By Ryan Brown, John D. Wagner
Selling your business is a highly personal event and having a third party assign a value to the worth of your enterprise can be off-putting to some. A common refrain from owners early in the process is, “But my business is worth more than that!”
Very likely, it is.
But how can you ensure you get paid the true value of your business instead of passing along a bargain to the buyer?
Companies are acquired for their cash flow but valued based on their EBITDA percentages. When you are being acquired, and you and your investment banker will receive letters of intent (LOIs), those LOIs will set out a framework for pricing your company. In most LOIs, a dollar amount is offered for your company, but it is nearly always the result of a multiple of EBITDA. For example, if the LOI states that the target company will be acquired for $6 million, and the company has a $1 million EBITDA, the company is being valued at 6X.
For a business with unrealized cost optimization or sales margin opportunities, a seller would be leaving money on the table if he accepted an LOI that applied the multiple-of-EBITDA valuation method to last year’s financials. To show you the impact of the math, let’s say that your previous fiscal year’s EBITDA was again $1 million, which would value your company at $6 million in the 6X formula from above. Now, let’s say that six months into the new fiscal year, your trailing twelve-month EBITDA shows improvement, and it’s $1.2 million. So instead of a $6 million enterprise value, the 6X formula would value your company at $7,200,000… a $1.2 million net lift in business value paid at closing.
And this may be the low end of the scale. The industry sector (and deal structure) determines the ranges. For a business that sells at 12X, the same $200K EBITDA improvement would translate to $2.4m in total enterprise value.
But the time to aggressively address performance opportunities is well before an investment banker begins the process of contacting target buyers (Exhibit 1). Approximately 18 months prior to expected sale, a specialty performance improvement firm should be brought in to get the business operating expenses in the right swim lanes in as a percent of sale for the industry sector. Once EBITA has been heightened at a consistent 12-month run rate, then engage the investment banking firm to take the company to market.
Exhibit 1: The Art of the Deal
The key to maximizing your total enterprise value is to look at the key performance indicators (KPIs) of your company as an acquirer would view them. The central KPIs to improve are:
- Sales Revenue
- Cost of Goods Sold (COGS)
- Gross Profit (GP dollars)
- Gross Profit Margin (GPM) by customer at least for the top 20 customers by volume
- Operating Expenses (OPEX)
Examples of typical opportunities that can influence the above metrics are displayed in Exhibit 2 below.
Exhibit 2: Maximizing the Multiple
Companies typically sell during a time of growth, and thus EBITDA improves in raw dollars as the deal moves to a closing. But we have found that the EBITDA percentage will remain largely unchanged during that time. You can’t fix these problems in the 100-120 days it takes to offer a company for sale and close the deal. A truly maximized sales price is indicative of the discipline that the company exercises as a culture, even before they made the first call to the investment banker.
Ryan Brown is managing director of Next Level Essentials LLC., a profit improvement practice that aids in preparing businesses for sale, scaling high growth businesses and jump-starting profitable growth.
John D Wagner is a managing director of 1StWest Mergers and Acquisitions, an investment bank that has transacted more than $1 billion in deal values.