Every day, families, individual business owners and management teams sell their businesses, large and small. Our investment banking firm, The Westbury Group, assists clients in this complex effort. We see an enormous range of values that sellers receive for their businesses. Having witnessed and participated in hundreds of deals, we’ve identified several factors that have the greatest impact on getting a good price for your business.
We’ve developed a simple quiz to help you understand how buyers are likely to assess your company if you bring it to market. You can also use it to identify areas of weakness and work to improve them before you start the sales process.
Are you using an adviser?
Hiring an M&A advisory pays for itself many times over. A robust academic study done by leading professors of economics, which analyzed more than 3,000 private company transactions found that “private sellers that hire M&A advisers receive significantly higher acquisition premiums.” The median benefit was 24.6 percent.
Are you willing and able to give the sales process sufficient time?
A well-managed, orderly transaction usually takes six to nine months and even longer if there’s a hiccup such as not reaching your forecasted numbers or accounting errors are uncovered. It takes that long to produce strong marketing materials, identify a good set of buyers, approach those buyers, negotiate the terms and for the buyer to do their due diligence. A seller may be able to accelerate that timeline, but usually at the cost of a lower price. Furthermore, much of the timeline depends on the buyer’s schedule, not yours.
Are you willing to assist the buyer for a suitable transition period?
Having the owner stay for a sufficient period is usually critical to transitioning a business successfully to a new owner. This requirement is particularly important when the owner controls or has a significant influence over important customer relationships. The exception to this rule is when the owner truly has not been involved in the business for a couple of years or more.
Does your company have at least $3M EBITDA?
Westbury has reviewed transactions from 2012 to March 31, 2018 and found a very consistent pattern: the larger the company, the greater the value, measured as a multiple of EBITDA. There are two factors driving this correlation. First, in general, the larger the firm, the lower the risk, because larger firms are less susceptible to both external and internal disruptions, which could jeopardize the entire business. Second, many buyers will not look at companies that are too small. There are certain plateaus ($1 million, $3 million and $5 million EBITDA) at which more buyers will seriously consider a deal. And the more potential buyers who are involved in a sales process, the greater the competition, which tends to drive the price higher.
Is revenue growing?
This factor is easy to understand: the higher the growth, the stronger the potential return for a buyer. Sellers who are on either end of the spectrum may want to consider the timing of going to market. Buyers may look to squeeze sellers with declining revenues. But sellers with skyrocketing growth should be careful as well: buyers may insist on structuring the deal so that a significant portion of the value is put into an earn-out, which the seller only receives when they prove that the high level of growth will continue well past the closing date of the acquisition.
What is your gross margin percentage?
Sellers bringing a company to market for the first time may wonder why gross margin matters. After all, profit is profit. The answer lies in what the gross margin percentage signifies. Buyers see gross margin as an indicator of a company’s market pricing power. A company with a proprietary product or service can value-price its offerings, which gives buyers comfort that their acquisition is not at the mercy of the market. A commodity player who sells the same product line as all its competitors has few defenses. On the other hand, buyers buy distributors every day, and are particularly attracted to those that have higher margins than their peers, a sign of a competitive advantage.
What percentage of your revenue is recurring?
Buyers love recurring revenue, which they equate with stability. If a subscription-based target company’s revenue is primarily recurring, most of the next year’s revenue is already in the bag on Jan. 1. On the other hand, a product company selling widgets or a project-based service company starts off each year with a blank slate. One should note that recurring revenue is only valuable if customer retention (“stickiness”) is high. If 80 percent of your contract customers do not renew, then the business is much more like a nonrecurring business — worse in fact, because customer defection is a sign of market dissatisfaction with the company’s offering.
How unique is your product or service?
Buyers are like art collectors as they want to acquire something unique. The more unique your company’s product or service, the less vulnerable you are to competitors entering your market and trying to undercut your price. If you’re just selling a commodity, you may be able to differentiate your business by bundling it with a more value-added service.
Is there a strong argument for a sustainable, defensible, competitive advantage?
Sustainable competitive advantage signifies that your business enjoys a “moat” protecting your business from competitive attacks. There are four main sources of competitive advantage: scale, customer captivity (your customers’ cost of switching to a new provider), cost and government protection. Sustainable competitive advantage lowers the risk associated with buying your business, which, in turn, increases the amount that a buyer would be willing to pay.
MANAGEMENT & ORGANIZATION
Quality of Second-Tier Management
As a business owner, you know your company inside and out and are probably the driver of its growth and success. Buyers know that and may be concerned about what will happen after the sale when you move on from the company. If you have a very strong management team beneath you, and they plan to stay with the company after the sale, you’ve eliminated a major concern for the buyer. If you don’t have that team in place and you don’t need to sell immediately, one of the most important steps you can take to increase the value of your firm is to put that team in place.
Quality of the employees
The quality of the employees is as important as the quality of the management team. For many industries, such as high-end manufacturing and professional services, the profile of the workforce is of paramount concern to a buyer. What skills do the employees have? What training have they received? What is employee turnover? Strengthening your employee team can have a huge impact on how a buyer looks at your business.
Related but separate from the quality of the employees is the culture of your organization. Buyers do research on what current and former employees say about working at your firm on sites such as Glassdoor. At the point in the sales process when the buyer is walking through your facilities, they will look for clues as to the company’s culture and how happy your employees are. What cartoons do your employees post in their work areas? How are visitors treated when they enter the building? The cleanliness of the facility — inside and out — can also leave a big impression. Although these are qualitative factors, they can dramatically sway a buyer’s perspective.
OPPORTUNITIES AND RED FLAGS
Is there valuable intellectual property not currently used in the business?
Intellectual property (IP) can be an important source of sustainable competitive advantage. Companies may have IP that is not being used in the business. As a business owner, there are two ways to extract value from that intangible asset. First, you can sell it with the business and your adviser can highlight the additional economic value associated with that IP. Second, you can sell or license it prior to the sale so that you aren’t giving the buyer an asset for which you will receive little or no value.
Is there significant customer concentration?
If you have significant customer concentration (one customer generates 15 percent or more of your revenue and profits) a buyer will have concerns. From the buyer’s perspective, that concentration represents risk because if that one customer leaves, a significant portion of your business disappears. You may not be able to do anything in the short term, but if you’re thinking of a sale a few years down the road, do whatever you can to bring on other customers to reduce your concentration. If that is not possible, be prepared to have buyers offer anywhere from 10 percent to 25 percent less for your business.
Are there any red flags?
If there is any criminal history (whether or not associated with the business), bankruptcies, extensive personal or business litigation, or legal or environmental challenges, it will come up during the sales process. Sophisticated buyers are very thorough in their due diligence. Be prepared to have a clear, concise and, if possible, positive explanation of these red flags. The most important guideline is to never hide these problems. Doing so will damage the trust that is the foundation for any successful deal.
Jon Rubin is the managing partner at Westbury Group in Westport, Connecticut. He can be reached at 203-745-0272 or firstname.lastname@example.org. Ted Yang is the managing director at Westbury Group. He can be contacted at 203-803-4470 or email@example.com.