For any founder in Hong Kong considering a sale of their business, the path from initial discussion to a closed deal follows a structured sequence known as the Mergers and Acquisitions (M&A) lifecycle. Though no M&A transaction ever plays out the same way, this framework generally provides a more or less standard progression for what can otherwise be a complex and overwhelming experience. This article will also go over key metrics your business will be evaluated on and the relevant reports they go under.
The M&A Lifecycle
Phase 1: The Preliminary Termsheet
Once a prospective buyer has been found, the M&A process can formally begin with both parties signing a preliminary termsheet, a document that expresses the mutual interest of both parties in moving forward with the transaction. This agreement lays out the foundational terms of the potential deal and acts as a guide for the upcoming negotiations, including rules around privacy and non-disclosure. Although largely non-binding, the termsheet signals a genuine commitment from both sides to commit substantial resources into the deal. For transactions of substantial value, this is also the appropriate moment for parties to bring in legal counsel to safeguard their interests.
Phase 2: Due Diligence
Signing the termsheet marks the start of the official due diligence period of around 2-3 months. While this is the official start, astute buyers often begin their investigation much earlier. At this point, the buyer’s team of lawyers and advisors will request a comprehensive set of documents to scrutinize your business. The requested information will typically cover:
- Financial History: Audited financial statements from the past three years, alongside your most recent management accounts.
- Customer Analysis: Data that helps in evaluating the risk of customer concentration and churn.
- Business Performance: Official statutory reports and other records that provide insight into your company’s operational track record.
- Ownership Verification: Legal documentation that confirms your ownership of the company.
- Contractual Obligations: A thorough review of all major agreements with suppliers, clients, and staff.
Phase 3: Negotiating the Deal
With the findings from their due diligence in hand, the buyer will enter into price and term negotiations with you, the seller. Their offer will be based on a detailed valuation of your company, encompassing tangible and intangible assets part of the sale as well as current and future liabilities.
A crucial element in this valuation that is not derived from any one metric is goodwill, which is the value assigned to non-physical assets like your brand’s reputation or strong customer relationships. This is a premium paid over the fair value of your net assets and is a hotly negotiated part of the deal.
The results of the intensive negotiations then culminate in the drafting of a Sales & Purchase Agreement (SPA) that will seal the deal.
Phase 4: Closing the Transaction
Once the SPA has been signed and executed and funds are transferred, legal ownership of your business will be formally handed over to the acquirer, concluding the life cycle.
Key Financial Metrics in a Business Valuation
The buyer’s valuation of your company will be heavily influenced by a set of critical financial metrics. A clear understanding of these indicators will empower you to better anticipate their valuation approach and strengthen your negotiating position.
EBITDA & EBITA
Often referred to as the universal language of valuation, EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) offers a standardized measure of a company’s core operational profitability. It strips away the effects of financing and accounting decisions, allowing buyers to make a clear comparison between your business and its industry peers to establish a valuation benchmark.
Modern tech companies, and tech startups in particular, will by their nature often have fewer tangible assets under the company’s name, and therefore have fewer depreciating assets to include into the calculation. It may be more accurate then to use EBITA to assess a tech company rather than EBITDA.
Working Capital
Working capital represents the necessary cash flow a business needs to sustain its day-to-day operations. Buyers will conduct a thorough analysis of your working capital to gauge the company’s liquidity and ensure it can comfortably meet its short-term financial obligations. The standard formula for this is current assets minus current liabilities.
Revenue Concentration
Revenue concentration is used to assess the risk tied to over-reliance on a small number of clients, and is determined by comparing the revenue generated by your top five customers to your company’s total revenue. A high concentration can be a point of concern for buyers, as the departure of a single major client could pose a significant threat to financial stability.
| Metric | Focus | The Buyer’s Concern |
| EBITDA / EBITA | Core Operational Profit | How profitable is the business at its fundamental level? |
| Working Capital | Liquidity & Cash Management | Is there enough cash to keep the business running smoothly? |
| Revenue Concentration | Customer Dependency Risk | How much does the business depend on its largest customers? |
Valuations based on the Audit Report vs Quality of Earnings Report
Your primary objective as a seller is to showcase your business as a stable and consistently profitable entity, told mostly through the financial metrics you provide the buyer for due diligence through their relevant financial reports. While standard audit reports are a required component of due diligence, they don’t include EBITDA or liquidity metrics, and so don’t always tell the whole story of your business activities.
An audit report is primarily concerned with ensuring compliance with Hong Kong Financial Reporting Standards (HKFRS). However, these standards may not fully capture the true earning power of a business. To bridge this gap, a Quality of Earnings (QofE) Report is often included.
The QofE report is designed to demonstrate the sustainability of your profits, effectively proving to a buyer that your business is a reliable cash-generating operation, frequently utilizing the EBITDA metric, which is widely regarded as a more accurate measure of true earnings.
Normalizing Earnings with the “Add-Back” Method
A key feature of a QofE report is the use of the “add-back” method to normalize earnings, also called normalised EBITDA. This technique involves adding back certain non-recurring or discretionary expenses to the profit calculation. Examples include one-time legal fees, personal expenses of the owner run through the business, or salaries paid at rates significantly above the market standard. By making these adjustments, you can present a clearer picture of the company’s true, ongoing profitability.
A Comparison of Financial Reporting
| Feature | Regular Statutory Audit | M&A-Ready (QofE) Financials |
| Primary Goal | Verifying Tax Compliance | Demonstrating “Normalized” Cash Flow |
| Focus | Adherence to Historical Accounting | Projecting Future Earning Potential & Stability |
| Adjustments | Standard Accounting Practices | Strategic Add-backs of non-recurring or personal costs |
| Revenue Analysis | Recognition based on HKFRS | Deeper analysis of customer cohorts, churn, and concentration |
Preparing Your Business for a Successful Acquisition
Getting your business ready for an acquisition is a long-term strategic effort that requires a significant investment of time to organize your finances and position your company to attract the best possible valuation. If a sale is on your horizon, it is essential to begin conversations with your CPA long before any potential buyers appear, easily taking one to two years to fully prepare a business for sale.
This period is needed to streamline operations, remove personal expenses from the books to present clean financials, and resolve any issues on your balance sheet that could deter buyers or result in lower offers. A proactive and well-planned approach is the cornerstone of a smooth and financially rewarding M&A transaction. If you’re considering selling your business in the near term and are looking for advice, drop us a message and we’d be happy to help!
