What makes your business valuable? Most business owners can explain what differentiates their company from competitors, which may include brand, product capabilities, key people, technology, or aspects of a service offering. However, taking a step back to look at your business through the lens of a prospective buyer—a more objective lens—is something most business owners should undertake before starting the selling process.
When you decide it’s the right time to sell, understanding what a buyer will want to know about your business in advance of undertaking a sale process is critical. Why?
First, it’s important to know what about your business is most valuable to potential acquirers, as well as what may be “deal breakers.” Second, you will be better prepared to respond to buyer due diligence. Understanding what information will be scrutinized may require internal organizational change or require the need to address challenges that may be perceived as “weaknesses” by one or more potential buyers. Strategic matters with the greatest impact on value will be the focus during early discussions, while risk assessment becomes the primary focus during the later stages of due diligence.
Here are eight areas potential buyers will evaluate when considering an acquisition of your business:
1. The Story
What is your “story?” Your story is the first thing any potential buyer will want to know about your business. For a strategic buyer, this will be quickly followed by the need to understand how your business will add value to their organization. For private equity firms, a rapid focus on growth opportunities will ensue. Without growth, financial buyers can’t achieve their target return on investment. Whether strategic or financial, a weak story that does not address an acquirer’s needs will end discussions. A compelling story increases interest (and valuation) and often leads to multiple potential acquirers.
2. Financial Performance
Buyers will analyze the historical financial results of your business. This analysis is not limited to revenue and margin data, but will include a deep review of the income statement, balance sheet, and statement of cash flows to understand the true trends and growth drivers in your business. Engaging an accounting firm to perform a quality of earnings analysis may also be a good investment. You also will be expected to provide a financial forecast for the next one to three years. You should prepare an “aggressively defensible” forecast, but an inability to support the forecasted growth targets with clear assumptions and specific strategies will erode your credibility.
3. Products and Services
A buyer will want to understand the details of each product or service offered, including how each is produced and marketed, as well as any and all products or services in development. This information will shape the buyer’s perspective on how complementary your business is to theirs and provide insight into the post-transaction integration. This determination significantly impacts valuation, but also acquisition risk, since integration issues are typically a main concern for buyers.
Where you operate and the geographies you serve are also critical considerations for buyers. An acquisition can provide a buyer immediate geographic diversification or a broadening of its customer base. If your business has been expanding geographically, the buyer will want to understand the historical return on investment generated from geographic expansion, particularly if the forecast provided anticipates further expansion. In addition, most buyers will want to separate your company’s historical rate of growth between organic and inorganic (i.e., growth via acquisitions) growth, since organic growth is more highly valued.
5. Management Team and Employees
Your management team is key to your business and a buyer will want to fully understand the roles and responsibilities of executive and second-level management. It’s important to identify and address any gaps (i.e., key open positions, under-performance) prior to undertaking a sale process. Ensuring that employment policies and procedures are documented and in place will save time and money (and may preserve the deal) during due diligence.
Often buyers will not want to undertake an acquisition without at least a medium-term (two to three year) commitment from the owner/CEO; in other situations, however, the buyer might have more flexibility. In transactions with financial (i.e., private equity firms) as opposed to strategic buyers, the continuity of the management team is of critical importance.
If technology is a significant component of your business, buyers will spend substantial time (and money) to assure functionality, scalability, and legal protection. Internally developed software and other protected intellectual property that provide a competitive advantage are likely to be of significant value to a buyer. Prior to commencing a sale process you should take the necessary steps to ensure your company’s technology assets will withstand extensive due diligence.
During the initial stages of a sale process, you will be asked to provide on a no names basis the historical trends among top customers, turnover and retention rates, key wins and losses, customer concentration, contracted versus non-contracted revenue, and the recurring nature of the revenue. Issues with these items will hurt the valuation of a business and often eliminate interest from certain buyers (including many private equity firms). Non-disclosure of these facts until the final stages of buyer diligence (when actual customer names are disclosed) is delaying the inevitable and unwise.
For certain businesses, a buyer may want to assess your vendor relationships and concentration. Buyers may be concerned with alternative sources of supply, pricing levels, and the nature and length of purchase commitments. If you are evaluating a sale to one of your larger competitors, there is often immediate accretion to operating margins due to their ability to gain greater pricing leverage with suppliers.
The breadth of the information you will be required to share when selling your business is both broad and detailed. Although many items are quantitative (i.e., size, growth rate, margins, customer concentration), the ultimate value of your business is about more than just the numbers. Being prepared to address the above items will strategically and successfully position your business for maximum value to interested acquirers.
Stephen Gaines is the Managing Director and Head of Business Services Investment Banking at Janney Montgomery Scott. Janney’s Investment Banking practice is a leader in middle-market M&A and financing solutions for public and private companies.