Before taking your company to market, it’s important to understand how buyers determine value and how to maximize business value. This article explores how buyers think about your business and offers methodologies designed to increase the value of your business at the time of transaction.
Types of Buyers
During the sale process, the goal is to maximize the number of qualified prospective buyers to increase enterprise value. There are two types of buyers, the strategic buyer and the financial buyer (including family offices in the financial buyer set). Strategic and financial buyers have different motivations. Attracting both typically increases your company’s value.
Buy versus Build
Every acquisition decision is a “buy versus build” decision for a strategic buyer or a private equity-backed strategic company. Positioning your company for the buy is important to create the market for it. For larger businesses, a financial buyer might invest in a “platform” company with which to begin an industry consolidation process in a fragmented market (also known as a “rollup”).
What is Business Valuation?
Business valuation results in the price a buyer is willing to offer for a company. There are a myriad of factors that are used to determine value. Among them the size of the market for the company’s products and the business growth opportunities within its reach; historical and projected revenue growth; the prospective recurring nature of a company’s revenues; the company’s product margin profiles; how scalable the company is — that is, how fast it can grow and whether profitability as a percentage of revenue grows faster than revenue itself; and the strategic value of the business to a buyer.
Companies that maximize business value demonstrate a compelling business growth story, focusing on sustainable sales (i.e., repeatable revenue from any given customer — subscription models, for example, typically command very significant multiples) and scalable profitability (typically measured as Adjusted EBITDA) that grows more rapidly than revenue.
Revenues and Margins
Not all revenue is created equally. All other things being equal, buyers will pay more for businesses with higher margins. To understand this, we guide sellers to know revenue and margins by several indicators:
- Product or service line
- Customer
- Distribution channel
- Category of customer or market type
- Geography
We meet companies every day that don’t have this information readily available. To maximize business value, leaders need this data at their fingertips and must demonstrate how they’re using it to make strategic decisions. Not knowing these fundamentals is a sure way to leave money on the table.
Another factor that will be evaluated is “concentration” in any of the above factors. Too much reliance on any single customer or product line creates — at the very least — the perception of risk that such a customer or product disappearing will materially impact revenues and profitability.
We focus on understanding the information within the company and creating strategic growth plans that build on its strengths while improving the fundamentals that drive business value. These growth plans draw on the proprietary elements within the business and its financial capabilities to execute on them.
Leadership
The quality of the management team is a critical factor when evaluating a company. Equally importantly, it is equally vital that no single leader be so central that the business cannot effectively function without them.
Financial buyers generally don’t manage the day-to-day operations of companies they acquire, relying instead on the existing management team and functioning at the board of directors level. If the team does not inspire confidence in a buyer, some or all prospective buyers will not participate in a process, reducing the number of prospective participants, potentially dampening value or creating an environment where there won’t be a trade.
Strategic buyers, however, might not place leadership as their highest priority, having their own leadership team to manage the acquired business.
Other Factors
Other important factors include:
- Size and growth of the market
- The quality of the plan and “story” that is being told in the transaction process
- The fit of the investment banking firm engaged to conduct the sale process
- The business’s capacity to handle projected growth and the capital required to meet anticipated demand