When it comes to making acquisitions, buyers use different criteria to evaluate businesses. Some may place more emphasis on strategic factors while others will focus solely on the financial numbers.
Despite this, there are a common set of considerations that are important to all buyers, which advisors should understand. Advisors can help clients by asking the right questions as they prepare to sell their businesses.
Recurring revenue: The most significant factor affecting a company’s valuation is recurring revenue. Buyers will pay a premium for businesses with predictable and stable revenue streams that are expected to continue into the future.
These revenue streams often come from providing essential and critical goods or services, and may be backed by long-term contractual agreements. Examples of industries with recurring revenue models include insurance and software, where premiums and subscription fees are paid at regular intervals.
Growth and profitability: Buyers prefer businesses that have grown consistently over multiple years, with expectations for continued growth. Businesses that are cyclical or have stagnant or declining growth are less appealing. The same goes for earnings: upward growth trends are preferable. Additionally, a business is more attractive to buyers if it has above-average profit margins relative to the rest of the industry.
Barriers to entry: Businesses operating in industries with barriers to entry and few competitors are generally more valuable than those operating in commoditized industries with many competitors. One example of an industry with significant barriers to entry is pharmaceuticals. Product development often requires large upfront costs as well as specialized knowledge and expertise. Additionally, completed products are protected by long-term patents.
Customer base: There are two aspects of a company’s customer base that impact valuation: customer concentration and customer quality. A business in which no single customer represents more than 5% of revenues would be more valuable than a business where the largest customer represents 50% of revenues. This is referred to as customer concentration. Customer quality matters because buyers will typically be more interested in blue-chip commercial customers than individual retail customers.
Management team: Businesses that are highly dependent on the owner pose a risk to buyers. This dependence often means the value of the company will decrease once the owner leaves. Instead, buyers prefer that there are existing management teams in place who can continue to run the business after an acquisition. In addition to being more valuable, these companies also attract more interest from a larger pool of prospective buyers—particularly financial buyers who do not want to be involved in the day-to-day operations of the business.
Information systems and processes: Companies that have information systems and standardized processes in place are generally more efficient and have better data for decision-making purposes. These systems and processes also have the benefit of reducing the business’s reliance on its owner, which is more attractive to buyers.
Synergies: A buyer who can achieve synergies by acquiring another firm will pay more for it. For example, a buyer may be interested in acquiring businesses with complementary product or service offerings that open up cross-selling opportunities. The larger the value of these benefits, the more a buyer is willing to pay. These benefits are realized through increased revenue and reduced expenses; cost savings can be achieved if there are duplicate functions such as sales and marketing, or accounting, that can be eliminated.
The advisor’s role
Clients need to be aware of what buyers are looking for in order to increase their business’s marketability and maximize its value. Advisors can help clients who are preparing for a sale by addressing these considerations and introducing them to an experienced mergers and acquisitions specialist to lead the transaction. Once a sale is completed, the advisor will have the opportunity to manage the proceeds of the transaction.
Mark Groulx is the president and founder of AIM Group Canada, a Toronto-based mergers and acquisitions advisory firm specializing in the sale of privately owned businesses. Reach him at firstname.lastname@example.org.