Succession or exit – it’s a stark choice, but since we are all mortal, one of these is going to happen!
A recent study of Canadian businesses showed that while 70% recognized that a transition or exit will have to take place, only 7% had a plan! And incidentally, selling at the best price at the right time doesn’t constitute a plan!
I worked for an international mergers and acquisitions company in both London (UK) and Boston (USA). While I was there we carried out a study of 250 M&A transactions we were involved in, over a span of 8 years. The transactions took place in Europe, US, and Canada.
We wanted to find the key areas that buyers looked for in a transaction. Based on the study, we developed a framework for ranking and assessing a company on the factors that were proven to drive a valuation.
The main areas of value enhancement that emerged are described below.
1. Financial
This category includes basic financial metrics such as profitability and revenue growth. Companies with high profit margins and high rates of revenue growth obviously command a higher valuation.
Other aspects include the type of revenues a company generates. Recurring revenues can add to a valuation as it makes the company’s cash flow more predictable. So, for example, a company that sells big ticket one-off products could look to build up more of an offering around maintenance and post-sales services for their product – where they can sign their clients into multi-year maintenance contracts.
Companies with strong cash generation are also more attractive to buyers. They are able to take on more debt that can be used to finance growth. It also makes a leveraged buy-out possible.
2. Market & barriers to entry
In this category the factors include the strength of customer relationships and degree of uniqueness the company enjoys in its market. Companies that have a direct and strong relationship with the end users/purchasers of their product will get a higher valuation.
Brand, which clearly has to be part of a long-term strategy, plays a large role in the value a buyer places on a company. We found that a strong brand can make up to 70% of the value in a company.
In terms of barriers to entry, companies should use many mechanisms to defend their position. Examples are legal protection though patents and trademarks, exclusive relationships with key suppliers, and building internal expertise through strategic hiring. Anything a company can do to make it harder for competitors to enter their space will help command a premium on valuation.
3. Human resources
In this category, the framework looks at both technical skills and management skills. As companies grow, it is important to distribute the key skill sets deeply across the organization. Often after an exit, the founders will want to leave, either because they have a large financial gain or they prefer to be entrepreneurs over working in a large corporation. A buyer will place a premium on a deep management team so the company can continue to innovate and execute even with the loss of the founders.
4. Strategic fit
This factor relates to the degree that the company being acquired is a strategic fit for the buyer’s product portfolio. We have seen cases where buyers are willing to pay a 50%-70% price premium for a company that fills out a missing piece of their product portfolio and gives them access to the markets and expertise.
Partnerships are an excellent way to lay the foundation with a potential buyer. A partnership is a low-commitment way for them to get deeper experience with a potential acquisition. If things work out well and strategic synergies start to develop then it is easy to take the step towards a deeper relationship.
5. Governance
The last factor involves good governance. We have found that a strong board of directors can add a 25% premium to the value of a company. This is due to the buyer having more assurance that the company has been well governed and there will be no unexpected surprises they need to deal with.
A Few Final Thoughts.
There are 3 main ways in which the succession issue can be handled: a younger generation of the family takes over; the executives buy out the owner via a management or leveraged buy-out (MBO/LBO); or there is a liquidity event (the shares are given some realizable value) by means of a trade sale or listing on a public market (Initial Public Offering or IPO).
Whichever route is taken, it is clearly in the shareholders’ interest to maximize the value of the business prior to that event. The ideal time to begin that process is on day one, but it may not be too late; 2 years is a realistic timescale in which to groom a company for sale/transition.
Let me leave you with 2 thoughts. Begin thinking about it today. And get some help from people with experience.
Jim is a senior advisor with an extensive career in Europe and North America who specializes in strategic corporate development for the technology sector.
After an early career in which he designed airborne and commercial computer systems in both Canada and the UK, he joined, a US computer manufacturer, Datapoint, where he managed international marketing covering seventeen European countries. He then worked for 3i, Europe’s largest venture capital and private equity firm, where he facilitated investment in UK technology companies for their expansion to the United States. Jim joined Regent Associates, a boutique M&A investment bank in the UK, before relocating to the USA where, as co-managing director, he established Regent’s USA presence in Boston.
Jim’s investment banking experience includes buy, sell, corporate divestment, MBO and fund raising mandates for clients based in Canada, USA, Europe, China and India including Mitel, Polaroid, DEC, ICL, Huawei and HCL. Transactions he has led span the areas of telecommunications, applied technology, software, e-commerce, and professional services with completed deals totalling $400 million.
Jim lives in Toronto where he also mentors early stage companies and participates on a number of advisory boards. He is a graduate of London University, with an honours degree in electrical engineering.
