Deal Structure and Valuations

Growing a successful digital, creative, or tech business can often be a lifetime’s work. But what happens when you’ve realised your growth ambitions and want to realise some of the value you have created? Selling a business can also be a daunting prospect. There are a variety of ways a deal can be structured and it can be a difficult area to navigate, but they all fall into a few broad categories. At an early stage, it is these categories that you should focus on, once you get further into a sale process your advisors can explain the nuances in detail.

In this article, Brabners LLP’s Simon Lewis (Partner) and Anthony Grogan (Solicitor) explore the key points around deal structure and valuations.

Asset Sale v Share Sale

Digital, creative, and tech businesses often have distinctive assets (such as intellectual property, software, or creative portfolios) that can heavily influence deal structure. In an asset sale, the limited company sells its business and assets to the buyer. These deals are often favoured by buyers as they can avoid taking on unknown liabilities, but they do involve the risk of losing contracts and/or regulatory consents, important to the operation of the business. However, for Sellers, they can leave them with what is, in effect, the shell of a company and therefore the subsequent complications of winding up the selling company in order to extract the sale proceeds and dealing with any liabilities that have been ‘left behind’. For digital, tech and creative businesses, asset sales may involve the transfer of key intellectual property, software licences, or client contracts. It’s important to consider how these assets are held and whether they can be easily transferred to a buyer, as this can impact both deal structure and value.

A share sale is generally favoured by sellers as they are more straightforward and allow the sellers a ‘clean break’ from the company. The buyers, in purchasing the shares, are on taking on everything, a so called ‘Warts and All’ approach. Share sales are also beneficial to the sellers from a tax perspective, in that the tax situation is more straightforward. As a result, the majority of transactions with a deal value in excess of £1m will be share sales.

Trade Sale v Private Equity

Understanding the motivations of different buyers can help you position your business effectively. Trade sales are sales to buyers that will acquire a business with a view to retaining it for the foreseeable future - incorporating it into their existing business or as a new division. Trade buyers in the tech sector can be anyone from larger software companies, to established entrepreneurs, to digital agencies looking to expand their capabilities.

Private equity sales, on the other hand, are to buyers who acquire businesses with the intention of selling them in a few years after growing their value (3 – 5 years is typical). Private equity investment has become especially common in the tech sector. This is because private equity firms are attracted to technology businesses for their high growth potential, scalable business models, and the opportunity to generate significant returns within a relatively short timeframe. Many tech companies operate in rapidly evolving markets, where additional capital and strategic guidance from private equity investors can be vital for accelerating product development and market expansion.

Full Exit v Roll Over of Shares

Whilst certainly possible, sellers often do not keep any of their shares in a trade sale, even if they remain with the company for some time afterward.

In contrast, during a private equity sale, some or all sellers usually choose to 'roll over' a portion of their shares, allowing them to remain shareholders in the future. While this results in receiving less cash upon completion of the sale, it offers the potential for a larger total payout later, especially if their business is successful in scaling after the investment, or they sell alongside private equity after the business has increased in value.

Trade Sales: Cash on Completion v Deferred Consideration/Earn-out

It is becoming increasingly rare for the entire purchase price to be paid upon completion of a trade sale. Instead, part of the purchase price can now often be deferred to a later date.

This deferral may simply allow the buyer more time to gather the necessary funds, and provides a reserve for any breach of warranty claims which arise against the sellers. It may also take the form of an earn-out, however. An earn-out ties a portion of the purchase price to the company’s performance after the sale, enabling the seller to benefit from anticipated future performance while allowing the buyer to assess whether those performance goals can be met before making the payment. Below, you'll find a table outlining the advantages and disadvantages of these options.

Valuation

Valuing a company can often be more of an art than a science, and may simply come down to what a buyer is willing to pay. That said, there are some fundamental concepts used in valuing a company, which can vary based on the nature of the business.

• Profits v Assets

One straightforward method for valuing a business is to total the value of all its assets. This approach can be effective for companies with low day-to-day profits but significant asset value. In the digital, tech and creative sectors, intangible assets like intellectual property, proprietary software, digital content, or creative portfolios, often drive value more than physical assets. However, a simple asset valuation is generally inadequate for most digital, tech or creative companies, whose worth is primarily derived from their trading profits rather than physical assets. For these businesses, a profit-based valuation is typically more appropriate.

• Why not profits plus assets?

It is rare to find a valuation that combines a company's profits with its physical assets. The prevailing assumption is that the assets are essential for generating profits, meaning there shouldn't be additional costs associated with them. However, exceptions exist for certain capital assets, like property, where the asset's value may be included in the sale. In such cases, an adjustment to the company's profits is typically necessary.

• What is EBITDA?

For many business owners, profit is measured in how much money is left at the end of the year to either take as dividend or invest back into the company; it means that factors such a corporation tax rates or borrowing costs are relevant considerations. However, when it comes to valuation, a company’s profits are typically represented as 'EBITDA,' which stands for Earnings Before Interest, Taxation, Depreciation, and Amortisation. This approach aims to clarify the core trading profits of a business before any accounting adjustments are applied.

• Maintainable EBITDA

The key to any valuation lies in determining what the EBITDA will be post-sale, after removing any peculiarities in accounting treatment from the current ownership. This figure is referred to as the maintainable EBITDA. It's common for owners to work full-time without drawing a salary, opting instead to take dividends, which can inflate EBITDA figures since there are no senior management costs included. Consequently, the EBITDA for valuation will be adjusted downward to account for the anticipated costs of senior management going forward. On the other hand, if payroll includes family members with inflated salaries that could be replaced at a lower cost, the EBITDA for valuation purposes would be adjusted upward.

• The ‘Multiple’

Valuations are frequently presented as a multiple of EBITDA, and companies within the same industry often exhibit similar trends in these multiples. Industries that are in high demand at a given time—like solar panel installers in 2011/12—typically have higher multiples across the board. However, it's not as simple as stating that all widget manufacturers are valued at three times EBITDA. Instead, each industry generally has a range of multiples, with companies viewed as low risk or having high growth potential usually achieving multiples toward the upper end of that range.

In the digital, creative andtech sectors, valuations are often driven by factors such as user growth, recurring revenue streams, and the value of proprietary technology or creative content. Demonstrating strong growth metrics and registered intellectual property can help achieve higher valuation multiples.

• Cash Free/Debt Free

In addition to the purchase price, a buyer will benefit from any cash within the company and take on any existing debts. Therefore, most valuations are presented on a ‘cash-free/debt-free basis,’ meaning the final price paid will account for the company’s cash and debt situation. For instance, if a company’s core business is valued at £5 million but has net debt of £3 million, the buyer will only pay £2 million to the seller, as they will be assuming responsibility for the £3 million debt.

What Brabners can offer

Brabners works with businesses across the Liverpool City Region and beyond, supporting owners and investors through every stage of their journey. Many of their team are well-versed in the legal, technological and creative landscapes to provide current, effective guidance and tailored solutions. Brabners is also the only UK law firm to offer dedicated deal advisors — combining legal and financial expertise to help businesses, investors and entrepreneurs to achieve their goals.

Whether you're a founder planning an exit, a disruptive start-up exploring potential expansion or a shareholder seeking to understand your rights, their team contains over 50 highly regarded experts who can help you to achieve your objectives. If you would like to discuss any of the points raised in this blog, please contact Simon Lewis or Anthony Grogan, and they would be happy to assist.