In the first two segments of this series (part 1 and part 2), we covered the basics of valuations and the key areas that help drive up valuation multiples. In this final portion, we’ll discuss some of the primary discount factors that should be considered.
While there are numerous things that can drag a multiple down, there are some areas that many partners should ensure are shored up prior to considering an exit. Generally speaking, these have to do with the maturity of the business and its ability to continue to succeed under new leadership.
Making Yourself Obsolete
So often, I see the owners of the business playing an integral part of the day to day operations. While it’s good to stay connected, this often means that the success or failure of the business is too reliant on one individual. I frequently see the CEO acting as a primary seller, intimately involved in the delivery of services and at the center of virtually every operational decision. This stifles growth and is often perceived as a significant risk to the suitor, given that at some point, that individual will move on.
Letting go and running the business from a more strategic level can be quite difficult and for some, nearly impossible. That said, for the business to remain a valuable asset in a post-transactional environment, a set of well-defined processes needs to be implemented so that the value shifts away from a dependency on specific personnel and more toward the execution against a proven approach that generates results that span all functional areas. Having this well documented and entrenched into the DNA of the business instills confidence that perpetual, high rates of returns can be achieved.
Functional Leaders Capable of Continued Growth
Based on insight shared with us by mergers and acquisitions (M&A) and analyst firms, the majority of the transactions taking place are with companies who have greater than $5MM in annual revenue. Companies of this size typically have at least one or two functional leaders running sales and/or the services practices.
As part of the due diligence process, the potential buyers are likely to look deeply at the capabilities of these individuals to determine their ability to deliver against long-term aspirations. In many cases, they’re going to be concerned not with their capacity to manage their current span of control but with what they can do against future ambitions given there will be a desire to scale against their investment. Can these individuals manage larger teams? Do they have the ability to lead through others if the organization were to become layered? Do they have the right systems and instrumentation in place to inspect and course-correct the business through a disciplined approach? The ultimate question buyers want to know is, would they hire these individuals as net-new candidates when the business reaches the expected goals they have set as part of the acquisition?
Ensuring the Right Fit
Having a healthy P&L and an attractive balance sheet are one thing, but alignment of both culture and strategic direction will play a role. While you may have a great roster of customers, a really intriguing set of IP, and a strong set of processes, the culture must gel with that of the buyer. Is your company adaptive to changes in market direction? Is the mindset of the staff that of a challenger with ambitions to continue strong growth? Are there strong, effective, trust-based relationships across and within teams? Is there a high degree of accountability and a demonstrated history of agile course correction? These are just a few of the key indicators of a healthy, well-functioning culture. One of the hardest parts of making 1+1=3 is integrating the two organizations. For that reason, it will be important that the acquired entity has an adaptive mindset and teams can be integrated in a frictionless manner.
The intent of this 3-part series is to share some of our observations and learnings from those who specialize in these types of engagements. Given the complexity and sheer amount of time it takes to manage a transaction (both buy-side and sell-side), I highly recommend connecting with a firm such as Revenue Rocket who specializes in M&A. These groups can address questions, provide guidance, and offer services to help you navigate the process.
As a next step, we’ll be conducting a session on the topic of M&A this year at WPC. The session titled “How to Retire Early and be a Hero to your Shareholders” will take place on Wednesday, July 15, at 2:30pm. Joining me will be Mike Harvath, CEO of Revenue Rocket, Mark Seeley, CEO of Intellinet Corporation, as well as John Havlick and Nicholas Vossburg of Comparex to discuss their recent acquisition.
We look forward to seeing you there.
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