Value Creation. Abstract:

Transcription

1 Value Creation Abstract: If you are a Seller anticipating a sale transaction soon or in the future, you should be concerned with how your company will be viewed in the minds of the potential Buyers and how you can affect that. You have a price in your own mind. The question is, What can you do to cause Buyers to be willing to pay you that price or, better yet, more?. Buyers tend to categorize companies into industrial and industrial sub groups to establish expected median valuation multiples. Then, they look at what adds value, what detracts from value and what might be show stoppers. Buyers mainly buy into the future of your company. By carefully adjusting these value factors and articulating an attractive, credible, defendable future, Sellers can often increase the perceived value of their companies significantly in a short period of time (Office Phone) Denary LLC (Mobile) 4611 Bee Cave Road, Suite 108 kbresnen@denary.com (Fax) Austin, TX Denary, Inc. All rights reserved. Securities offered through Independent Investment Bankers Corp. a broker-dealer, Member FINRA / SIPC Office supervised by: IIB, 2900 N. Quinlan Park Rd., Suite 240, Austin, TX Phone: Denary is not affiliated with Independent Investment Bankers Corp.

2 Value Creation You have seen this in your own industry: Valuation multiples (X Revenue; X EBITDA) for publicly traded companies and for acquisitions, both public and private, vary greatly. Sophisticated buyers and investors consider some companies as being worth only half the industry median, while they may happily transact other companies in the same industry at twice, three times or more than the median. And the median multiples vary significantly from industry to industry and among industry sub-sectors. Why is that? What makes the difference? Can a company be intentionally designed and crafted to justify a premium price? Can your team quickly move the value of your company from below average to well above? Yes and Yes! Value Economist will say that value is only and ultimately determined by a free market transaction between a willing buyer and a willing seller. As a seller, anticipating a sale transaction soon or in the future, you should be concerned with how your company will be viewed in the minds of the potential buyers and how you can affect that. You have a price in your own mind. The question is, What can you do to cause buyers to be willing to pay you that price or, better yet, even more.. For the purposes of our discussion here, we ll define a buyer s value as The highest price a well-informed, qualified buyer would pay in a competitive sale process. Let s parse this definition. Denary LLC Page 2 of 9

3 Any buyer of almost anything goes through a three step thought process: What would I be willing to pay? (highest price when well-informed) What can I pay? (qualified buyer: one that has a need and has the money) What do I have to pay? (Am I the only buyer or must I compete?) This paper focuses only on the first question. Our companion paper on Capturing Created Value addresses the other two questions. How Buyers Set Price Three Steps While buying a business is much more complex than buying a home, the valuation thought process of buyers is somewhat similar. They tend to think: Neighborhood Lot House. Every industrial sector (Neighborhood) has different median multiples. For example, the median revenue multiple of professional services companies is about 1.1X. The median for software companies, at 2.4X, is more than twice that. Buyers will tend to categorize you as being in a certain sector and that will begin to establish in their minds the median Going Rate multiple. Denary LLC Page 3 of 9

4 The major industrial sectors are made up of numerous sub-sectors (Lots). These too each have different median multiples some high, some low. For example, on average, buyers expect to pay a different revenue multiple for healthcare software companies than they would pay for a gaming company. But buyers rarely pay the median price for anything. They pay more or they pay less. Within each sub-sector, some specific companies will fall well below median (M), while others will greatly exceed the median. The distribution is such that companies in the highest quartile may be % more valuable than companies in the lowest quartile. Denary LLC Page 4 of 9

5 You can transition your company to higher valuation quartiles in a relatively short time by adopting certain Value-Directed TM Strategies and taking Value-Directed TM Operational actions. Value Creation You can t easily or quickly change the neighborhood or the lot of a house. You can only fix it up some. Businesses are different. In a relatively short time, they can be re-positioned in the minds of potential buyers. For example A mostly professional services firm may transition to become partly or mostly a software company. Or, a software provider may reconfigure its business to a Software As A Service (SAAS) model Even without changing its industry sector or basic business model, a firm with many value detractors may systematically transform itself to one with many value adders. We at Denary have bought, sold and secured funding for numerous companies, both as principals and as advisors. Here is Denary LLC Page 5 of 9

