This post is the second of two parts discussing Preparing for an Exit and making sure that your Company is worth what it should be. You can review Part 1 here.
Valuation Drivers:
In Formula 3 (EV=Adjusted EBITDA ×5) there two terms – the number five and Adjusted EBITDA. The following discussion provides guidance to positively affect both. Some of the items are easily addressed while others cannot be fixed. We believe that it is our job as investment bankers to help you recognize ways to improve value and present your company to the market in the best possible light.
Impacting the multiplier
Why do some companies receive a 7x multiplier instead of a 5x or 4x multiplier? The answers typically revolve around risk – the lower the risk, the higher the multiple. For example, if Verizon Wireless was in play, a potential buyer knows that it has long-term contracts with recurring revenue. Additionally, a buyer knows that every month Verizon’s customers pay their mobile phone bill, and they know the historic net customer gain/loss per month. These specifics are very attractive to a buyer as it creates a clear picture of the expected revenue over the next couple of years. Additionally, no single customer accounts for a significant percentage of revenue. These factors greatly reduce a buyer’s risk; therefore, the buyer is willing to pay up. The following are some concepts that can increase the EV multiple for a company – it is not all-inclusive, but touches on those with the greatest impact:
- Long term contractual revenue
- Recurring revenue
- Strong historic revenue growth
- No customer concentration (none greater than 10%)
- Products protected by intellectual property
- A strong pipeline of projects or customers
- Large number of customers
- Number of products
- Weak competitors
- Large barriers to entry
- Strong/improving industry trends
- Large company size (total revenue)
- No, or minor, legal issues that can be quantified
- Large amount of dry powder in the private equity market (potential buyer pool)
EBITDA Drivers
Affecting EBITDA is straightforward. Some of the ways to impact EBITDA are listed below:
- Increase sales (new territories or new products)
- Reduce cost of goods sold
- Product value compared to competitor’s – price premium
- Fixed costs vs. revenue
- Increase number of shifts worked instead of adding space
- Sales organization cost
- Management bloat
Timing
I recently attended an event hosted by BNY Mellon on planning for the future with regards to gifting and trusts. One of the items that they shared was an investment “clock” for businesses. It related a company’s interaction with the economy, the markets’ emotions, our emotions, and what action an owner should take during these cycles. One of the key takeaways was that we are at a time on the clock in which market demand is high and capital is relatively cheap and accessible, which could mean it is a good time to consider a sale. Furthermore, the combination of these two factors typically drives up prices. Contact me if you are interested in receiving a copy of this clock.
Summary
If you have made it this far, the takeaways that I want you have are as follows:
- Figure out your ME (talk to one of the CFA professionals if you would like assistance).
- Determine if that is enough for retirement. Contact your financial planner to complete an assessment.
- If your company’s ME value is lower than you want or need to retire, initiate plans to increase your company’s value.
Alternatively, consider selling a portion of your company now to a private equity firm and then sell the balance in five to seven years at possibly a greater amount than your initial liquidity event.
If you are contemplating selling your company and are about to hire an investment banker, remember the worst thing you can do is take your eye off your company’s operations and let your revenue and EBITDA decline. Selling a company is a long process that can take up to a year. Declining operational performance will negatively influence valuation and in all likelihood cause the buyer to walk from the transaction. The owner must remain hyper-focused on growing his business and allow an investment banker to focus on the process. I hope that this paper has helped shed some light on valuing and improving the value of your company. Specifically, I have had great success in increasing acquisition multiples, and in one instance was able to increase the multiple from 5x to 8x adjusted EBITDA. I achieved this success by helping the seller with the above concepts and running a structured process that positions the company in the best possible light – results will vary.
Posted by Matthew Bishop.