Due Diligence

Buyers of businesses are naturally concerned that they have made a “good” buy and that any representations made to them have been true and correct.

To provide this assurance there will often be a condition in the agreement for sale and purchase for the buyers (or their professional advisors) to check the business further. For the smaller business this may be as basic as approving the lease and the financial statements.

For the larger business the process may be far more complex and take longer to complete. The focus will be on three main areas: legal, financial and operational. Experts may be required to evaluate the different areas.

Business owners planning to place their company on the market need to anticipate the probability of some form of due diligence requirement. To ensure a win – win deal they need to be aware of what the buyer will want to see, have the information ready for inspection and be certain that no unexpected surprises will emerge. And the seller needs to see the process from the buyer’s perspective.

Missing documents, lack of co-operation or a lack of understanding of the process can lead to uncertainty, delays, suspicion and, often, cancellation of the contract,

The experienced business broker should educate both the buyer and seller on the due diligence process so that both have reasonable knowledge and realistic expectations. However, it is not the broker’s job to conduct due diligence for the buyer. The broker can facilitate the flow of information, anticipate obstacles and check that those responsible for various tasks are carrying them out in a timely fashion.

Below is a list of information that may be required under due diligence for a mid size business. This is not meant to be complete or appropriate for any specific business.

• business structure – company, partnership, sole trader
• historic summary
• financial statements and GST returns
• lease details
• assets schedule and identity of any plant, , leased, hired, or not passing in the sale
• organisation structure, employment contracts and staff schedule
• pricing, structures, discounts, terms of trade
• marketing and advertising strategies and commitments
• any trademarks or patents
• contractual arrangements e.g. franchises licenses, supply contracts etc
• computer software and other IT information
• any legal issues

Factors that influence the value of a rent roll

There are a number of factors that influence the value or worth of a rent roll. We have listed below a checklist for your reference;

1.       Number of properties under management

2.       Number of landlords

a.       Number of multiple landlords

b.      Number of owner related properties

3.       The % of commission obtained each property

a.       Trust system report only give averages of entire rent roll

4.       Geographic spread of properties

5.       The $ of management fees per property per annum

6.       Management fees - $per annum

7.       Letting fees for last 12 months

8.       Sundry fees for last 12 months

9.       Type of properties under management

10.   Length of time each property managed

How to buy a rent roll

To buy a rent roll you need to be a licensed Estate Agent.  When you buy a rent roll the price you pay is a multiplier of the management fees. Items that effect values have described in other articles on this Blog, however these are some factors that influence value;

1.            The number of properties under management- if the rent roll being sold is too small then buyers will find it hard to secure finance from a Bank. If the rent roll is small then due to finance restraints the price will be affected negatively.

2.            Banks generally like to lend on a rent roll of 150 or more properties.

3.            The ratio of landlords to properties will influence value. Ideally a 1:1 ratio is perfect.

 

4.            The geographic spread of properties.

5.            The mix of properties under management .

Any offer to purchase a rent roll will encompass the price offered, settlement terms, is it subject to finance or not, the restrictive covenant offered by the vendor and the retention period and amount.

The broker will draft up the heads of agreement and then once all parties agree on the sale price then the vendor will instruct its solicitor to prepare contract of sale. The contracts are exchanged, a deposit paid and then the buyer has the right to conduct due diligence investigations. No due diligence occurs prior to any agreement reached between parties.

At the conclusion of DD, the parties agree on the wording for the assignment letters to be sent to the landlords (VIC ) or new authorities will be sent to all landlords in the name of the new agent.

 The final settlement price is determined once all authorities have been returned or notification of assignments has occurred. Generally the settlement of a rent roll occurs at the end of the month thus allowing the vendor to account to all stakeholders. All tenant and landlord information is required to be transferred onto the purchasers trust system at settlement allowing for an easier transfer. Naturally there will be a period of involvement from all the parties to ensure that the transfer occurs as smoothly as possible.

 The retention sum and period operates for the purpose that if any property drops off for no apparent reason post settlement then a financial adjustment can be made on those properties that drop off at the conclusion of the retention period. An amount of money from the settlement sum is held in Trust to satisfy this clause.

 

Valuation in the Volatile World

Rent Roll buyers are buying the future income stream or profits of a business.

Historic results are no guarantee of future performance. Profit & Loss statements, Balance Sheets will show past profits and trends but cannot tell you what will happen next year.

Averaging figures for the last 3 or 4 years can be dangerously misleading, particularly if the business is experiencing a decline in the present downturn. The most recent results are the best indicator of the businesses’ health and future profitability. The buyer must make a subjective judgement as to what the future really holds.

Businesses that consistently monitor their cash flow will be in a better position to take advantage of when the economy will rebound.  Eventually businesses will emerge leaner and stronger from the experience.

The challenge for the buyer is to predict the future performance of a rent roll that is for sale; how much the downturn will impact results, and how prices will be supported by the increased supply of buyers looking to replace decreased sales income with rent roll income.

Business valuation is never a precise science. All valuations are opinions and the only true test of value is an arms-length sale in the market-place after a thorough marketing program.

Vendor Finance is now becoming more popular

With the banks continuing to be cautious lending money to cash flow business (such as rent rolls), we are seeing more sales where the owner leaves in some money for the purchaser. This makes good sense for both parties- the buyer benefits from the seller’s continuing interest and support in the success of the business and the seller gets a higher interest rate and less risk by investing in a business they know and understands.

Analysis of the commission rates of a rent roll

Most trust management systems will provide a potential purchaser of a rent roll with a management statistics report.

Generally this will show the statistical information of the portfolio or the rent roll, such an average rent, gross fees, letting fees, number of properties managed, number of landlord, arrears etc. It is important for a potential purchaser however, to obtain the actual commission rate charged for each property managed to review whether there is a variation in the rent commission charged across the rent roll.

The value of the rent roll is in part based on the commission charged. That said there should be a price variation or lesser multiplier paid on a rent roll where there are a number of fees charged at 4 or 5%. It is too hard to increase the commission rate to 6-8% as owners will resist this increase. Therefore as a conclusion, the higher the commission charged, the higher the multiplier a buyer will pay.

If you own a rent roll, start the process to increase your commission rate over time and to do this in conjunction with increasing your rent. It will be hard for the landlord to resist pay a higher commission if at the same time they are getting a rent increase.

Top 10 Exit Planning Mistakes

We have compiled a list of the common mistakes business owners make when they exit their businesses.

1. Bad timing – judging the best time to sell is important to maximise the price received.

2. Not being proactive – waiting for the perfect deal is like waiting to win the Lottery– it is highly unlikely.

3. Not considering all your options – Discuss with your broker the potential target market and the sale options.

4. Being distracted – do what you do best – run the company. Let the professionals market your
business and negotiate the best deal.

5. Not knowing your value – what is your business worth now?

6. Where to next? – An important part of exit planning is answering that question. As soon as you start to think about selling, act on it as you are likely to be distracted and take your eye of the ball and stop running the business with all your energy.

7. Tax implications? – Your accountant should be part of your team implementing your exit plan.

8. It takes time – selling a business is much more complex than selling a house so allow plenty of time. Information has to be assembled, multi-pronged marketing strategies need to be implemented, legislative and tax implications need to be understood, and almost certainly there will be unexpectedroadblocks and challenges before settlement.

9. Hard work ahead- do not get overwhelmed with the task ahead. If you have an experienced team handling the process they will smooth the way and sort the problems.

 10. Ensure your listed price is correct- Agents spend a life time educating their clients about value- when you are selling head your own advice.