26
DUE DILIGENCE AND
ACQUISITION COSTS
When looking at smaller entities, these
costs can be significant, taking into
account professional advisors fees,
they could be as much as 10% and
this is a potentially large outlay as a
proportion of the purchase price or
investment value. This may be part
of the reason bigger players tend
not to participate at this end of the
market as the same work and costs
are required for much more valuable
businesses or larger investments.
Such high costs add to the price
and therefore to the risk, but can
be mitigated by the purchase of
stakes in extremely undervalued
companies at low cost, or by the
investment opportunity itself,
with high potential for improved
management and funding to increase
profits and repay the original fees
quickly. Of course, this depends on
expert knowledge to identify the right
opportunities and increase revenues.
EXIT AND LIQUIDITY
As a financial asset, there is an income
stream for a Precision Engineering
company. Machinery, stock and
premises all have utility and so tangible
value. Additionally, some companies
have accounts going back many years
to allow for fiscal examination. That
said, their ultimate value depends
upon there being buyers for these
specialist companies and the question
is, what they are prepared to pay,
particularly when bank finance is
not readily available. The buyers’
market for smaller companies remains
limited, with institutional investors
and corporate buyers focussed on
acquiring businesses with higher
enterprise values; exit and liquidity
both rely on the availability of third
parties with acquisition ambitions.
In addition, the investee companies
are, for the most part, unquoted
and investment in this asset class is
largely based on the growth of the
companies over several years which
may be a lock in period, depending
on the investment structure.
This makes exit at short notice,
potentially very difficult and certainly
not guaranteed.
Cyrus IM believes the disparity, in
terms of external investment interest,
between companies with a value
below £10m and above £10m offers
an attractive investment opportunity:
Managing Partner Peter Schwabach
states “The absence of investors in the
sub £5m market offers the opportunity
for investors to inject growth capital
into these businesses, valuing them
at a low multiple of EBITDA. Whilst
the process of eventually aggregating
these businesses into single operating
entities, lowering overheads, increasing
sales, products and margins means
that the aggregated businesses can
be sold into the active M&A market
at a higher multiple of EBITDA
generating a premium to investors.”
Obviously, one of the associated risks
here is in growing the businesses
sufficiently to attract a buyer for
whom they are large enough and
fulfil a particular function. Such
entities in the secondary market
might include Siemens, Salsa, US
companies and institutional players.
LACK OF AVAILABILITY
OF ADDITIONAL
EXTERNAL FUNDING
The fact that banks are generally
unwilling to loan to smaller Precision
Engineering companies, even outside of
the credit crunch, has been one of the
factors which has led to a number of
underfunded companies in the sector.
This may be a good thing for investors
looking to cash in on undervalued
businesses with growth potential, but it
is a bad thing in the context of securing
additional, affordable funding to keep
up with developments in machinery
to retain efficiencies and keep running
costs under control, not to mention to
take advantage of growth opportunities.
The only alternatives to bank overdrafts
for many smaller businesses has been
the factoring of their trade debt or
the securing of asset finance against
new equipment both of which carry
high interest rates plus set up fees.
The landscape in terms of SME lending
in general, does however, seem to be
slowly improving with the British Banking
Association reporting in its Bank Support
for SME’s – Q1 2015
47
figures that, in the
first quarter of 2015, UK banks approved
£5.7bn of new loan facilities to SMEs, 3%
more than Q1 2014. However, the overall
amounts allocated were skewed towards
medium sized businesses: Of the £7.1bn
total, £2.8bn of new loan and overdraft
facilities was for smaller businesses and
£4.3bn was for medium businesses.
Whilst grants and other funding routes
are available and political support
is strong, these routes are unlikely
to entirely fill the gap left by banks,
certainly for the smaller Precision
Engineering entities, and are perhaps
not as easy for older, less dynamic and
more stagnated companies to access.
POLITICAL RISK
This is a national industry and changes
in government policy could affect it.
However, politically, following the recent
general election, the UK governmental
landscape is now settled for the next
five years and political will is historically
and generally agreed on the importance
of the sector to the British economy. As
a result, government backed incentives
and structures designed to encourage
investment into certain industries which
lack funding options, such as Enterprise
Investment Schemes and Venture
Capital Trusts are unlikely to see their
benefits eroded or entirely removed, in
the same way renewable energy has.
That said, there are law changes to EIS in
the offing and these are likely to impose
changes to the structure of deals.
Perhaps the most significant current
political risk lies in the UK’s future in,
or out of the European Union. Any exit
from the EU could diminish the UK’s
attractiveness as a place to invest and do
business which is clearly underpinned
by the UK’s influential membership of
the EU. This membership also offers
the largest Single Market in the world,
unhindered by any tariffs or costly
regulatory barriers, EU funding and free
movement of labour within European
borders, which gives engineering
DUE
DILIGENCE
EXIT AND
LIQUIDITY
LACK OF
ADDITIONAL
FUNDING
POLITICAL
RISK
