If you are a business owner and serious about selling your business at its optimal value, then it is best to understand the strategic
of your business rather than the traditional financial value.
A strategic sale is not about a valuation, it is all about creating a compelling value building opportunity for potential strategic buyers.
What is a Financial Valuation?
Conventional, financial valuation methods have limitations because they undervalue future growth potential as well as the increased
revenue streams of the merged entities.
The financial valuation method uses an EBIT multiple, which is based on historical figures and several implied assumptions about
what the business will look like in the future, in the hands of any buyer. Assumptions such as:
- The business will continue to sell the same products in the same markets;
- The business strategy will continue unchanged;
- Management will continue to manage the business in the same manner in the future;
- Access to funding, networks and knowledge will not change in the future;
- Financial results in the near-term future are assumed to be a linear projection of the near-term past.
This approach relies on the idea that the best evidence for future performance is recent history. Calculating a valuation for the business
is then a simple extrapolation of past performance. Valuations built on multiples of current earnings (EBIT) are very common only because
they are easy to calculate.
Businesses acquired to be operated as a standalone business will be purchased on the basis of their inherent profitability and a financial
as there are few or no synergistic benefits in the deal for the acquirer. For example, a business bought by an individual who wants to
invest retirement or savings funds to buy a business to work in and manage themselves will require a financial valuation.
However, future revenue and product/market characteristics may be very different from the immediate past performance, particularly if the
business is bought by a strategic buyer.
PCG was a successful process manufacturing software development company with 160 employees. The business generated $10 million in revenue
and a net profit of approximately $500,000 when the owners decided to sell. Valuations at the time were 4x EBIT for IT companies so a
financial valuation of $2 million.
However, the company thought this undervalued the business due to the potential of its innovative products and R&D pipeline. They had
spent 22% of revenue on product development for many years which was much higher than the industry average of 12% and were ready to launch a
pipeline of new products.
They decided not to sell to a larger firm in the same industry for $2 million. Instead they took a different approach. Their advisors did
some research on the US market and found an IT company that had similar customer profiles but sold financial software in a crowded market
rather than process manufacturing software. The pitch was for the US company to diversify its product range.
The US company were very interested and commenced due diligence. Six weeks later, they purchased the company based on the growth potential
and paid $9.6 million.
What is a Strategic Buyer?
Strategic buyers are attracted to businesses where the buyer has the ability to leverage the underlying potential of the business.
The buyer will almost certainly change the management, increase funding, and bring new networks, distribution channels and knowledge to the
There is a disconnect between the way in which conventional business values are determined and the manner in which a strategic buyer will
extract value from the acquisition. The difference lies in the fact that the question ‘what is the value of my business?’ neglects to ask,
‘for what purpose?’
If the purpose of the question is to raise a bank loan, inform investors as to how the business is tracking or to see if the entrepreneur
can bring in some external investors, then it is appropriate to determine the value of the business as a ‘business as usual going concern’.
However, what if I want to know what value I would achieve on the sale of my business to a strategic buyer?
A strategic buyer will only purchase a business where they think they can bring new value
to the table which will give them a premium for their knowledge, networks, resources or energy.
In this case, the basis for valuation on sale must consider what the buyer is likely to do to the business. If, for example, we know that
the right buyer can significantly improve the growth rate, market penetration and/or profitability of the business, we should anticipate a
higher value on sale than that which would be calculated for the business sold as a ‘business as usual going concern’.
When a business makes the effort to provide the buyer with a different, more positive, more profitable future for the merged entity, the
owner will get a higher price than simply a multiple of past earnings.
Finding strategic buyers who will pay a premium above a financial valuation requires a detailed analysis of your business,
your market and the industry they operate in and is best achieved by engaging an experienced Merger & Acquisition (M&A) Advisor.
What is a Strategic Valuation?
To assess the potential exit value of any business, we must first understand how the business creates value for its different types of
strategic buyers. Those businesses which deliver inherent profitability must create value for future owners through enhanced profitability
and future profit growth.
Strategic mergers create value by enabling a corporation, the strategic buyer, to leverage a significant revenue opportunity created through
the combination of the two companies. Your strategic value drivers can create significant commercial opportunities for potential buyers. For
- Your business provides new products or services that the buyer can sell to its existing customers and/or expand its customer base;
Your business provides new technology, systems and processes to improve the buyer’s existing products and services and make them more
- The buyer’s products and services can be sold to your customers;
- Your business has intellectual property which can be leveraged for future growth by the buying companies;
- Your business offers a competitor new geographic territory to gain new customers;
- Your business offers more efficient distribution channels than the buyer.
Fundamental to the sale process is an understanding of the value that different buyers will extract from the business. The purchase price
(value of their investment) is derived from their estimate of the future stream of income.
A buyer should value any investment by applying a Net Present Value (NPV) formula to the stream of future cash flows. A risk rate or
discount rate is applied to the calculation which reflects the level of risk in achieving the income projections.
Using the NPV approach, we focus entirely on the future to determine our valuation. The only contribution our prior history makes is to
provide us with some evidence to validate some of our assumptions about the future.
If you want to extract the highest sale price for your business, you should seek out strategic buyers who can leverage the strategic value
of your business better than you can.
Financial sales are always going to be limited by the profit generating capability of the seller. A strategic sale, however, is only limited
by the size of the opportunity generated within the acquiring corporation.
By finding multiple potential buyers who can generate greater value in the business in the future than that which could be generated by the
current owner, the seller can readily achieve a premium on the sale of their business.
Finding those Strategic Buyers who will pay a premium above a Financial Valuation requires a detailed analysis of your
business, your market and the industry it operates in. This is best achieved by engaging an experienced M&A Advisor, at Ashfords
we're ready to help you.