7 Variables to Value a Company in Mergers & Acquisitions

The following is a guest article from Bill Cavanagh, Managing Partner at Gunflint Capital.

2015 Exits, Mergers & Acquisitions

It’s shocking how soon we forget. Last year when I wrote this piece, my kids stayed home from school because of dangerously low temperatures. Today, as I write, my son is home — because of dangerously low temps!

While time moves on, some things remain unchanged. Like last year, today’s business climate looks bright; it’s shaping up to be a good year in the exits and mergers & acquisitions industry.

We’ve provided some comments below that we hope you find informative. Happy New Year!

No Magic

I came across this piece at year-end written by Bill Snow, a Chicago-based investment banker. It is right-on:

Takeaway: Investment bankers don’t whisper magic sweet nothings in the ears of buyers to jack up prices. Valuation is the intersection of competition, the strength (or weakness) of the underlying business, honesty, the want/need of the buyer, the motivation of the seller, market conditions, and the skill of the investment banker.

The most difficult parts of the M&A process are due diligence and purchase agreement negotiations. These critical, final steps are where an inexperienced and unprepared seller can see the value of the deal decline as a savvy buyer renegotiates the deal at a lower price. Defusing problems and fending off attempts to renegotiate deals are where investment bankers earn their fees.

Value = Intersection of Many Variables

Business owners are mistaken when they expect an investment banker to work magic and get a buyer to increase an offer. Buyers are sophisticated and reject efforts to negotiate against themselves. Investment bankers don’t have magic tricks to get buyers to increase their bids.

Instead, valuation is the intersection of many variables. These include:

1) Competition from an Orderly Process

Running an orderly process means the investment banker creates competition. Competition provides options and is a boon to valuation. Sellers who negotiate with a single buyer (or a very limited number of buyers) run the risk of leaving money on the table.

2) Strength of the Underlying Business

A company with growing revenues, a strong bottom line, no customer concentration, and a strong management team is more desirable than a company losing money. If the fundamentals are sound, the seller can expect a good valuation

3) Honesty

A sure deal-killer is to mislead and misrepresent. Lack of honesty ruins a seller’s credibility, reduces valuations and makes closing a deal virtually impossible.

4) Buyer’s Wants & Needs

A buyer who wants a company more than all others is more likely to pay a higher price.

5) Motivated Seller

A motivated seller at the helm of a financially strong company -with multiple offers in hand– is in a much stronger negotiating position.

6) Market Conditions

Demand from buyers far exceeds the supply of companies coming to market right now and that is driving up valuations. The causes range from the central bank’s loose money policy to excess cash on corporate and private equity balance sheets to a low interest rate environment.

7) Investment Banker Skill Set

Advisors provide real value to clients especially in the final throes of due diligence and purchase agreement negotiations. The biggest value, by far, comes during the final few days before closing.

No Magical Sleight of Hand

What seems like magic results from a multitude of occurrences, all orchestrated by knowledgeable and experienced advisors. High valuations can be had, but they do not result from magic; they are the result of skill, foresight, planning, experience, and execution.

Why Valuation Counts

Your Deal isn’t Likely to be All Cash

In the lower middle market, most deals today include some form of seller financing, earnout or payments made in the future.

If Your Price is Too High, You Might Not Get Paid

If your buyer becomes unhappy with what they think is your fault, they’ll stop paying. This is especially true when you’ve sold your business for too much money.

Don’t Rock the Boat

If your buyer runs short on cash because they believe they are paying you too much, they might look for ways to cut costs. If these cuts hurt customer service, the business may suffer.

Don’t End Up in Court

If you over-value your business, your buyer will find a way to say that you lied. If that happens, they’ll stop paying and you’ll have to go to court. It’s better to fairly value your business upfront.

Think Like a Buyer

Put yourself in the buyer’s shoes. If you’re going to finance part of the deal you need to treat your buyer fairly. If you don’t, they’ll stop paying.

Or, Get More Cash at Close

To avoid these problems, get more cash at close. When you can remove yourself from the mix and sell based on a recurring revenue model, it’s easier to strike a deal where most of your money is paid in cash at closing.