valuation

A few words about your valuation

Your valuation is dependent on two major factors:

  • Your attractiveness to a new prospective buyer; and
  • Your key metrics, such as revenue, growth rates, market share & EBITDA

However, most companies do not possess a perfect set of numbers, so if that’s your situation, don’t worry – a lot can be done in a short amount of time to improve your valuation.

Here’s an example…

Let’s say your revenue is $5M per year, your growth rate is 12% over last year, and yet you don’t show a positive EBITDA. While it’s true that a multiple of EBIT is one way to value a company, that’s only part of the story. There are many companies looking for economies of scale and increased market share. So here’s how it might play out.

Let’s say a public company has a P/E ratio of 15X (not difficult to imagine, because the average P/E ratio for ASX listed companies is approximately 15X). And let’s say that they are looking to acquire your company for $10M, which happens to be 2X your revenue. If you have an EBITDA of zero, why would this company be willing to pay you $10M?

How much are you worth?

It all comes down to whether they can integrate your company into theirs, grow your revenue from $5M in the first year, while reducing operating expenses – somewhat easy to do, because they already have an departments for accounting, IT, HR, legal, etc. So by decreasing the opex by $1M, it will increase the company value to $15M.

So by acquiring you for $10M, they immediately add a potential value to their company of $15M. Not a bad deal. But it gets better. If your growth rate remains at 12%, then after 3 years, your revenue will have increased by 40%, or an additional $2M. So if they are able to keep the same ratio of opex to revenue (approx. 80% in this case), then their new EBITDA on your part of the business will be $1.4M, for a new valuation of $21m.

How to grow your net worth

In 3 years, this company will have more than doubled their return on investment of acquiring your company. This technique is called a “rollup strategy” and it’s one significant way that Private Equity companies make their money.

The story gets better when true integration happens – the multiplier effect of serving multiple markets with the same or similar resources. For example, let’s say you’re in Market A. It’s not difficult to see how you might target Markets B and C which are similar to A, but they give you the chance to widen the size of the net that you cast. In the same way, if your main offering is Product X, adding products Y and Z can increase your billings with the same customers by offering a broader range of relevant products.

This is how all successful companies grow:

  • More customers, same market
  • More products, same customers
  • More markets, same products

A quadruple win

If acquiring your company is first of all, a no-brainer for the uplift in their valuation, and second, a multiplier in terms of the number of products they offer to more customers in more markets, it becomes a Win-Win-Win-Win.

 

By you understanding the value of these Wins for your prospective new buyer,  it allows you to create an attractive value proposition, thus increasing the competition for the purchase and uplifting the money you’ll earn.

 

See what’s happening here?

Let’s go back to the original scenario we painted: $5M in revenue, zero EBITDA and 12% annual growth. Not a heck of a lot to cheer about. Solid numbers but not stellar.

But by changing the frame of reference from Seller to Buyer, we could establish that acquiring your company would be an astute decision, and not only for one reason, but four. And all of those four reasons result in a significant uplift in valuation and performance for your new owner.

That’s what makes a successful exit event.