Tag Archives: selling a business

Five Recent Examples of Acquirers Paying a Premium

What are buyers looking for in acquisition targets?  The objective of an acquisition is to create value.  This is accomplished by improving profitability and/or reducing risk; both enhance earnings quality and drive value.  More specifically, acquisition objectives can include achieving economies of scale or economies of scope, vertical integration, securing access to talented management, unlocking underutilized assets, gaining access to proprietary technology, increasing market power, shoring up weaknesses in key business areas, geographical or other diversification, to reach critical mass for an IPO or to achieve post IPO full value.

Below we list the rationale for paying a premium behind five recent real-life transactions.

To Maintain or Improve its Competitive Position: This may be the most common motivator for acquisitions by large companies such as Oracle or Cisco.  With the rate of change in the tech sector as fast as it is, it is a lower risk strategy to wait until a new solution is proven and a sector leader has emerged than pursuing this organically.   Acquisitions of this nature achieve a number of risk reducing objectives including strengthening customer relationships.

To Improve the Revenue Mix to Higher Valued Revenues:  Ever since hosted recurring revenue models (SaaS) came into existence, revenue quality has been a hot topic.  In this case the buyer was a public company and a large share of its revenues were of a product reseller nature.  These types of companies typically have a large customer base that they want to sell more products and services to.  The goal is to improve revenue quality.  Potential revenue quality improvements include moving from distribution to higher margin VAR (consulting), or from consulting to support/maintenance (recurring revenues) and, ultimately from support/maintenance recurring revenues to sticky, mission critical recurring (cloud application) revenues.  Acquisitions of this nature create value by improving revenue quality resulting in a higher valuation multiple.

To Fix Underperforming Parts of the Business:  In this case, a large company had a small division that fulfilled a necessary component in the value chain.  The division had HR challenges and was underperforming.  Not only did the seller have a superior technology but it also had a very knowledgeable management team that would become a great asset to the buyer.  The buyer was able to pay far in excess of any other interested party and stood to benefit much more as well.  Finding a buyer that can benefit from multiple aspects of a seller’s business is rare but when it happens, a very good deal is possible.

To Unlock the Potential of Underutilized Assets: In some cases, proprietary resources such as R&D, patents, proprietary processes and technologies and even personnel are underutilized because of limited access to capital or other constraints.  Acquisition by a more, well-resourced company can unlock value in these assets.  Acquisitions of this nature typically achieve revenue and/or margin improvement.

To Achieve Full Value as a Public Company: Reverse Takeovers (“RTOs”) are an active part of going public in Canada.  However, in some cases, once public, the company’s share price languishes as there isn’t sufficient value or liquidity to attract analyst coverage.  With publicly traded shares as available currency, an acquisition strategy will increase the share float and diversify the investor base.  In time, costs will have to be rationalized or synergies achieved in order to evidence margin improvement.  The stronger business attributes combined with improved trading liquidity will realize full value over time.

While the situations outlined above sound like textbook cases, in the real world, the stars don’t line up to create a premium sale as often as one might think.  The timing has to be just right, where the buyer-target fit is considered a high priority and the target business is of sufficient size (and that typically means having grown beyond start-up) to be worth the effort.  A managed sale process can bring a number of interested parties to the table and help identify the rationale to drive exceptional sale value.

Managing Operating Risk To Drive Value

In my previous post I said that if revenues are diversified and sticky then they are characterized as high quality.  A business with high revenue quality is one that will likely be around for some time to come, and is therefore highly valued.  However no business is risk free.  If your revenues are project oriented with little opportunity for repeat business, or you operate in an industry with low barriers to entry, or a people dependent business such as consulting, advertising or staffing, then what can you do to realize as much value as possible?

Mitigate the risks inherent in the business model by focusing on the following:

Differentiate your Product or Service
While at first glance, it may seem hard to differentiate a business in a well established and competitive sector, keeping an eye on consumer trends combined with creative marketing can often carve out a new profitable niche and present a tremendous growth opportunity.  Lululemon Athletica in the apparel sector and Chipotle Mexican Grill in fast food are examples of effective differentiation strategies.

Grow and Strengthen Customer Relationships
Reduce the unpredictability of project revenues by nurturing customer relationships.  If you can show that the same customers use your services several years in a row then you have an argument for revenue predictability.  If that list of customers is more than twenty then you have an argument for revenue diversity. Length of customer relationships is also a good indicator of a high quality product/service.

