Business owners should always have one eye on the equity value growth of their company.
Even if they believe they have thought through a succession plan for family or fellow shareholders, it is all too easy to “dream up” a valuation prior to a sale of the business.
In our experience, the vast majority of business owners base the decision to sell their business on reaching a certain revenue or profit milestones. They have a specific volume of revenue in mind and, once this is achieved, they then calculate the value of their business, using a formula of X multiples of either revenue or profit.
Valuation Formulae – More Fantasy than Fact
Sadly, this ‘formula’ is based on nothing more scientific than the multiples they see being paid for rivals or companies with a similar profile.
As a means of valuing your company, this is akin to consigning your fate to the Wicked Witch of the West.1
Valuing your company in this way can mean that you cheat yourself of genuine ROI for the years of hard graft, spent growing your business.
How much is my company worth?
A question which always materializes during initial discussions with new clients is, “How much do you think our company will be worth at sale?”. My answer is always simple, direct and brutally honest: “I simply don’t know.”
Obviously, we know what is happening in the market and how much interest there is in certain business models, technologies, solutions, sectors & customers etc. But no two companies are alike.
Perceived Vs Achievable Equity Value
Increasingly, after our initial analysis, we conclude that there is a huge gap between the potential valuation that can be achieved versus what is perceived as the current equity value.
Another aspect we have learned the hard way is that not every business owner has an objective or realistic view of the true value of their business.
A More Accurate Approach
Over the last 3 years we have developed a useful tool which enables us to gain deep insight into the true condition of a company, in a measurable and tangible way. We assemble the entire executive team or leadership for a 1,5-day strategy workshop, which includes several brainstorming sessions to scrutinize five key elements of their business:
- The competitive environment
- Their marketing capacity
- How their sales engine is really functioning
- The quality of their management team
- The effectiveness of their strategy and planning.
During this process, using a scoring range, we have seen many companies rate the ability of their company in certain areas as no higher than a 5. Yet, during initial discussions, the same companies have been presented as being “ready for a sale”.
Getting “M&A Ready”
Right now, approximately half our client engagements cover a 1-3 year period, during which time we provide pragmatic, actionable advice to get our client “M&A primed” and ready for sale, rather than taking them immediately to market.
This can sometimes be a painful process, but business owners should understand that simply achieving a certain revenue or profit level is not sufficient for them to achieve best ROI at sale; value is created in a variety of layers. Strategic buyers are looking for one or more of the following elements:
- Historical growth rate
- Projected growth rate, combined with a good equity story, detailing how this will be realized.
- Historic profit levels with projections for the next 3 years.
- Breakdown of revenue (Cloud based, term based, perpetual license, maintenance, recurring, Professional Services, consulting etc.).
- Direct versus indirect sales breakdown
- Quality of the sales force
- Productivity of marketing and synchronization with the sales team
- Quality of customers
- Geographical coverage
- Talent within the company
- State of the technology and roadmap of the products/solutions.
- Dependency on business owner
- Alignment of the key shareholders
Only with the right fit for a buyer, can a successful transaction be achieved.
Demonstrate Achievable ROI
Further, to be able to demonstrate how the acquisition can provide future incremental growth and provide differentiators for the buyer versus their competitors, is a key factor in achieving optimum sale price.
No buyer will invest between $10M and $200M to purchase another business without being completely confident of their ROI within the subsequent 3-5 years - if not sooner.
Be Open; Shorten Your Sales Cycle
A compelling equity story is required, in which the above components, plus many more, are measured and correctly positioned - taking into account both strengths and weaknesses.
Being open about this helps to shorten the sales cycle.
Therefore, we always start with a deep analysis to uncover the real, and sometimes hidden, value of a business. It may very well be the case that your company offers much more value than any of the companies you may have seen sold in a similar market segment.
Following our analysis, we are able to glean a much more realistic picture, not only of the current value, but also the untapped potential that can be realized by taking specific, corrective measures and mapping out a clear vision for the development of your business for the years ahead of you.
Exercise Caution When Changing Your Business Model
At this point, let me eliminate one element which is, in my view, consistently overrated – This concerns how much business is being done via a SaaS services model. Clearly, this model indicates a scalable business, once initial customers have been secured, become productive and generate recurring revenues. However, the truth is, that most software companies that have been in business for 10 years or longer, primarily rely on selling software licenses - Especially in European regions and some verticals such as manufacturing. Many clients and certain sectors still want to purchase their own software rather than having apps somewhere in the Cloud.
5 Year Development Period
Before any company starts to concentrate its efforts on developing a SaaS business model, which could easily take 5 years to develop, the following questions need to be carefully considered:
- Will this cannibalize the existing revenue?
- Will growth likely decline as a result?
- Will this cause profits to decline too quickly?
- Will the sales force, used to selling a product and not a service, need to be replaced?
- How will this impact any distribution channel?
Potential Difficulties in Transition
Smaller software companies with below $50M in revenue, will have a challenging time in realizing such a transition. Proving that they can deliver and secure new customers with a SaaS model is good as it shows they can do it. However, in order to accelerate growth, such companies may be better off under the umbrella of a much larger organization with the resources to leverage their own sales force and/or partner channels, to quickly scale up. In trying to develop this themselves, such smaller software companies might lose value rather than gaining it. This is particularly true in today’s disruptive technology marketplace with its increasingly narrow window of opportunity.
Be Brutally Honest with Yourself
The most important message to trigger the sale of a business is to have a brutally honest understanding and acceptance of the strengths and weaknesses of your company, plus a realistic understanding of its growth potential. This will also give a clear indication as to the best hunting ground/s for the right strategic buyers, willing to pay a premium price – one which acknowledges the true value of your company, rather than just simple multiples of revenue.
Changes Can Upset the Salesforce Status Quo
Another aspect affecting equity value, is the productivity of the sales force, especially where a completely new platform/solution has been developed; it is possible that a previously highly successful sales person might struggle to sell a new platform. Analyzing this in detail, prior to making changes, can avoid the situation developing where 50% or 60% of your current sales staff are not achieving their quota. This scenario will have a direct impact on both your top line revenue and your bottom-line profits - not to mention the morale of your sales force.
Be Prepared, Be Successful
Do your homework well in advance of a possible sale, in a measurable and honest way. Include your leadership team in the assessment. Although the path ahead may not be without its challenges, this straightforward, pragmatic approach will pave the way for a successful outcome.
It takes more than simply interpreting a balance sheet and P&L statements to come to decide on the best way forward for your business.