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Sustaining enterprise and asset value during company sale

Opinion Written by John Berry on 27th November 2018. Reading time: 4 minutes

Special Deal artem-bali-679602-unsplashSome owners think of selling ahead of time and set dates and plans. Some get to a point where they’ve had enough. Others unexpectedly realise that the firm has huge value and decide to cash in while they can. And when owners elect to sell, everything happens quickly – and often without thought for the employees.

As a result, buyers can have subsequent problems realising the value they thought they had bought.

There are two basic ideas around selling a firm and these drive all actions. First, the whole firm, can be sold as a going concern to a new owner – that’s a share sale. Second, individual assets that the firm uses to run the enterprise, and that a buyer might value highly, can be sold – that’s an asset sale.

Value in the firm

The value in the firm (whether during share or asset sales) centres on three asset types: employees, markets; and products (and services).

• The value in the employees is their know-how and their capability, which when combined with appropriate technology and ideas available in the firm, realise products and services to deliver to the firm’s chosen markets.
• The value in products and services, without the employees, is in the intellectual property – the ideas that could be transferred to another firm for it to exploit with its employees and technology.
• The value in the markets is not the markets themselves, but in the access to the markets that the firm has developed. Again, when transferred, this access could be exploited by the buyer without the seller’s employees or technology.

Share sale

If the firm is to be sold in a share sale, a buyer will place a value on the whole enterprise – with the intention of running the firm as a going concern. This enterprise value is calculated by projecting the P&L and Balance Sheet over the coming years, given the current, or some new business plan. There are several ways of doing this, but all focus on determining the predicted returns (in the form of dividends or later sale) considering the price a buyer will pay. Often accountants determine this price-over-earnings ratio by simply benchmarking with previous sales in the same industry. In small firms, rules of thumb are used such as, {enterprise value = five times the average net profits over five years}.

Asset sale

In an asset sale, identified assets are to be sold. It might be rights to products, acquisition of a sales function with good access to a market, acquisition of a manufacturing capability or transfer of some other part of the firm. Generally, a part of a firm is interesting to a buyer because it augments that buyer’s existing enterprises. The buyer believes that it can make more turnover and profit in its own enterprises by owning those assets. There are various approaches to valuing assets, but one approach is to calculate the substitution value – the cost to the buyer if it were to have to buy the goods or services elsewhere (rather than buy the assets from the seller).

As an example, take a firm currently buying high quality Internet connections from BT. They currently pay a high rental price for those and they would like to reduce this charge. They could acquire part of a firm that owns and operations fixed microwave links. Those fixed microwave links are a substitute for the BT links. If the buyer can acquire the links, they may realise a significant cost reduction over, say, ten years, with break-even on the sale and subsequent operations over, say, five years. As a result of the sale, the buyer may realise increased profits.

Employee value

Now, we saw in the introduction that employees feature highly in realising the post-sale value of the firm and any transfered assets.

In the enterprise value case, if employees don’t continue to generate turnover and profit, the enterprise has no value. In a share sale the employees’ commitment, motivation and engagement must be sustained. They are a critical part of the assets to be transferred.

In the case of asset sales, the TUPE regulations were introduced to protect the employees against those buyers who would buy the firm, and sell off the assets, and abandon the employees. This is particularly relevant when the asset value is not employee-dependent.

TUPE is quite complex. The essence of TUPE is that employees are attributed to assets. If there is a discernible entity comprising assets and employees, the whole entity must transfer under the sale. It mustn’t be sold split up. The employees transfer to be employed by the buyer under their present terms and conditions of employment doing the jobs they did before the sale.

If, of course, there’s no discernible entity, such as when patents or other intellectual property is sold, the assets alone can be sold. In this case, the seller would need to have dealt, pre-sale, with any redundancies in order to isolate the assets.

Working with employees

Where employees are instrumental to value anywhere in the firm, the sale can disrupt that value. Employee commitment, motivation and engagement must be maintained to maintain value as the assets transfer from seller to buyer. Here, communication with employees is hugely important, right from the point of intention through to actual transfer. Under a share sale, since the entity is remaining intact and jobs are ‘safe’, it’s relatively easy to protect the value.

It’s in assets sales that assets can be decimated. Commitment, the most basic relationship between firm and employees, is built through trust and destroyed whenever the relationship is threatened. And it is most certainly threatened as the employee transfers from the seller’s management to that of the buyer. Once commitment is destroyed, it takes a long time to be re-built. And, trust is likely destroyed across the whole firm – and not just in areas associated with the assets transferring. TUPE demands that managers consult with employees during asset sales, but that’s likely to be largely inadequate.

Maintaining value

So, summarising: during any sale, there’s a risk to the assets being sold. There’s a risk that the assets will not, post-sale, realise their value because employee commitment, motivation and engagement will be damaged.

Buyers should identify how significant employees are to sustaining asset value. Then they and the seller must work with the employees – and not just ‘consult’ – to ensure that none leave or become demotivated as a result of how they are treated as they transfer to the new owner.

{Photo by Artem Bali on Unsplash}


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