Focus on Execution Excellence
In a service business, it comes down to attracting and keeping the best personnel in order to deliver service excellence.  Human resources is a complex, multi-dimensional field and should include processes for recruiting, role definition and responsibility, position incentives and benefits, periodic feedback, and documentation and procedures to fill gaps in the case of unexpected departures.

Add Products and Markets
A one product company is riskier than a product line company.  A local company is riskier than one with a multi-national presence.  While it is easy to over-extend yourself, consider managed product and geographical growth to mitigate risk.

Cultivate Multiple Supplier Relationships
Don’t let your business become “captive” to a sole supplier of component parts.  Cultivate multiple supplier relationships to reduce supplier power and dependence.

Improve Profitability
Analyze your profit margin to see where you want to drive your sales — to higher-margin areas.  A trend of improving margins as a result of operational efficiencies and returns to scale will result in a higher valuation.

Protect Intellectual Property
IP can be patented, copyrighted or treated as a trade secret.  Identify the IP in your business and make sure it is protected and properly owned.

Build Your Brand
Spend time on all of the above will build your reputation and your brand.

The following chart summarizes various characteristics that drive company value.

op risks

Operating risk should be addressed by implementing formal processes.  A business with formal processes, systems and documentation reduces the dependence on individual talent and can quickly respond to exogenous shocks.  Items such as Service Level Agreements (“SLAs”), marketing plans, job descriptions, employment contracts, confidentiality agreements, professional codes of conduct, organization charts, etc. institutionalize a business.  Documented processes are transferable value.  Capturing and transferring knowledge will make the business more sustainable and more valuable.

If potential buyers feel that a business has a high risk profile, they will either not buy it, reduce the price they are willing to pay, or make a portion of the price contingent upon the business’s future performance.

Goodwill Transferability is Critical for a Successful Business Sale

In many cases, small businesses rely on key management; typically the founder and CEO. The founder and CEO will have developed the IP, maintain trade secrets in his/her head, manage client relationships and sometimes relies on personal trust as opposed to written contracts in client and supplier relationships.

Goodwill is that intangible asset that contributes to earnings as a result of name, reputation, customer and employee loyalty, location, products, etc. When goodwill is attributable to the individual it is called personal goodwill, when it is attributable to the entity it is called enterprise goodwill. Enterprise goodwill is created by adopting formal processes, systems and documentation which reduce the dependence on individual talent. Items such as Service Level Agreements (“SLAs”), marketing plans, job descriptions, employment contracts, confidentiality agreements, professional codes of conduct, organization charts, etc. institutionalize a business. If a key employee leaves and a replacement can be trained quickly to fill the position, then the business will be more stable, less risky and more valuable. Goodwill must be attached to the enterprise to realize value in a business transition.

Personal Goodwill Characteristics
The following characteristics would be indicative of personal goodwill:
• Small business highly dependent on owner’s personal skills and relationships
• No non-compete or employment agreements
• Personal services provided by the owner(s) an important feature in the company’s products or services
• Sales largely dependent on owner’s personal relationship with customers
• Product and/or services know-how and supplier relationships rest primarily with the owner(s)

Enterprise Goodwill Characteristics
The following characteristics would be indicative of enterprise goodwill:
• Company has written contracts with major customers and suppliers
• Company has written employment and/or non-compete agreements with key employees
• Formalized organizational structure, systems, and controls
• Company has formalized production methods, business processes and business systems
• Business is not heavily dependent on personal service performed by the owner(s)
• Company sales result from company name recognition and/or sales force

Enterprise goodwill must also be sustainable. Sustainability refers to the ability of the company to maintain the incremental cash flow over the medium to longer-term. Sustainability may require ongoing investment in R&D, promotional costs, and other expenses that have to be taken into account when assessing the value of goodwill.
To realize full value in the sale of a business, the owner-entrepreneur must make him/herself redundant by transferring personal goodwill to the business. This is done by putting formal systems and procedures in place. If a potential buyer feels that a business is largely owner dependent, they will either not buy it, reduce the price they are willing to pay, or make a portion of the price contingent upon the seller successfully transferring personal goodwill to the business.