A New Trend in the Market is Seeking a Different Kind of Value  

Key Takeaways:
  • Private equity buyers are paying top dollar for well-run companies with strong management and steady cash flow.
  • Business owners planning to sell soon should focus on building value and having a clear succession plan.
  • Strong operations and management can significantly boost a company’s sale price in today’s market.

 

A rising trend in the merger and acquisition (M&A) market is changing the approach to exit and succession for business owners across the country. And the results are consistently good when it comes to valuations of well-run, well-managed companies. Consequently, for owners looking to exit in the next three to five years, a key question to ask today is: Who are the buyers who are offering the strongest prices, and what are they looking for in the companies they buy? 

The private equity sector is increasingly shifting its focus toward buying strong, well-run companies – and paying top dollar for them. This is a shift from the historical approach utilized by private equity (PE) groups, which was to pay discounted prices for distressed or lagging companies, invest in improvements that would drive new revenues and then sell them for a profit. 

Today’s private equity groups are looking for sure bets – companies that have proven their worth with strong revenues and cash flow, captained by capable owners and management teams.

In many instances, the owners remain with the management team after the PE acquisition either permanently or for an extended earnout period. Increasingly, the PE buyers are holding these companies in their portfolios indefinitely as they build long-term value. 

The advantages for the acquired company in this kind of scenario are many and extend beyond the high valuations and purchase prices they receive. In some instances, acquisition by a PE group may open opportunities for a company. For example, a company owner may have wanted to add a product line to boost revenues, but couldn’t manage the capital investment needed to do it. As part of a new portfolio of similar companies held by a PE group, the company may now be able to expand its product lines by leveraging the goods produced by other companies in the group.  

Impact on Valuations 

The impact of this trend on business valuations is quite positive for those companies that are well run, have strong financials and effective management teams who plan to stay in place. These factors combine to minimize the risk component in a valuation, which strengthens the asking price and attracts buyers who are looking for proven winners.  

For PE groups seeking long-term value in their acquisitions, this kind of risk mitigation solidifies their ability to shift from a short-term strategy to a long-term value investment strategy. Instead of making their money on flipping a company they acquired at a discount, now they’re making money on economies of scale. Turning a $100 million company into a $1 billion company over a 10- to 15-year horizon is a much better payday. 

What Should Owners Do Now? 

If you are looking to sell your company in the next three to five years, and your goal is to get the best value, understand that the premiums being paid in today’s market are not just for companies that perform well. They are for management groups that will stay in place, owners who are willing to stay involved and markets that offer minimum risk and maximum growth potential.  

In other words, there’s significant value being placed on companies that require less improvement to be done on the back end and infrastructure. 

For business owners, the key steps to take today include: 

  • If you don’t have an exit or succession plan, now is the time to work on it with your trusted advisors.  
  • Become informed about where the value drivers are in your company and analyze how well they align with your exit plan. Are you on track to reach your goals? 
  • You may have strong financial performance and a strong balance sheet – but why? It’s important to have those advantages, but also important to understand the story behind the numbers. This is where the risk lies, as well as the value that is driving your company’s performance. 
  • Understand where your company may fall with regard to the “value gap.” Two companies in the same industry may each bring in $20 million in revenues. Company A has a 10% margin, and research shows they could get a market multiple of 5 in an acquisition for a purchase price of about $10 million. But Company B has a 15% margin, along with stronger infrastructure, better processes and better management. Its market multiple is around 6, for a valuation of $18 million. The $8 million that Company A is leaving on the table by not being in Company B’s position is the “value gap.” 

Impact on Family Succession 

Acquisitions involving PE buyers are generally fueled by an owner’s desire to get a big selling price, as well a wish to do the best thing for his or her employees.  

When it comes to family succession, other factors come into play. But as the marketplace increasingly rewards strong, well-run companies with high valuations and selling prices, family business owners should take those lessons and approach their own succession in the same way they would if selling to a third party. 

Succeeding a family business to the next generation doesn’t mean an owner shouldn’t set a goal of getting the highest value for the business. A lot of the work that will underpin that valuation and sale price is done by the selling owner, in many cases years ahead of the succession. And that preparation will put the company in much better shape for family members to operate it in the long run. 

That’s not to say an owner should expect family members to pay what a PE group would pay. That doesn’t usually happen. But an owner who cares about how the company will fare after the sale should consider applying the same criteria to family buyers as to a PE group, i.e.: 

  • What are their long-term plans for growing the company? Do they have the ability and the capital to achieve that vision? 
  • How will they involve the current management group? 
  • Do they have the operational, sales and management experience to run the company for the long term? 

Trends in the M&A marketplace will continue to impact valuations, as well as the opportunities business owners have to maximize their selling prices. If you would like to discuss your company’s value and options for a successful exit, contact an Adams Brown valuation advisor.