When owners are considering the sale of their company, there are two important questions they should ask: What is my company worth? and Who are the best buyers? The answers to both questions are subjective and can vary from time-to-time. Company valuations are dynamic based on a variety of factors outside the owner’s control (hence be prepared to sell when valuations in your industry are high). The best buyers can also vary from time-to-time for numerous reasons – focused internally, focused on other acquisitions, capital constraints, etc. More on this at another time.
With that said, every industry trades in a range of multiples. The question then is: what are the characteristics of companies that are valued at the higher end of the valuation continuum in their industry?
Here are seven characteristics of companies that trade at the higher end of the range for their industry.
How would your company measure up, if you were to sell it today?
Characteristic #1: Transaction size greater or less than $50 million:
All else being equal, larger companies are typically valued at the higher end of the multiple range simply due to scale. Scale can cure a lot of ills – larger companies tend to be less dependent on key management, have more bargaining power with customers, vendors and suppliers, are more competitive, and have broader product offerings and greater market share. Scale also attracts a larger and broader universe of buyer candidates. While it can be difficult for a $10 million revenue company to eclipse $50 million in enterprise value, consistent growth and revenue momentum can mitigate the size conundrum.
Characteristic #2: Differentiated product or process vs. a non-proprietary or commodity-like offering:
Owners can create value in a number of ways, including offering unique products/services. In fact, companies with differentiated offerings rather than “dime a dozen” products or services will be valued at the higher end of the multiple range due to their perceived competitive advantage.
Characteristic #3: Strong growth outlook vs. mature industry/nominal growth potential:
Rapidly growing companies will be valued at the higher end of the multiple range due to their future profit potential. As discussed previously in our email about Determining Future Value, buyers are ultimately purchasing an expected stream of future cash flows. High multiples based on current EBITDA can shrink rapidly based on the expected EBITDA one to two years into the future. Of course, the buyer assumes the risk of achieving that higher future EBITDA.
Characteristic #4: High market share, niche market and significant barriers to entry:
Clearly, companies that have captured a significant share of their chosen market, or that operate in a unique space with fewer players, and/or that face fewer threats from competitors because they are in a high barrier-to-entry market not only have a competitive edge, they are more likely to continue to generate positive cash flow and grow over time, thus, they will push the higher end of the valuation spectrum.
Characteristic #5: The company operates in a non-cyclical market:
Product and demand cycles are difficult to determine, and therefore, buyers often struggle to value companies in which the business is cyclical in nature – like capital equipment companies. If buyers are unable to determine correctly the length of the business cycle or the current spot in the business cycle, then the buyer runs the risk of valuing the company incorrectly, too high or too low.
On the other hand, companies with steady, non-cyclical products/services have more transparency and clarity in their ability to project future sales and cash flow, thus buyers are more likely to value them at the higher end of the multiple range.
Characteristic #6: Historical capital investment:
Has the business become dated, or has the owner continued to invest in the company? Obviously, owners who have “kept up with the times” in terms of equipment, technology, and other investments are likely to capture the higher end of the multiple range than those that have allowed their businesses to languish in the dark ages.
Characteristic #7: Sustainability of business model and organization:
Is the company selling a “flash-in-the-pan” product or service, or does it have a long-term, viable market? Is there depth to the management team, or is the owner “running the show” alone? As we alluded to earlier, companies that are valued at the higher end of the range are generally those with “staying power,” a deep management bench, and a competitive edge in their chosen market.
One of the keys to a successful sale is understanding the multiple range and how to move your company from the lower end of the range to the higher end of the range. Again, consider where your company might rank on the valuation continuum today. Now is the perfect time to take action in advance of a sale to maximize both the multiple and the value of your company.
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