Startup strategies need to be exit strategies. Your investors want to see their investment returned many times over. In the current climate, most exits tend to be acquisitions by larger companies. So growing a business worth buying should drive everything you do.

This article discusses how to judge your company’s value before a Merger or Acquisition (M&A). We’ll discuss how you can build a business which is attractive to corporate acquirers and achieve a good exit!

Read on to learn more…

Acquisition Value

When buying another company, the acquirer is most likely interested in the benefits to their bottom line. Profitability is key to M&A but it’s not as simple as you might think. What really matters is the change in profitability after merging, and that depends on the relative strengths and weaknesses of both companies. These combine in different ways to form a business which can be greater than the ‘sum of the parts’.

Synergies

Combining your company’s strengths with your acquirer’s can add enormous value. Corporations often lack the innovation and agility of startups, but they bring greater resources, proven capabilities and established relationships. This can help your revenues grow faster post-acquisition, which implies a greater exit value.

Technology

Larger companies might simply want to buy your technology for use in their own products or as part of a defensive IP portfolio. But if they can already get exclusive access through your licensing or distribution contracts, then they have less motivation to acquire your company.

If your partner’s competitors see you have made an exclusive deal, then they may also be dissuaded from trying to acquire you. So avoid signing away too many rights to big customers who might one day be your exit opportunity!

Talent

Some M&A evaluations overlook the value of talent. In tough markets, companies can need more than one good invention and must compete through continuous innovation. Your team’s ability to continue inventing is therefore vital to your success.

Younger companies are often more agile and so can adapt to changing market needs. Your team’s ‘tacit knowledge’ of your technologies, products, customers and processes can be a huge part of your company’s value.

Sales Channels

Technology companies are often acquired when their products have a good fit with the acquirer’s channels. Your innovative products may have already achieved impressive revenue growth. But an acquirer with broader market access should sell more of your products than you do, increasing your value

Customer Base

Developing a strong base of customers is valuable, especially when they are new to your potential acquirers. Your customer relationships and reputation help build your company brand value. And your acquirers may have other products they want to sell into your market. Combining your customers and products with theirs can multiply value post-merger.

Supply Chains

Corporate supply chains also offer opportunities to grow value by reducing costs of manufacturing and logistics. An established global network enables efficient supply chains which would be expensive for a new company to build. However, different product types may require incompatible processes, so simplistic streamlining may lead to challenges in Post-Merger Integration.

Processes

Quality and compliance processes are generally more mature in larger companies, and a new acquirer usually wants to do things their way. But newer regulations may be better understood by new companies. Consider what process knowledge and experience you could bring to a new owner and how this could help them access new markets.

Duplication

Larger companies can reduce overhead costs by sharing them across many subsidiaries and departments. Merging ‘admin’ functions such as finance, HR and IT is common after acquisition. Marketing, Sales and Service teams may also be integrated to unify brands and avoid duplication. Operations and R&D teams may prove harder to merge due to differences in processes and culture.

M&A tends to involve companies with similar markets and products. Choosing the brands, products, teams and facilities for the best future organisation therefore makes sense. Post-Merger Integration such as this may not be welcomed by your team, but it is an inevitable consequence of M&A and another potential source of value.

Valuation Methods

New companies are often valued by comparison with similar ventures. Without much financial history, it makes sense to use related investments as a guide to what your company is worth. But as your business grows, its valuation is driven more from the numbers you deliver than the promises you made.

Comparison

Consider buying an old car. You could use a formula based on its age and mileage. Or you could look at a few similar vehicles and make your own judgement. Companies are valued using a variety of financial formulae. And there’s some ‘intuitive’ approaches too.

Acquisitions of other companies provide a useful guide. Understanding what makes them similar or different to your business helps calibrate your estimate. Revenue, employees, technology, products and markets need to be weighed in your judgement. Dave Berkus is famous for his formula which prices each company risk area in turn. This is designed for startups but can be adapted to assess scale-ups too.

Public companies may also be worth comparing, although many trade at a premium to how much a corporate acquirer would pay. Equity markets are also subject to trends which can help or hinder your valuation.

Multiples of revenue or (more reliably) profit are often used for different industry sectors to provide an easy guesstimate. These reflect the typical profit margin ratios for each industry but can disguise the range between poor and high performers. Ideally, you want to your business compared with a successful larger company whose performance you aspire to match.

Estimation

Mature businesses are usually valued on future revenue projections based on their financial history. This takes account of the margins you have achieved so far and your plans for sales growth.

When new products and markets are in sight, their potential contribution needs to be factored in too. Each opportunity adds another layer to your plan, with increased revenues and costs. These can make a significant difference to your valuation, but they will attract more scrutiny during an acquisition!

Aswath Damodaran’s books provide many examples of ‘Discounted Cash Flow’ estimates for different types of businesses. Calibrating your model against another company’s value and financial performance helps improve your estimate. Consider carefully how an acquirer may judge the Net Present Value of your future sales and costs.

Competition

Maximising your exit value requires having more than one bidder. So your strategy needs to stay open to as many potential acquirers as possible. Close partnerships with one major player might put off others so bear this in mind when making long-term deals. It’s important to keep as many potential exit candidates in the running for as long as possible.

What’s your business worth?

In the end your company is only worth what someone will pay for it! And if there aren’t any good offers, then it might be better building your business a bit more before you try to sell it. Bear in mind that your investors will have their own idea of what valuation they want and the small print may give them the final say.

Comparisons and estimates are good ways to start the M&A conversation, but in the end a bidding race will give the best exit valuation. Make sure there’s a real competition!

If you’d like to discuss how to maximise your exit value, please get in touch!