One of the most challenging aspects in structuring an M&A transaction is not necessarily the determination of a purchase price, but rather how that purchase price is allocated between the assets being sold. The major conflict at the core of this issue is the existence of tax polarity between the buyer and the seller. Generally speaking, the seller of the business is trying to maximize after tax proceeds while the buyer is trying to minimize the consideration relative to the after tax cash flow of future operations. Given these concerns, sellers typically look to sell stock while buyers usually want to buy assets. (Many times buyers prefer asset purchases because, in most jurisdictions, it limits liability. In Brazil, for example, it does not limit liability.)

Section 1060 of the IRS tax code attempts to mitigate conflicts regarding the allocation of the purchase price to various assets. Under Section 1060, both the buyer and the seller of a business are required to use the residual method for purchase price allocation. This means that the purchase price is first allocated to assets to the extent of their fair market value and any excess will be allocated to goodwill and going concern value.

A purchase price allocation is important to include in a purchase contract between a buyer and a seller because it gives guidance as to the tax consequences of the transaction. An allocation acknowledged by the two parties will allow the buyer to determine the basis of depreciable and amortizable assets while the seller is able to compute the sales price of the individual assets in order to determine any recapture amounts. With an allocation in place, the seller is also able to determine capital gains and ordinary income from an asset sale.

Although coming to an agreement about purchase price allocation can be challenging, having a tax expert and an experienced investment bank negotiating between buyer and seller will help both parties reach agreement on an allocation that is beneficial or at least fair to both parties and that conforms to IRS standards.

When determining the value of a business, there are three basic approaches that can be used to determine the fair market value. These three approaches are the underlying asset approach, the market comparable approach, and the income approach.

The underlying asset approach is a technique in which the assets of the business determine how much it is worth. The assets being valued are both tangible and intangible which means they are considered in the valuation regardless of whether or not they show up on the balance sheet. The final value of the business is determined by a simple formula: Assets – Liabilities = Value of the Business.

Another common method of valuing a firm is the market comparable approach. This is where one compares a business to publicly held firms whose stock is trading. A value is derived by examining the public firm’s EV/EBITDA or EV/Revenue multiples and applying a similar multiple to the non-public, target firm. (EV = Enterprise Value and EBITDA = Earnings Before Interest Taxes, Depreciation and Amortization)

The third way of valuing a company is the income approach. The income approach is based on the company’s potential earnings in the future. The most common way of doing this is by using the discounted cash flow method. The discounted cash flow method (DCF) is where one projects the cash flows that the business will generate and then discount these returns to their present value.

No matter which approach is used, the accuracy of the valuation will depend on the level of detail and depth of analysis that is used in deriving that valuation. It is important to ensure the accuracy of all inputs used in these valuation approaches as these inputs will ultimately impact the value calculation of the target company.

One final note on valuations; “paper” valuations are interesting and useful, but they may or may not be an indication of what a willing buyer may pay a willing seller. Versailles Group has sold a number of businesses for more than any “paper” valuation would have indicated. The key to achieving such a valuation is to have the right buyers and a strong auction.

Versailles Group is pleased to announce the publication of its first eBook, "When To Sell Your Business."

Most entrepreneurs spend more time building their businesses than planning for eventual sale. This guide is meant to assist entrepreneurs in deciding the timing for the sale of their business.

To download your copy, please follow the link at the top of the page.

M&A deal activity is continuing at a rapid pace. Global volume this year has already exceeded US$3 trillion and will likely surpass last year’s record volume.

One particularly bright spot for M&A activity has been Europe. For the first time in recent history, European M&A has expanded dramatically. For the first three quarters of 2014, this has meant nearly US$800 billion of transaction volume. By comparison, for the same time period last year, there was less than US$500 billion of transaction volume in Europe.

When a business owner is considering the possible sale of their company, one of the first questions he or she is probably going to ask is who wants to buy it?

There are typically two types of possible buyers in an M&A transaction. The first type of buyer is financial sponsors usually called private equity firms. These firms look to make acquisitions as financial investments. The second type of buyer is strategic buyers who look to make an acquisition of a business that is a potential fit into their current operations or enables them to achieve strategic goals.

The financial buyers generally are more concerned with the valuation and risk of an acquisition compared to strategic buyers. The financial buyers care much more about the target company’s current and projected financials and are generally in constant contact with financial advisers and intermediaries looking for possible acquisition candidates to pursue. By definition, financial buyers are very value conscious.

Strategic buyers are generally looking for companies that can fit into their own operations and, other than the obvious candidates, can be more difficult to identify. Strategic buyers or just “strategics” usually are competitors, suppliers or other companies that operate in the seller’s industry or related industries. The advantage of these types of buyers is that they tend to operate a similar a business so it may be easier for them to understand the seller’s operations, motives for selling, and possible risks.

