Market and competition impact sale price
By Scott Bushkie – CBI, M&A Advisor
Previously, I wrote about how to transform your company from one that sells at a three multiple to one that sells at a six. I reviewed some of the top factors contributing to your company’s sale price: customer concentration, quality of financial management, and management team depth.
These are all factors a business owner can typically control within a relatively short time frame, in as little as two to three years. That said, other key business elements such as industry and competition also impact the sale price, but business owners will need a much longer-term strategy in order to effect change in these areas.
Let’s start with the most obvious: your product or service. Businesses that sell at a multiple of three or less typically have a completely discretionary product or service. No one “needs” what you’re selling. Residential housekeeping services, restaurants, and boat dealerships, for example, all offer discretionary products or services.
Also ranking a three multiple or less are businesses with a small or potentially shrinking market, businesses in a fad market (designer cupcakes, perhaps), and those subject to heavy government oversight (think health care businesses affected by the changes with Obamacare – out of their control, increases the risk to a new buyer).
On the flip side, to sell at a multiple of five or more, your product is non-discretionary, you belong to a large and growing market, you maintained steady business throughout the recession, and you face little government involvement in your work.
In an ideal scenario, you sell a product that is essential to your customers – something mission critical to their business. But if not essential, the next best thing, of course, is to sell something your customers “should” have.
It’s the difference, for example, between selling commercial fire alarm systems (must have), security systems (should have), and coffee delivery services (nice to have). Or, to use an example from a company we just sold in Wyoming, a utility locating service. It is against the law to start construction/dig on a property until you have called 811 and the utilities on site have been properly located and marked.
Closely related to product-type is the nature of your competition. You may sell at a multiple of three or lower if you sell a commodity product with low margins. These companies have thousands of competitors with little to no differentiation other than who’s out hustling or making better use of technology.
To earn a value between three and five, your customers will have limited alternatives to buy your product. You will have average margins around 10 percent of revenues with a balanced market share of your industry. And new competition is limited because entering your market requires a significant investment in equipment and real estate or other meaningful barriers to entry.
But to earn a value of five or greater, you’ll sell a proprietary product with high margins, about 15 percent of EBITDA or better. Ideally, you’re a market leader with few like competitors. Or perhaps you have significant capabilities that would be hard to recreate, such as a niche engineering capability or intellectual property protected by patents.
Be aware that hitting a low multiple benchmark in any one category doesn’t mean your business will actually be relegated to a lower price.
For instance, we’re in discussion with a company that sells a commodity product with hundreds of other competitors in their industry. Going by the guidelines above, they could earn a multiple of three or less. However, this company is a market leader. They’re doing more than $25MM in revenue and $4.0MM in EBITDA, they have a strong experienced management team, low customer concentration and have automated their systems with state-of-the-art equipment.
That means this company can run faster and at less cost than anyone else in their market. And that means they can take on big national customers and really dominate that space. I’m optimistic we can get them a five multiple or better under current M&A conditions.
On the other hand, we just sold a business with 97.7 percent customer concentration at a multiple of three. That company offered mission critical services in a red hot, rapidly growing market, but neither of those factors was enough to overcome the risk related to the company’s near-exclusivity with just one customer.
As I’ve said before, financial performance is just one factor in a company’s sale price. To earn a higher multiple, you need to lower risk and increase opportunity for the next business owner.