If you have thought about selling your business you need to understand the business valuation spectrum. Specifically, you need to understand business valuation from the perspective of a buyer. Selling an operating business is unlike selling any other asset. The value of a business varies from month to month, from buyer to buyer. Another fact: buyers will not consider an asking price. Your question: how to establish business value in the M&A sale process?
Buyers choose the strategic growth option (acquire a business rather than build it) to create value. They will always be looking for synergies and opportunities to cut costs by eliminating repetitive processes and positions. This can be a significant component to value and if, as a seller, you understand M&A integration, you will understand the buyer’s perspective a bit more.
Prepare a Confidential Information Memorandum (“CIM”)
There are a number of reasons the CIM is a critical tool in any M&A process. First, it gives a seller the opportunity to present their company in its best light. Second, it saves buyers a ton of time assembling the relevant data, information and background that goes into the book (yes, the CIM is a book, a biography and outlook for your company with a table of contents, relevant value building sections and an appendix). Third, it enables you to control confidential information and who receives it when running an M&A process.
An efficient M&A process means each prospective buyer receives the same information in the same time frame and is informed of the M&A sale process guidelines and time frame.
Experienced buyers will know exactly what to look for in the CIM to establish business value. Buyers will know how the seller expects them to establish business value and present it in an indication of interest or letter of intent.
Think about the name of the document. 1) Confidential means that it’s privileged information, provided pursuant to a confidentiality agreement, that cannot be shared by its recipients. 2) Information means that the details included in the book will be the basis for valuation, and verified in due diligence. 3) Memorandum means that it is in writing, so be certain every last detail is accurate and verifiable, pursuant to disclaimers, time, etc.
Company Specific Metrics
The reality is business valuation is established between a seller and a buyer given the lengthy process of negotiation. The negotiation is based on facts. The facts include financial statements, tangible assets and associated liabilities, contracts, intellectual property, recurring revenue, diversification, risk mitigation and so on. Depending on the industry there are also other relevant key performance indicators (“KPIs”) that influence business valuation.
So how do you establish the facts and begin a productive dialog about agreeing on business value? This is the role of the Confidential Information Memorandum. It’s your company’s biography. It tells the story in two separate, yet complementary languages:
- Narrative – A written description of everything that matters in the day to day operations of your business
- Financial – A detailed historical financial analysis that establishes trends and a viable set of achievable financial projections
Your Confidential Information Memorandum sets the boundaries for everything you want the buyer to consider when determining they establish business value. They can apply their approach to business valuation to the facts you both agree to.
I think of a CIM as a recipe to establish the approach to business value. It serves as a set of instructions as to what you are generally expecting for a business value in an indication of interest. Think of it like a recipe for a cake: when you start with ingredients for a chocolate cake, you don’t expect to end up with an ice cream cake.
Written properly, your CIM will enable an interested potential buyer to prepare an offer within your expected value range.
It lets buyers know about the company’s journey to the present, what differentiates the seller from its competition and where management sees the business’s economic opportunities for a few years out. The purpose of the Confidential Information Memorandum you prepare for, and provide to prospective buyers never includes an “asking price” for the company. Rather, the CIM must be written to carefully and professionally take the reader through all of the contributing factors to establish business value the way you see it. The sell-side M&A strategy is always to maximize value.
This is done, in part, by drawing attention to the future your business is positioned to capture and benefit from. Based on all the hard work you put into the past, and leveraging the historical trends, your goal is to get credit for upcoming revenue and earnings benchmarks. Depending on your fiscal year end and the current period, our goal is to establish value based on the future. You can see how important it is to present viable financial projections. Want to learn how to prepare financial projections?
The single most important objective of the CIM is to build a great story around how you have created unique differentiation in your industry and how your core competency, technology, know-how or whatever it is cannot be duplicated easily. This establishes a strong rationale behind the buy versus build strategy because there is no bigger value builder than sustainable revenue growth and quality of earnings.
It’s also important to convey the reason you aren’t the best person to lead the company into this amazing future, and the buyer(s) you are talking with could be – this is your reason for selling. Your CIM should provide the reader with all of the variables in the business value equation the way you see them, and they should too:
- What has been the top line driver for the business over the past three years
- What developments do you focus on to improve and adopt this driver as you industry evolves
- Provide thorough, consistent financial statements for the past three years and year to date (or trailing twelve months)
- Provide a narrative (MD&A) of the past three years’ financial statements (with references) including any adjustments you’ve highlighted as non-recurring or discretionary
- Discuss your industry, who your major competitors are and what they are doing to evolve with the industry
- Demonstrate your competitive advantages and how they enable your company to take advantage of the market opportunities
- Provide financial statement projections for three to five years out with a discussion tying all of the above points together and support your financial projections
Providing prospective buyers a professional, thorough and interesting CIM is only the beginning to establish business value in an M&A deal. You also have to have a thorough understanding of the M&A market environment, relevant company public valuations and what the discounted cash flow value of your financial projections are. Basically, you need to have an idea of how the market will value your company.
M&A Market Trends
Current M&A market trends will also help establish business value based on relevant comparable transactions. Factset is a good source of M&A market trend data.
Having reasonable expectations when running an M&A sale process is really important when contemplating offers. Good information about M&A valuation trends in your industry will help you understand the buyers’ perspective. Comparable transactions offer perspective on what financial factors contributed to successful transactions.
Valuation factors that we look for include:
- Enterprise Value / Revenue
- Enterprise Value / EBITDA
- Enterprise Value / Net Income
- Enterprise Value / Book Value
When we have good M&A valuation data sets we can apply them to a seller’s financials to give us additional business value indicators. Do your market research, the more verified information you have the better informed you will be.
Establish Business Value
By writing an effective Confidential Information Memorandum that accurately conveys the facts that make a company unique and by presenting a case for a strong future, you will help establish business value in the M&A sale process.
If you do this right when running a tight M&A auction process, you will receive competing indications of interest within your expected range. A tight range means you have viable prospective buyers willing to negotiate business value and transaction terms. You should have at least one opportunity to increase the business value as you proceed to a Letter of Intent (“LOI”).
If you don’t do this right, you will not have a viable buyer at a business value you would seriously consider.
This is a highly simplified view of the typical M&A auction process initiated by a seller. Business valuation is complicated and fraught with constantly changing variables that often seem irrational. This is because the future is uncertain and confidence in successful return on investment can be a big figure in the equation.
Another thing: the market is always right.
If you are a motivated seller, and you are sure your company is operating at peak performance, you can analyze recent comparable transactions to understand where valuation multiple trends are for your industry. This will give you at least one point of reference on potential business value.
When you know what to expect you can negotiate from a position of intelligence and strength to establish business value in an M&A sale.