Management should begin to prepare MUCH earlier than leaders realize – typically two or three years prior to a transaction
Executives contemplating a company sale face a variety of challenges. Finding suitable legal and financial partners, creating a process to identify and evaluate potential acquirers, and keeping stakeholders informed with “just enough” information are a few examples.
One essential but often overlooked challenge is that of making the necessary preparations for maximizing the value from the sale. Management should begin to prepare much earlier than leaders realize – typically two or three years prior to a transaction (a time when leaders are usually focused on other priorities). But starting early with a concerted effort to build value over the several years prior to a sale will lift company performance in ways that deliver significantly stronger multiples when it comes time to close the deal.
Preparing a company for sale requires action in the four key areas outlined below.
1. Get a Realistic Assessment of the Company’s Market Value
a. Obtain an external assessment of the current value of the company
Company leaders often form their own sense of the value of the company based on tenuous data. A friend at the club boasts about selling their company for a huge sum – not mentioning that 50% of the purchase price is contingent on achieving tough financial targets. Or they read about an M&A deal in the press for a company “just like ours” that sold for an 18X EBITDA multiple – not realizing that the company is larger, has higher margins, better systems. This perspective can create a significant gap between perception and reality, and a formidable barrier to a successful sale.
Developing a realistic estimate of market value is challenging for several reasons – from technical (which performance numbers to use) to market (which comparative statistics to use) to strategic (what sorts of buyers to consider) to personal (an individual’s sense of value – or of outcomes) to interpersonal (“Uncle Bob always underestimates, so my estimate has to be higher than his.”) For example, when considering the sale of a family-owned manufacturing organization, various family members developed valuations which varied by as much as 100% – or a difference in views of over $50 million dollars.
Bringing in an external, impartial valuation expert is the best way to determine a realistic value for a company. “Don’t try this at home” is sage advice when it comes to creating a realistic company valuation. Valuation is a mixture of art and science, or more accurately, hard analysis and expert judgment. However, there are four key methodologies for doing a valuation:
Discounted Cash Flow: discounting expected future cash flows back to present value, based on an appropriate discount rate
Review of Publicly Traded Comparable Companies: analyzing the market prices of the equity of comparable, publicly-traded companies, applying appropriate discounts and premia
Review of Comparable M&A Transactions: analyzing recent sales of private businesses operating in the same industry as the subject company business
Asset Valuations: Estimating the value of assets that the Company holds which are not encompassed by the above methodologies. These assets may include both hard assets, such real estate, and intellectual property.
After undertaking these analyses, the valuation expert will appropriately weight the estimates derived from these different methodologies.
Also, consider how detailed and accurate the valuation needs to be. Valuations come in different flavors – from early, initial valuations based on some ballpark estimates of a few core criteria to rigorous in-depth analysis drawing on multiple methodologies and incorporating a long list of valuation criteria. In the early stages of considering a sale, it is often worthwhile – and cheaper – to start with a high-level valuation.
The difference between the external valuation and your sense of the company’s value is an important reality check and chance to test your assumptions before diving head-first into pursuing a sale.
b. Re-run the valuation based on improving core aspects of the performance of the company over the next two to three years.
Most companies have significant opportunity to improve performance in ways that will deliver much higher value in a sale. Understanding how improving performance can drive increased enterprise value – and identifying which aspects of performance matter the most – is critical to achieving strong shareholder commitment to undertaking the improvement effort.
The impact of addressing an organization’s weaknesses and improving performance prior to sale can be dramatic. Both top-line revenue growth and net profit margins are key metrics that buyers consider when valuing a target acquisition. Consider a hypothetical company that is considering a sale in three years, at which time it expects to have revenues of $250 million. The following graph, based on Westbury’s experience, illustrates the values that this company might attract in the market. In general, profitability and revenue growth rate greatly affect the EBITDA multiple (i.e., the value of the company divided by its EBITDA) a company attracts in a sale. In this example, at the low end, with flat revenues and only 5% net margins, a company might only attract bids with an EBITDA multiple of 5.25X and a sales price of $65.6 million ($250 million x 5% x 5.25X). With stronger revenue growth of 15% year-over-year and 15% net margins, that same company could attract an EBITDA multiple of 12X, generating a sales price of $450.0 million ($250 million x 15% x 12.00X).
2. Strengthen – or Establish – the Company’s Shared Vision
Building a shared vision among key stakeholders about the need for better performance is the first step towards capitalizing the potential for higher valuation. Leaders must also create a plan for going after those results in ways that increase the likelihood of a successful outcome.
There is a substantial difference between obtaining “general agreement” and driving towards a “shared vision” of the need for better performance. The latter means working through different views and perceptions that are often divergent, and then developing a sharp picture of “future success”, which is understood and agreed to by all key stakeholders.
The chart below is an example of one way to frame the picture of future success – in this case two or three years into the future and in terms of results across several dimensions including strategy, finances, operations, organization, and culture.
Creating this picture entails aligning on the key valuation metrics to target. Revenue and cash flow are always important. Other metrics such as EBITDA, churn rate, margin/profitability, product and customer mix, etc. vary in importance by industry, company size, and growth stage.
Success also requires agreement on what measures need to be improved to drive a higher valuation, and then unpacking what levers must be pulled to move the needle on those measures. For instance, a manufacturing company might need to reduce waste to lower COGS and drive higher profitability, while an early stage biotech company might need to focus on creating a high-performing R&D function that produces robust product pipeline.
3. Undertake a Rapid Performance Improvement Program
Developing the clarity and commitment outlined above is essential for success. But this is only half the battle. Mobilizing the organization to actually deliver much better performance is just as important.
Achieving a major performance step-up in any organization requires overcoming tough barriers to change – established ways of working, embedded assumptions, entrenched cultures and more. The way to break through these barriers is to harness the energy and productive behaviors that arise when organizations step up and respond to crises or “must do” situations. In these situations, low-performance norms are replaced by teamwork, initiative taking, high achievement, focus, and success.
While these breakthroughs typically occur spontaneously during a crisis, they can also be created as part of an organization’s on-going performance. The key is to instill some essential characteristics into the organization in a managed way, and to make these capabilities part of the new DNA of the business, as illustrated below:
Such an approach can have a major impact on results in a matter of months. For example, one mid-sized manufacturing company used this approach to lift on-time shipments to customer. For years, on-time shipments were stuck at 80% – far too low. A series of “rapid results” efforts made quick breakthroughs (100-days at a time) in performance, building confidence and new capabilities along the way. After less than a year, performance had climbed to a sustained level well above 95% – with a tremendous impact on company profitability.
4. Build an Effective Management Team
In preparing for a sale, shareholders should recognize that a capable management team can add value to an enterprise in two ways. First, without such a team, the value improvement efforts outlined above exceedingly difficult to achieve. Second, a good management team can make the company much more attractive to certain buyers. The chart below summarizes the various scenarios that are typically at play.
The matrix shows that a buyer with strong operating capability might put a premium on a high-performing management team, because they do not necessarily need the management team to remain and operate the company. On the other hand, a buyer with weaker operating capability might require a high-performing operating team in order to even consider the acquisition. Therefore, to make itself an attractive target to the widest range of potential acquirers, company leaders should invest in creating management team capability.
Capability can be enhanced through a variety of means including skill and personality assessments, training courses, conference/workshop participation, individual and team coaching, and rotational programs. In addition one of the best ways to build strong management is by leading the sort of rapid performance improvement program mentioned above.
By addressing these four areas of focus sooner rather than later, leaders can dramatically increase the value of their company. Then when the time is right for a sale, the process can focus on selecting suitable partners and finding the best acquiring company.
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