If you are a business owner looking to sell your company, maybe you heard that other companies in your industry sold for 3X EBITDA. Or perhaps a friend told you they sold their business for 6X EBIT. What makes this difference? What should a business seller do to get the highest possible purchase price?
Regardless of what you heard, owners consistently overestimate what their business is worth. This is mainly because they simply don’t understand what drives value. To understand the importance, you have to think like a buyer.
The Buyer’s Viewpoint
The more attractive the company is from the buyer’s point of view, the higher the purchase price will be. Key factors a buyer will look for when making an offer:
- Strategic fit: A so-called “strategic fit” between two companies is always given when one or more aspects of the selling company (products, technologies, patents, customers, management, market access, sales channels, etc.) represent a considerable added value from the perspective of the buying company. As a rule, the buyer should realize this added value in the short term. E.g., perhaps the buyer can include the acquired company’s products in their worldwide sales channel and achieve high sales and EBIT margins in a short time or generate a considerable competitive advantage. In such a case, the buyer is willing to pay a strategic purchase price. This is a purchase price that exceeds the independent valuation of the acquired company. As the seller of a company, consider which potential buyer can realize which strategic, added value by taking over your company.
- Cash flow: According to the strategic fit, the cash flow–or rather the free cash flow–of a company has the most significant influence of a single key figure on the company value and the purchase price. A one-time, sharp increase in EBITDA makes potential buyers suspicious and must be justified by the seller. As a seller, continue to calculate all one-time effects (expenses and income) from the EBITDA and present a so-called “normalized EBITDA” for past years, adjusted for certain factors and one-time effects, and list all modified impacts individually. The better these things are documented by the seller and convincingly presented to potential buyers, the higher the company valuation and, thus, the purchase price.
- Management skills and “broad” management composition: First impressions count. This applies to discussions with potential buyers and job interviews–and can rarely be changed afterward. The more convincingly management presents the company and themselves in initial talks with potential buyers, the higher the buyer will value the company. In such initial discussions, the entire top management (company executives and board of directors) should be represented, contributing to a positive company presentation. Corporate buyers only buy companies if they are convinced and see no dependencies on specific individuals. The worst-case for a company sale is when the seller plans to depart the company immediately after selling and, at the same time, is the only one who, for “reasons of confidentiality,” does not involve another manager in discussions with potential buyers. In this case, the buyer assumes that there are many potential risks in taking over the company. As the seller, involve all executive management in your sales plans from the start! Motivate them and show they might benefit from a corporate takeover.
- Broad customer base: Buyers get downright nervous when they read or hear that fewer than five customers are responsible for more than 50 percent of a company’s sales or EBIT. Ideally, no one customer accounts for more than 5 percent of total sales. Suppose a company generates significant sales with a few large customers. In that case, it can only be sold at a reasonable price if the contracts with those customers have a very long term and cannot be terminated if a change in ownership. If this is not the case, a buyer may request written assurance from those customers before signing the contract that their contracts will be extended by several years under at least the same conditions. If this is not possible before a contract is signed, the seller must accept a high earn-out share (> 50%). Furthermore, in the purchase/sales contract, the buyer receives extensive withdrawal rights if a contractually defined key customer terminates the contract after the takeover or if the contract conditions deteriorate significantly.
- Recurring sales: The higher the proportion of recurring sales in the total sales of the company to be sold, the more secure and stable the business model, the more reliable and predictable the company’s sales and earnings, and the higher the company value or the EBIT multiple or sales multiples. Buyers love stable sales from long-term contracts that cannot be prematurely terminated and that are automatically extended, if possible (e.g., annual maintenance contracts, service contracts, update contracts, recurring software licenses). As a company seller, verify that long-term (profitable) contracts with customers are automatically renewed. Also, determine those contracts in which the customer has the right to terminate business due to a “change in control” and seek to renegotiate those terms.
Every company value expresses uncertain expectations: past and current performance do not guarantee future results (I’m guessing you’ve read that in every investment prospectus you ever saw). The company value spans a range based on a yardstick of best practices.
“Build your business such that you can sell it in 5 years.” I’m sure you’ve heard this statement hundreds of times. But, what does it mean? Ultimately, building a business to sell means understanding what drives value – developing strong management skills, cultivating a broad customer base, creating recurring revenue streams. If you build your company in this way, I’m confident that you’ll be happy with the results when it comes time to sell.