Depending on an owner’s motives for selling and his or her desire for involvement post-closing, either type of buyer may be appropriate. Having an experienced M&A adviser to identify, contact, negotiate, and structure a transaction with these buyers is essential in order to ensure the most value for the business and the best terms to make sure that the owner is properly compensated and, if wanted, a desirable role with the company after the acquisition is complete.

As the chart below shows, M&A activity has expanded rather dramatically over the last five years. We expect this trend to continue, but not forever!

Are you prepared for the next bear market?

We all know that the world’s economies are cyclical. The current bull market has been going for about 5.5 years versus an average of 4 years. Given this simple fact, it’s important to focus on your M&A goals and strategies. To be clear, we do not believe that the next bear market is imminent. We do; however, believe in being ahead of the curve.
Now is a good time to start a transaction that will either close by year-end or early next year. Too many entrepreneurs and companies procrastinate only to find it’s too late to maximize value or miss valuable opportunities. The question is, given the current strength of the M&A market, why wait to pursue a transaction?

The chart below shows the first six months of M&A activity for both 2013 and 2014. In all geographies, the volume, year over year, has increased.

The gradual improvement in the world’s economies is driving this increase in M&A activity and pushing multiples up. For example, across all industry sectors, the Enterprise Value to Revenues multiple, has increased from 1.17x in 2012 to 1.26x in 2013 to 1.50x in 2014.

Versailles Group is pleased to announce that it was awarded the Financial Adviser of the Year Award for the sale of Photon Technology International Inc. to Horiba Ltd.

Here is the link to the actual Press Release from Yahoo Finance.

The text of the Press Release is listed below for your convenience.

BOSTON, July 15, 2014 — Versailles Group, Ltd. (www.versaillesgroup.com) announced today that it was awarded the Financial Adviser of the Year Award for the sale of Photon Technology International Inc. (www.pti-nj.com), to Horiba Ltd. (www.horiba.com) (TSE:6856). Versailles Group acted as the exclusive financial advisor to Photon Technology International Inc. Terms were not disclosed. The transaction closed on Feb. 10.
The award was granted by UK-based AI Global Media, Acquisition International Magazine and DealFlow Source. Voted for by a global network of expert M&A professionals, advisers, clients, peers, and industry insiders, the award celebrates excellence in all areas of M&A.

The winner of this award was determined by three factors. First, voting forms were distributed to Acquisition International Magazine’s dedicated base of 53,000+ subscribers and over 150,000 individuals in its in-house database. Second, Acquisition International does substantial in-house research. Third, Acquisition International asks nominees to supply supporting documentation which they feel may cement their nominations. All of this information is used to make a determination as to which firm will receive the Financial Adviser of the Year Award.

About Versailles Group
Versailles Group, a 27-year-old Boston-based investment bank that specializes in international mergers, acquisitions, and divestitures, advised Photon Technology International Inc.’s shareholders on the transaction. Versailles Group works with companies in the U.S., Europe, Canada, Asia, and South America.

About Acquisition International Magazine
Acquisition International is a monthly magazine published by AI Global Media Ltd., a publishing house that specializes in corporate finance news and reporting. AI works alongside leading industry analysts to ensure it publishes the most up to date figures and analysis. Acquisition International has a global circulation, which brings together all parties involved in deal making. In an increasingly global deal market Acquisition International Magazine is uniquely positioned to reach the deal makers that matter.

Worldwide M&A activity is continuing at a rapid pace this year for a number of reasons including the availability of credit, the robust liquidity of large companies and private equity firms, and the continued improvement in the economy.

By sector, Financials, Healthcare, and Consumer Discretionary transactions accounted for over half of the M&A transaction value. If one examines M&A transactions by the number of transactions, 66 percent of the transactions were completed in the Financial, Consumer Discretionary, and Industrials sectors.

The following pie chart and table show M&A activity by sector.

M&A activity was very strong in Q1; in fact, the M&A market this past quarter was more active than any quarter in the last several years. April and May continued this trend with a high level of activity in terms of both deal value and the number of transactions.

This heightened activity is driving multiples up as depicted in the chart below, which shows the percentage increase in TEV/Revenue multiples by industry from the last 12 months to the last 90 days.

Why do deal multiples matter? If you’re a seller, you’ll receive more value for your company. If you’re a buyer, you’ll end up paying more. Therefore, it’s an opportune time for sellers to put their company on the market. Similarly, buyers should consider a transaction before the multiples increase further.