Strategies to increase the valuation multiple
Despite what the experts say, valuing a business is a blend of science and art. Valuations can be relatively objective when dealing with profit numbers but are highly subjective when arguing a multiple. When addressing what multiple your business commands think in terms of risk to the acquirer. Fundamentally, the lower the risk the acquisition could fail – the higher the multiple, and conversely the greater the risk to the buyer – the lower the multiple. So how can an owner de-risk a transaction for an acquirer, as so argue a higher multiple?
Below are eleven pointers on how to move the scales of subjectivity in your favour and justify a higher multiple.
- Quantum of revenue. This is a proxy for market share and scale. As a rule of thumb, the greater the scale the lower the market risk (which therefore increases the multiple), and the reverse is true: sub-scale activities increase risk.
- Consistency of growth in revenue relative to market conditions. This provides evidence that growth is achievable–not just a pipe dream–and so justifies a higher multiple.
- Quality of revenue. Annuity revenue and long term (profitable) contracts de-risk the business. The further the outlook with contracted revenue the lower the risk and the higher the multiple. If you cannot lock-in future revenue at least have an impressive pipeline management system to prove your proactive pipeline management BD activities are effective.
- Quality of clients. Ideally, your clients will be impressive and representative of all potential sectors, so there is a balance between the different buying cycles of, for example, the private and public sector (where this is possible). Share of client wallet will be known and ideally high, repeat revenue will be evidenced and new client growth will decrease client dependency – all of which de-risks it for an acquirer.
- Absolute quantum of EBIT and the return on sales. How these compare to industry norms and how consistent they have been over time are crucial. For example, professional service firms’ EBIT margins of at least 20% are expected; poorer performance increases perceptions of risk and reduces the multiple
- Sustainable EBIT. Inconsistent profit performance reduces the firm’s ability to forecast effectively and also reduces the multiple – see the next point too.
- ‘Clean’ EBIT. In other words, does EBIT require excessive ‘normalisation’ to justify a ‘sustainable’ EBIT that is being applied to the multiple to calculate enterprise value? The cleaner the EBIT, the higher the multiple, as forecast EBIT is seen as less risky.
- Reliability of forecasting. All of the above help in judging predictability, since it is the forecast profit that ultimately proves a valuation made today, and in turn justifies a higher multiple. Has past performance tracked close to budget or forecast?
- Size of offices and business units. Sub-scale activities weaken a multiple because they are generally loss-making, a distraction to core activities, bring into question management’s judgment and usually require either additional investment to create scale or additional cost for closure.
- Dependency. The less dependent the firm is on ‘key’ employees and ‘key’ clients the lower the risk. ‘Spread and lock-in’ applies equally to talent and clients–the wider the spread, the greater the multiple.
- Leadership. Acquirers are also seeking new leaders who can have an impact that extends beyond the business they have just acquired. Don’t underestimate the general shortage of experienced executive talent and the value of your personal and team brand could bring to the new organisation.
In working with our clients, we seek to identify and prove up attributes that will increase the opportunity to justify a higher valuation. Having worked on many buy-side mandates as principals and advisors we understand what acquirers seek and how they value an opportunity. Our goal is a win-win for both seller and buyer.
If you’re interested to learn more about your company’s valuation, please send me an email.
