Business owners often reach a point where they start to contemplate the sale of the business they’ve built, whether that’s to fully cash out value and free themselves up for the next challenge or bring in private equity (PE) investment to provide an element of cash out alongside support to drive additional growth under the PE house’s part-ownership.
Ultimately, the value of a business is whatever the best bidder is prepared to pay for it and valuations will always have an element of subjectivity to them. But, how are company sales values driven – and what can you do now to maximise value of ahead of taking your business to the market?
Calculating the multiple
The most commonly accepted methodology to derive the price of a business is through a taking a multiple of earnings. The multiple can vary considerably depending on the nature of the business and the market it operates in – and is arrived at by looking at a combination of qualitative and quantitative features. The key drivers generally fall under one of two categories - resilience or growth.
In the resilience bucket, primary considerations include factors such as:
Quality of earnings – Are the company’s revenues recurring and repeatable rather than dependent on one-offs?
Customers – How many are there, is there any concentration, and how sticky are customer relationships, or to put it another way what is the customer retention or attrition rate?
Barriers to entry – How difficult would it be for another business to replicate the company’s services? Does the company own the IP to the products it sells?
Team – how complete is your team? Are there are gaps? Do you need to plan for succession?
Growth is the other driver of multiple and is particularly important when looking to sell to PE, who as a rule of thumb are looking for earnings to at least double value over a 4-year period. Prospective buyers and their advisors will look at a number of other indicators.
Growth levels – What level of growth has been achieved historically and is forecast to be achieved?
Market opportunity – Is the market the business operates in growing? How big is the addressable market and what current share does the business have? How scalable is the business?
M&A opportunity – over 60% of PE investment as reported in the KPMG mid-market PE review is into bolt on acquisitions for existing portfolio companies. Is there an opportunity for your business to be a platform? Do you have a pipeline? How tangible can you make this appear to bidders in a process?
Cash flow conversion – How do profits from the business convert into cash, for future investment in growth. Focus on cash conversion has naturally increased recent times as economic conditions have tightened.
Multiples can be inferred by looking at comparable companies in your sector as well as comparable completed deals. However, these are indicative and no two businesses are the same really, so we advocate a more detailed exercise – benchmarking – where the KPIs that drove the multiple in our deals are identified and used to benchmark your business against.
How can you have an influence?
Your multiple is not static - what you do now can and will have an impact. There will be business model areas that you can address and optimise relating to resilience or growth. One way of thinking about it is “walking through the door backwards”. Identify want you can and want to look like in the future and put the steps in place to get there.
From a more granular point of view, once you have identified the KPIs that drove the multiple in comparable businesses, track your progress in improving against them.
But, do you have the data, systems and processes in place to robustly monitor your KPIs? Being able to extract and present your KPI information will have a significant impact on how your business is perceived by a prospective buyer. It immediately shows that your business is data-driven, tracking progress against performance criteria, and that you understand the drivers and drags on your business’ value. This in itself makes for a more attractive purchase proposition and is worthy of the investment and time and resource.
Earnings measures
Armed with the multiple, the other part of the equation is earnings. This may be of revenue, EBITDA or EBIT depending on the nature of your business. Ultimately, it’s intended to be a proxy for the level of sustainable cash generated from profits.
Revenue multiples are often associated with technology businesses with a low “cost to serve” and an overhead base which may be inflated by upfront investment to grow. EBITDA is the most commonly used measure in non-technology businesses, while EBIT is generally used for businesses with models that are more capital intensive (needing to invest in assets to operate or grow).
Ultimately, you want to present a “sustainable” earnings figure. However, this is not necessarily the highest possible figure as it needs to be robust. If you’re too aggressive, this may be challenged in due diligence and then by the buyers, leading to changes in the offer levels from opening bids.
In arriving at the sustainable earnings future, adjustments should be made to reflect one of items – these can increase or decrease the base earnings figure depending on their nature – and are referred to as one-off or non-underlying adjustments.
Other methodologies are applied to underpin the deliverability of a future earnings figure – and hence point bidders to a higher structuring earnings figure for the multiple to be applied to.
Run rate adjustments should be made to reflect the prevailing momentum in a business, annualising a recent period of trading to present a more accurate reflection of the business now. Pro-forma adjustments may be made too, to reflect the full year’s impact of things that have happened in-year or potentially in the immediate future, such as a recent acquisition or a significant new contract.
Finally, there are buyer-specific synergies that should be quantified and presented to prospective buyers. These can be revenue synergies (the prospect of increased revenues through access to a buyer’s customers, cross-selling opportunities etc) or cost synergies (the prospect of lower costs through economies of scale, merged people or office costs, IT costs etc). In presenting these synergies you are helping the buyer see the value of your business in their hands – and hopefully taking some of that incremental value back in what they are willing to pay to acquire your business.
It’s also important to appreciate that the value we’re talking about here is not what you will actually receive in your pocket as you will be selling your business free of debt and cash, and with a normal level of working capital. The value of the debt, cash and normal working capital in your business will be agreed with bidders and reflected to arrive at the Equity Value, which is the actual consideration you’ll receive for your shares.
If you’re contemplating a sale, plan ahead as what you do now will make a difference. Get an experienced and knowledgeable advisor on board – to help identify your KPIs, value drivers and value drags, and ultimately conduct a process that approaches the right prospective buyers at the right time, with appropriate tailored messaging, to create and leverage competitive tension and maximise the value of your business.
