There are several areas that need to be reviewed, evaluated, and often addressed before a company is ready to be presented for sale to prospective buyers. The following are some considerations to think about and address in order to prepare for a sale and maximize your company’s value:
Check Your Ego: One of the most common comments we hear from owners is something like “Our product is superior to everyone else. If we had a sales dedicated sales and marketing team, we could easily be a $XX million company.“ Upon further probing, we find out the company is at least 10 years old, but hasn’t yet broken $5MM in revenue. This is one common example, your company’s pain point could be in another area. Unfortunately, if you’ve been at something for this long and still don’t have a great deal of traction in the market, you aren’t worth a premium to a potential buyer. Be realistic about what a buyer is actually getting with your company – you may have strong technology or service but there may be a whole list of items that need investment in order to turn your company into a sales juggernaut.
Have Reasonable Expectations of Value: Media sources that publicize billion dollar cash and stock transactions executed by huge multi-national companies are not in the same league as most privately held business transfers, and can’t be used effectively as a comparison for the sale of company generating less than $30M in revenue. Your M&A advisor is incentivized to maximize your transaction, but there are realistic limits. If your $3M company has 20% ($600K) EBITDA, and has been growing at an average pace, a 6X or 7X revenue (a $20M valuation) would take the buyer 33 years to make back their investment. Approaching your transaction with realistic expectations will increase your odds of a successful exit.
Make Yourself Replaceable: For many companies, the founder is the driving force behind many areas of the company (sales, operations, implementations, development, etc.). In order to sell for top dollar, it is important to turn these tasks over to key people on your team, especially if you are starting to think about retirement or leaving the company post-sale to do something new. A strong team that functions well without reliance on the owner(s) is attractive to potential buyers because it lowers their risk.
Clean Up the Financials: It is surprising how often we see companies whose financials are not GAAP compliant, do not accurately reflect inventory or assets or include excessive owner discretionary items. Your internal financial statements give a potential buyer a picture of how you run the rest of your company. In fact, it is extremely rare to see a really well run firm with messy financials. Before considering a sale, ensure that you are GAAP compliant, get your statements reviewed or audited annually, and stay away from setting up overly complicated company structures that require a ton of inter-company transfers and adjustments. Potential buyers want to see clean, consistent financials that are easily read and understood. If you have to start explaining gaps in your financials, you risk a running a strong buyer away from your deal.
Focus on Growth: Profitability is important, but what buyers really want to see is a pattern of growth in the most recent years. If you are growing consistently year over year and your projections forecast more of the same, buyers are going to flock to your opportunity and will reward you for any growth above the market’s rate with a premium valuation. In the absence of any additional investments or internal improvements, a buyer wants the certainty that the investment will provide sufficient ROI. It is critical to be aware of what is happening in your market. If you are growing at 20% but the market is growing at 30%, be prepared for disappointment.
Develop Strong Systems: A strong internal infrastructure accomplishes two things: It helps everyone in the company to work more efficiently and effectively, as well as proving to potential buyers that you have your act together. Most buyers are looking for a company that can scale up. Stable internal systems provide the company with the ability to scale more efficiently than a company without these in place. In some cases, the acquirer will fold you into their infrastructure, while in others you may be acquired as a foundation for additional acquisitions. In the latter scenario, having strong systems and processes in place makes you additionally attractive.
Recurring Revenue: As society moves toward all things “as a service”, buyers look for a strong recurring revenue stream as compared to project-based revenue. A premium is placed on companies that have a significant portion of recurring revenue as a percentage of overall revenue.
Evaluate Your Team: Take the time to look honestly at your structure and staff. Are there gaps in competencies? Is there a strong management team, or is your org chart flat? Are any of your sales people consistently underperforming? Making changes to your team in the years preceding a sale to facilitate your firm’s growth will pay off handsomely when it is time to go to market.
Stability: This applies to all aspects of your business, clients, partners, employees, and suppliers. Low turnover and long-term customers show stability, cohesiveness, and lower risk in most cases. One of the biggest risks to a potential buyer is a lack of stability. Not only is it hard to value a company with an inconsistent earnings history, having longer tenure of your relationships, deeper roots, better communication, and more elasticity will offer the resiliency necessary for overcoming post-transaction challenges.
Consider the Structure: Every deal is closed with unique terms and structure. There are many ways to structure a transaction – varying widely is the amount of cash at closing versus any paid out over time or contingency based. It’s important to note that when more cash is paid up front, the overall valuation tends to be lower than if a larger sum is paid out on contingencies or over time. Often times when selling to a strategic or financial buyer, there will be some mix of cash, payout over time, earn-out or stock in the new company. Increased risk to the seller is the tradeoff for a higher valuation.
This list is far from exhaustive, but includes some of the common issues we run into time and time again when reviewing the readiness of a company for a sale. Many of these potential weaknesses don’t take significant time or investment to improve, but knowing where to focus your efforts will yield the best possible results.