result of this, there are three ways in which you can purchase the business of a company limited by shares:
- by acquiring all of the shares in the company (a share sale);
- by acquiring the business of the company as a going concern or by acquiring a particular part of the business of the company as a going concern (e.g. a trading division) (commonly referred to as an asset sale or business sale); or
- by purchasing the particular assets that you require (a sale of assets).
Note: the sale of target may be conducted via an auction process, whereby a number of potential buyers are invited to submit bids for target.
Share Sales
Share sales occur as a result of a buyer purchasing the issued share capital of a company.
It is possible for a buyer to purchase only some of the issued shares. In such a case, following the purchase, the company will not be wholly-owned (i.e. owned by a sole shareholder) and particular issues may arise in the running of the company as a result of the existence of a minority shareholding. It is more common however for all of the issued shares to be purchased, so that the target company will be wholly-owned following the purchase.
When a share sale completes, the target company itself does not change. It continues to trade as it did prior to completion but with a new owner. The shares will be transferred by stock transfer form.
Asset Sales
Asset sales occur as a result of a buyer purchasing either the whole of the business of a company as a going concern, or when a company has separate and distinct trading divisions within it and the buyer purchases one or more of those trading divisions as a going concern. By ‘a going concern’ we mean that the whole of a business is purchased (or a large proportion of the assets including the goodwill), so that the business can trade after completion of the purchase just as it did prior to completion of the purchase. A key feature of an asset sale is that each asset needs to be transferred separately and have part of the purchase price apportioned to it. For example, a TR1 will be required to transfer any property to the buyer, IP will need to be assigned or licensed to the buyer and contracts will need to be assigned or novated. Employees who work for the business being transferred will transfer to the buyer automatically under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (known as ‘TUPE’).
When an asset sale completes, ownership of the company selling its assets (i.e. the shares in that company) does not change but the business that is being sold does change hands. Following the sale, the selling company continues to exist. If it has sold the whole of its business, it will now be a ‘cash shell’, a company with no assets except the cash proceeds of the asset sale.
How do you ‘acquire’ a partnership or sole trader?
Partnerships and sole traders operate unincorporated businesses where there are no shares owned, in comparison to limited companies which are owned by the shareholders.
This means that in relation to partnerships and sole traders the only option open to a potential purchaser is an asset sale (i.e. to buy the business as a going concern) or to buy the individual assets that it requires.