Recently Cass Business School of the City University London and Intralinks collaborated on an insightful study on steps business owners can take to enhance their standing with buyers and thus improve the values offered and/or deal structure when exiting. Entitled “Attractive M&A Targets: Part 1 - What do buyers look for?” I found it to be quite informative.
This study is similar to the Generational Group’s Roadmap for Enhancing Value (REV) that we provide every client as part of our standard evaluation process. Our REV looks at a couple of dozen key valuation categories and rates the client in each. Then, based on that rating, we make suggestions that can be implemented to enhance both the company’s valuation and also its sale-ability in the eyes of buyers.
The folks at Cass and Intralinks have essentially done the same thing, only they analyzed 23 years of acquisitions and reviewed more than 14,000 transactions that occurred during that time frame. Based on their excellent analysis there are several things business owners can do to enhance their value.
Today we cover the first: revenue growth.
Simply put, what they found was that companies with above-average revenue growth make better acquisition targets. This is how the study explains it:
“Target companies have higher growth than non-targets. Our study finds that growth of target companies, as measured by their three-year compound annual growth (CAGR) in sales, is 2.4 percentage points higher than that of non-targets.”
What they have done empirically through their research is prove what deal makers have been saying for years: Buyers are looking for companies that demonstrate a track record of solid expansion AND can provide documentation to support it will continue. It is far easier to convince a buyer to pay several millions of dollars for your company if you prove that it has the momentum to keep growing its top line.
However, what they also found was this:
“Companies are also most likely to become acquisition targets if they have either much higher or much lower growth than the average. Companies in the top or bottom deciles for growth are on average 20% more likely to become acquisition targets in any given year than companies overall.”
That may sound odd. High growth of course makes sense as we have discussed. However, why would lower growth companies be also attractive? Because they have potential. Remember buyers are buying your future, NOT your past.
This is how a VP of M&A with a German company explained it to the authors:
“Low-sales-growth businesses can be a good deal if they are affordable and have the potential to improve sales in the long run by getting funding assistance to develop the operating quality and also improve the business objectives by injecting more capital into the business. The profits can be capitalised on in the long run.”
This view is supported by the senior vice president, M&A of a U.S. public company:
“We would conduct a detailed analysis on the company’s financial position and its operational processes, and try to find a solution to improve sales growth by investing in new technology or by replacing the management.”
What these professional buyers are saying is that if historic revenue growth is not demonstrated, if the CAGR is not consistent over 3-5 years, it is NOT a deal breaker. But the key term in the first quote above is “if they are affordable.” Most buyers are not going to reward you if you have been complacent and your revenue has dropped over the past few years. They may acquire your company but will do so at a discount over a premium valuation, the type of valuation you will get if you have CAGR of 10% for three years vs. CAGR of 2%. The latter company may get acquired but the former will get a higher valuation.
Here is the key to all of this: If you want an optimal deal, work on creating a solid, dependable, consistent revenue stream. And as a corollary, build a revenue base that is not concentrated on a single client or market. In a word, diversify!
As mentioned, we provide a roadmap to each of our clients, which gives them specific action items to pursue and work on and do so, in many cases, while we have them in market. It is a fabulous tool and is very helpful to any owner wanting to eventually close an optimal deal.
If you would like to learn more about our REV document or our services in general, please call me at 972-232-1125 or email me at email@example.com. I would be glad to have a confidential conversation with you about your company.
We also conduct educational exit planning seminars where many of these concepts are first introduced to business owners. If you would like to attend one, use the following link to learn more and register:
By Carl Doerksen, Director of Corporate Development at Generational Equity.
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