When the time comes to consider an M&A sell-side transaction as a private company, the first question I get is always the same: How much is it worth? And while there’s nothing wrong with that, it’s the answer that is seldom right. This is because the question is more specifically asking less about how well a banker can find a hot buyer in a hot market to pay up, and more about a few key measures that can really make all the difference in value. Here’s why…
In most cases CEOs and business owners all want the same thing, top dollar, and why not ask a Premium Price for a premium business? That makes sense if we are all looking at the same thing. However, while many business sellers try to coincide the sale of their business with a hot seller’s market in hopes that a rising tide will lift all boats, the real price premium comes from within.
Getting a Price Premium (which is to say a higher than average price on the sale of a business) really comes down to convincing the buyer of your business to pay more than a similar business in the same industry. Regardless of whether the market is hot or cold, in our experience as investment bankers closing dozens of deals, getting an above-market premium price stems more from these 3 key buckets:
- Annual Sales Growth
- Industry Leading Margins
- Superior Brand Equity
Annual Sales Growth
As you know, most industries today contain a range of competing enterprises in size from start-ups to mature international companies. And in most cases, the pre-market value of each is measured as a multiple of EBITDA (earnings before interest, tax, depreciation and amortization). This multiple is based upon identifying and comparing prior sales of similar companies. However, what’s often overlooked in these company-to-company comparisons is the direct product-to-product SKU line item sales and margin growth factors. Why?
Because product or service category growth comparisons is the big equalizer. If a smaller company outsells, and out-profits a larger competitor in a product-by-product comparison, the smaller company’s product line should receive a higher valuation to a buyer. This is why larger companies routinely pay premium prices for smaller niche market players with tremendous growth prospects. That’s because premium growth attracts premium value, period.
The key to receiving a premium value is therefore a CEO’s ability to directly deliver on both incremental category and market-share growth per product, per year. The more successful a product line’s growth, the higher the valuation will go. When growth is above industry category norms or averages, for instance say above 10% annually, a growth premium as high as 20% could be added to your company valuation and potential transaction price in an M&A deal.
Industry Leading Margins
This one gets a little tricky, because depending on size and industry, top performers who deliver on sales growth can also deliver on higher margin growth if they are able to sell higher priced goods and services. Nonetheless, big or small it’s your Gross Margins and EBITDA Margins which are perhaps the two most actively tracked and compared metrics against competitors and your company’s own prior period results. Once benchmarked, however, achieving margin growth every year is not easy. Input prices can change quickly, new competitors can enter the market, and frame-braking innovations can disrupt channel demand, among other things. But for CEO’s that do out-perform competitors and show steady margin improvements, let’s say from 5% to 10% or more each year above their competitors, they can expect as much as another 2 times EBITDA multiple or better in increased market value. Now that’s a premium price to market.
Unfortunately, the opposite can also be true. Declining or stagnant margins will not excite a new buyer, especially in mature and declining industries. These companies use size and scale to overcome slow margin growth. And in this case bigger is better because larger companies have at their disposal more ways to reduce costs and leverage efficiencies such as robotic automation, and volume purchasing power discounts from vendors. Beyond these, growth in mature industries comes mostly via M&A transactions. And having industry leading margins across a competitive landscape generally means acquirers will pay up to get what you have.
Superior Brand Equity
What’s in a name? Everything. For eons advertising and promotion have been the mother’s milk of most successful marketing campaigns. Whether your company is B2B or B2C makes little difference. Why? Because humans still make the purchasing decisions for nearly all business and personal consumption. eCommerce which got its legs in the roaring nineties did manage to automate procurement into eProcurement and thus removed most human interference. Still, until computers make all purchasing decisions, companies of all sizes must still aggressively promote their brands to new and existing customers or risk decline. This is where mature companies with mature product line brands can stay on top with large marketing and promotion budgets. When it comes to branding, having lots of money to get the message out can lead to early sales success. As new market entrants introduce new product and service innovations, mature companies can always and will always counter attack any way they can, including an outright purchase of the offending competitive threat rather than out-spending them on marketing.
Perhaps, most noticeable today is the premium market valuations put on high-tech companies whose ability to promote and sell their brand (think Apple, or Facebook) can quickly lead to out-sized sales and market-share growth. This is what a powerful brand can do when it works. However, often times smaller companies who do understand the benefits of a strong brand can quickly over spend, destroy value, and still fail to establish or sustain a profitable growth trajectory.
Developing a strong brand does not necessarily mean spending truckloads of money on pitching your product line, rather what buyers who pay premium prices want to see is a strong brand that provides mostly the repeated promise and delivery of a satisfying transaction between two parties. Without that, few brands will add meaningful improvements to corporate market valuation. On the other hand, if your company’s products and services are growing at a healthy clip year over year, a considerable campaign effort to increase the value of the brand itself makes perfect sense, and can in turn increase company value substantially. The bottom line here is that having a higher level of brand recognition can translate into a premium price valuation. Make sense?
So to summarize, the overall Valuation of a business is what humans perceive the value is of the company’s products and services, and the promise of a consistent repeat performance. Getting a premium price in an M&A transaction is not about what your company’s past accomplishments were, although that’s important, rather from a buyer’s perspective to get a premium valuation depends on how well they see themselves earning a profit standing somewhere in the future in your company shoes. So if you are considering the sale of a business, make it easy. Before you consider a merger or acquisition value above and beyond what a hot or cold M&A market multiple will offer, look to improve these 3 key valuation metrics above first. That’s where the real premium comes from.