6 Companies that succeed with these sorts of transformations can often increase their market values significantly in one or two years. Since we are in the markets and follow corporate and private equity buying habits and trends very closely, we understand the many factors that add or detract from what buyers are willing to pay. All of these factors tend to work together to improve both the qualitative and quantitative performance of your business, including the fundamental financial measures. As these improve, so do the various valuation multiples likely to be applied to your business. This can result in an exponential growth in your firm s valuation. For example, if your revenue were to double (2X) at a fast rate, your revenue multiple might also double (say from 1X to 2X). This would mean your company s value increased by 4X! Denary LLC Page 6 of 9

7 Value Adders - There are numerous factors in your business that can make your company more valuable to buyers generally and may highly impact some specific buyers. A few examples: Size matters. Manufacturing companies with revenue under $25 million have a median EBITDA multiple of 5.4X while such companies with revenues over $100 million experience a multiple of 7.3X - Even without other improvements, by judiciously combining companies, expanding geographical territory or adding new lines of business potential value can often be created. Growth Rate matters. Software As A Service companies with growth rate under 20% realize revenue multiples of less than 3.6X, while companies with growth over 40% achieve median multiples of 7.6X - Aggressive, effective marketing programs can rapidly add value by both increasing the revenue and increasing the revenue multiple. Profitability matters. Software companies with EBITDA under 10% trade at revenue multiples of 1.8X; similar companies with EBITDA over 20% trade at 4.5X By careful attention to target customers, pricing strategy and efficient operations, a company can double or triple its market multiples and the basis that multiple applies to. There are many more factors, qualitative and quantitative, that make a company more attractive to buyers and tend to raise the amount a buyer can justify paying in a competitive buying process. Value Detractors Buyers look carefully at all of the aspects of a company they are considering buying. They particularly seek out those factors they believe actually detract from the company s value or which they feel they can use in negotiations to reduce the price. The list of these factors is lengthy. Some of these factors are common to most companies; some vary from industry to industry and company to company. Examples of Value Detractors include: Customer concentration; Few new customers Aging products; few new product offerings Old technology Small market share; slow growth markets Ineffective or inefficient operations Poor, little or no documentation of products or processes Poor morale; High employee turnover Weak industry reputation Limited geographical coverage Weak sales, marketing, distribution systems Unaudited financials; weak financial and administrative systems Denary LLC Page 7 of 9

8 Show Stoppers Experienced Buyers attempt to very quickly identify if there are any compelling reasons to reject or not consider the candidate company any further. Again, there can be an extensive list of factors that could be show stoppers. Some example of these might include: Clearly unrealistic and indefensible price expectations of the seller Rapidly, unrecoverably deteriorating market or business performance Shareholder disputes Inability to retain key talent Legal problems actual or potential IP ownership issues or disputes Labor relations Problems with government or regulators Unresolvable or undefined contingent liabilities To the extent a company can anticipate and positively address all of the most important Value Adders, Detractors and Show Stoppers, it can greatly increase its audience of potential buyers, increase its actual and perceived value to those buyers and increase its likelihood of an highly successful, orderly sale process. Value Perception Finally, buyers will certainly look at the recent history of your company and will look at what is there today as we have just described. But buyers don t pay for What Was or even, most often, for What Is. Buyers buy and will only pay for what they believe the future will bring What Will Be. Denary LLC Page 8 of 9

9 Buyers ultimately buy into and pay for the promise in your company s Shared Vision, Value- Directed Strategy and Operational Excellence. Buyers will weigh your firm s ability, in the context of their ownership, to extend a compelling and credible brand promise to a large number of desirable customers. They will also judge your ability to deliver on that brand promise consistently and efficiently. This will form the basis for their estimated of what your firm might be worth to them. If you can articulate a Game Worth Playing and show you have the Team to win that game, buyers will line up to compete to buy you. Denary helps companies like yours Accelerate Value Creation through Value-Directed TM Strategic Planning, corporate development initiatives, operational excellence and strategic transactions. If you would like to continue this conversation and explore Value Creation opportunities for your own company in greater detail, please give us a call at Denary LLC Page 9 of 9