Opinion: Andy Currie

As the property market adapts to a world of significantly reduced speculative development, a relative lack of liquidity to fund projects and reduced partner profits in many of the consultancy firms reliant upon the property market, we expect to see an upturn in M&A activity across the sector. This has already started in part with the recent combinations of Deloitte/Drivas Jonas and Capita/NB Real Estate and it will be interesting to watch the further developments as consolidators seek to broaden their multi disciplinary offerings.

There is little doubt that there is a strong business case for these broader service offerings. However, in my experience, this business rationale is irrelevant if the respective parties do not invest enough time up front to assess whether their cultures will marry. There could be very different cultures at play for a variety of reasons such as geography, business structure – partnerships versus limited companies – and position in the food chain such as engineering firms versus a QS or architect. It would be difficult to imagine, for example, either a broad based firm such as Atkins or a US engineering led firm such as Jacobs being able to integrate a design led architect such as Foster + Partners.

It is therefore vital that, when assessing their strategic plans, business leaders are clear about where they want to get to and what resources they need to get there. Is it simply a matter of doing the same things, only better, or is it a matter of capital, or a matter of international reach and perception or are customers encouraging one stop solutions that can only be achieved by business combinations? Having answered these questions, the manager will be in a far better place to assess whether he wants to be involved in any M&A activity and, if so, as consolidator or consolidatee.

In the heady days of 2006 and 2007, many trade buyers watched in amazement as they lost out to financial buyers in auction processes.

Everyone knows that this was largely as a result of cheap and readily available debt providing financial buyers with the ability to bid higher. However, there were other reasons at play – namely, financial buyers provide a management incentive in the form of sweet equity and financial buyers are set up to execute transactions in relatively short timescales whereas trade buyers generally are not.

Interestingly, the lie of the land is changing - if we analyse a number of deals we have completed in the last 12 months as well as some of those we are currently working on, we can see trade buyers increasingly using private equity style structures as well as having dedicated M&A teams who are able to execute quickly – we recently completed a £50m cross border sale 28 days after agreeing heads of agreement.

One structure we saw recently from a trade buyer was that the management team on the sale could take out 60% of their value in cash at completion. The remaining value was rolled into an instrument with a fixed repayment date – 3 years – and a fixed valuation methodology. What we particularly liked was that the valuation methodology was on an upward ratchet subject to profit growth so that if profits were flat the management got 7 times year 3 profits but if they met their plan they got 9 times year 3 profits This would have have equated to the management getting 3.5 times the 40% they had reinvested thus bringing their total proceeds to 195% of day 1 consideration.

Now this may not be suitable in all circumstances but there are times when combining the synergies and cross selling opportunities of a trade buyer with a private equity buyer style incentive mechanism can be exceptionally attractive.

There are already some clear trends emerging within M&A in early 2010, which I think will only become stronger and stronger as the year continues.

Firstly, on the evidence to date, on the sale of businesses we expect trade buyers (as opposed to financial buyers) to dominate. Furthermore, we expect an increasing percentage of trade buyers to come from overseas. The reasons for the latter trend are numerous and include the comparative weakness of Sterling, particularly against the Euro and the dollar.

Whilst you can argue about the accounting transaction of profits, it is now much easier, psychologically at least, for a French business to write a cheque for €55 million on a £50 million deal as opposed to €70 million when the exchange rate was 1.40. In addition, the average corporate in the UK has more financial gearing than its overseas counterpart and therefore its ability to pay is comparatively constrained

With regards to buy outs, management teams have the ability to exert more influence over a buy out process. In the bull market, sale processes were run with staple debt, vendor due diligence and generally had a large number of interested funders who pushed the price up for the benefit of vendors. These conditions no longer exist and therefore there is the ability to negotiate a better deal for the benefit of the management team.

Interestingly, it is not always about price – the traditional vendor led process takes away the ability for management to negotiate their terms with the private equity community. Therefore, vendors actually have a better chance of a deal being delivered if they give management their head – a well incentivised team is more likely to deliver the deal.

In more and more of our deals, we are seeing a handshake deal between vendors and management on day one and then management entrusted to deliver the deal – this has many benefits and is the right way to deliver a management buy out.

A key feature of nearly all private equity transactions is the use of a non executive director to act as chairman of the board and provide a link between the executive directors and the private equity investors. As an aside, it is interesting to ask the private equity guys how many of them have non execs. You would have thought that, given their insistence on non execs in deals they back, the private equity firms would all have non execs themselves. Think again!

Anyway, back to the real issue. I am a real fan of the use of non execs and do not know why so many businesses wait until they are told they have got to get one before they consider the use of a non exec. If you come from the approach that two brains are better than one then what is there to lose? Being a CEO can be a lonely place and it is sometimes difficult to see the wood for the trees - there will inevitably be some emotional attachment to historic ways of doing business as well as some of the people in your business. A non exec is not there to necessarily change the way you run the business but he will ask questions that may be others, closer to home, will not. A non exec should act as a sounding board when you are uncertain over strategy, people, funding etc. Granted, you need to establish the rules of engagement and ensure that there the boundaries are understood - after all you are the CEO and the buck stops with you.

One final warning - if you are considering giving the non exec some equity, wait 6-12 months until they have proved their worth and their fit in your business.

Many business owners wrestle with the issue of when is the best time to transfer ownership to a new management team, be they the next generation of a family or the second tier who have proved themselves worthy. In the current climate, these concerns of owners will be compounded by fears over valuation. However, if nothing is done there is the danger that the business will meander and good managers leave.

At Catalyst, we are commonly using two tier share structures whereby we crystallise the current value of the business into preference shares and then allocate the ordinary shares to the new team. The preference shares can pay a yield and be repaid, subject to certain defined events. In this way, the current owners get full value, they get a yield ahead of what they would get in the market and the new team is incentivised appropriately. There are many variants of these structures which may or may not involve raising outside capital although, despite what our Chancellor may think, the banks are not too forthcoming.