Focus on strategic benefits to the buyer

We all know of small ventures which were purchased for more than 20 times revenue or 100 times EBIT. Whenever this would come up in conversation, I would hear people stating how lucky the founders were and what a difference luck and timing makes. But if you have seen a lot of these, is it just luck and timing? My own research into this phenomena suggests that you can set out to build a company which can have these huge exit values.

Just after I started my last business in the USA in 1995, a company called Red Pepper was purchased by Peoplesoft for 25 times revenue. Peoplesoft wanted to get into the manufacturing software business and needed an icon product to launch their campaign. Red Pepper had the market reputation to do that for them. A few years later, I sold my own business to Peoplesoft for 6 times revenue, even though at the time it was running up a $1 million loss. Since I had sold a prior business for $1 million which had never traded and an earlier business for US$9.6 million which was only breakeven, you might say I had a lot of ‘luck and timing’. However, these exits did happen in periods of significant growth in the computer industry and so one should question whether they were anything but luck.

Huge multiples are the result of process not luck

So if told you that I assisted a small sport travel business to get 40 times EBIT you would no doubt wonder if there was an underlying process which any venture could follow to set up a high value exit. The fact is that any business which has the potential to enable a large corporation to exploit a large scale revenue opportunity can gain a significant premium on sale.

However, very few people understand how to set up such a deal. We have spent most of our lives believing that our businesses are worth some meager multiple of EBIT. In fact, if you talk to most professional advisors, investment bankers and business brokers, they will focus their analysis of your business on what profit you are achieving now and what your likely revenue and profit growth will be in the near term future. I will freely admit that such analysis makes good sense when you are dealing with conventional businesses. If the only value they contribute to the buyer is the generation of revenue and profits through their own resources, an EBIT multiple valuation seems reasonable. But what about those businesses which can enable a large corporation to exploit a national or global opportunity?

What can the right buyer do with the business

Most private business are heavily constrained through lack of finance, limited capacity, poor access to large distribution channels, lack of skills and so on. The inhibitors to growth often prevent them from exploiting their underlying potential. In the hands of a better resourced and more capable buyer, the underlying potential can be aggressively exploited. Even so, most products and services can only generate limited growth due to the competitive nature of the market they are in. But what if you had a world class product or service which had a clear competitive advantage? Could you find a large corporation which could exploit this advantage on a national or global scale to achieve 50 or 100 times your revenue in a relatively short period? This is the basis of a strategic value sale.

The fuel for such an opportunity lies in the assets and capabilities which a large corporation can exploit, usually within an existing large customer base. How do you know if you have the right assets or capabilities to drive such an opportunity for a large corporation?

What creates the foundation for a strategic sale?

First you need to examine your own assets and capabilities. What do you have or do which could provide the basis for resolving a serious threat or enabling a large scale revenue opportunity for a large corporation? Often these are things which currently provide your competitive advantage but they may also be things which you are not exploiting in your own business but which some other business could. Products and services which typically drive high growth rates solve compelling needs, that is, solutions to problems which you must solve. Products or services which can be delayed, where there are many alternatives or which you can decide not to bother with, do not satisfy the compelling need test.

Next, you need to determine whether you can provide the buyer with some reasonable period within which they can exploit the asset or capability without it being copied, eroded or negated by an aggressive competitor. Something that can be easily acquired, assembled, developed or negated is of little interest to a large corporation. Thus you need a strong competitive advantage, perhaps build on intellectual property or deep expertise.

You want the buyer to come to you

Lastly you have to have a proactive approach to the market. You can only do this when you pursue a well defined but large niche market of clearly identified and reachable customers who are willing and capable of buying your product or service.

If you can satisfy those attributes in your business you have the potential for a strategic sale. Now all you need to do is to identify which large corporations can exploit the opportunity. Your exit value is then based on what they can do with your product or service not what you are doing with it. Simply get them to compete for the chance to acquire you so that they can exploit the underlying revenue opportunity.