Business owners, founders and entrepreneurs don’t always have a chance to plan their exit. Selling their business is sometimes an event that comes about either when a buyer makes an offer, or as the byproduct of difficulties the company experiences (revenue shortfall, regulatory and market changes, founder’s personal or health issues, etc.). In all cases, it’s never a good idea to rely solely on a classical multiple of earnings valuation when coming up with your asking price for your company.
A successful exit requires a successful sale. Selling a business is more than understanding the business’s past value to its original owner (earnings / EBIT / discretionary earnings valuations). It’s about understanding the value to the buyer. The buyer’s value or strategic value of a business can often be significantly higher to the buyer than it was to the seller when he ran and owned that business. Dr Tom McKaskill, an Australian expert investor, entrepreneur, and scholar says “Strategic value is created by the buyer. It is what it is worth to the buyer who has the ability to exploit your underlying assets and capabilities.” This is the essence of what you want to sell to to a buyer is your are investor or entrepreneur trying to maximize you exit’s financial outcome.
Not all companies have strategic value because this value lies is the underlying assets and capabilities of the firm. Some businesses, are really only valuable for in a very narrow set of circumstances (example: a painting restoration business specialized in late 19th century Dutch Paintings) or have to much personal goodwill attached to their value (example: a boutique ad agency that built its reputation exclusively on its founder’s talent). This said, even in these examples, asking questions such as these can help identify where your firm’s strategic value lies – from Tom McKaskill’s great book “Invest to Exit” -available as a free ebook here:
- “Who makes money when I make money?
- Who does not make money when I make money?
- Who can make more money than I can from my products?
- Who can remove a constraint on my business?
- Who has a problem I can fix?
- What threat can I reduce or eliminate?
- Who sells to the same customers I sell to?
- Who uses the same technology I use?
- Who needs my customer base?
- Who needs my technology or people?”
Once you have answered some of these questions and identified some potential target buyers, you need to do prepare for the discussions. Materializing the strategic value of your firm may mean actually modeling how your buyer’s business, profits, and growth would get impacted in details by the acquisition of your firm. This type of business modeling will have to include:
- Your firm’s classical earnings-based valuation.
- Your future market and earnings potential were the buyer decide to keep the business unchanged for a period of time.
- The merger efficiencies and economies of scale for the acquirer were they decide to merge part of the firm’s operations into theirs.
- The market dynamics created by the acquisition of your firm (especially if you compete in the same sector or industry).
- The strategic opportunities which the acquirer may be able to take advantage of post-merger:
- price increases,
- international opportunities,
- offshoring of production,
- leveraging of your company’s intellectual property: patents, special skills and know how.
Exploring the buyer’s valuation means creating a detailed financial model to measure the relative value of some of the scenarios above. This will help you argue why your company may be worth more than X times your earnings to a particular buyer. It will help your buyer become convinced that you are aware of your full value and will force him to divulge more about his/her negotiating position, thus allowing you the benefit of not passing a chance to make more money on the sale than a classical valuation may have permitted.
Soon, we will be posting an example of such a valuation. Contact us if you would like to help with a strategic valuation project.