Value: It’s a word with many meanings. There’s a fair market value, book value, intrinsic value, and more. In talking about your exit, the value we focus on is transferable value. Let’s look at an example.
Picture three seemingly identical companies, each engaged in moving time-sensitive freight for their customers. They all have a national presence, $2 million in EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization), and about $25 million in annual revenue. It would be logical to assume that they all have about the same value.
However, one company had little value, one sold for 3.5 times its EBITDA, and one sold for 5.5 times its EBITDA. The difference in value was $3 million to $7 million to $11 million.
Neither revenue nor EBITDA alone determined the prices and terms of these deals. The keys to the differences in purchase prices were the presence (or absence) of Value Drivers and the ability of those Value Drivers to survive the owner’s departure.
Value Drivers are internal characteristics of a company that third-party buyers—especially private equity groups—look for in an acquisition. Strong Value Drivers are effective company traits that will continue to operate once the original owner departs. Consequently, those Value Drivers increase both the company’s EBITDA and the multiple of EBITDA buyers will pay for the company.
We measure the effectiveness of Value Drivers in two ways:
- Their positive contribution to cash flow.
- Their ability to continue to contribute to cash flow under new ownership.
Think of Value Drivers as the “things” buyers are buying from you: Why would anyone want to buy your business if its continued success is dependent on you, the departing owner, rather than the Value Drivers? Buyers only pay top dollar for businesses that will not miss a beat when the original owner is no longer in charge.
Success in business is determined not by how well you run the business, but by how well the business runs without you.
Let’s look at the three aforementioned companies more closely to see exactly what motivated buyers to open their wallets or walk away.
- Company A: The owner/operator was responsible for management and operations, and his personal and industry contacts were the sources of all new business. All roads ran through the owner, so without him, the business had little value.
- Company B: This company had a capable management team. Many of its systems and procedures were state of the art. However, there was one glaring weakness: Its major customers, responsible for over 50% of the company’s revenue, had a decades-long relationship with the company’s owner, not with the company. No buyer will pay millions for customer accounts that can, and indeed often do, go elsewhere the day after closing.
- Company C: Finding the owner of Company C wasn’t easy. She spent weeks on vacation or visiting grandchildren, and when she was in town, she was engaged in a variety of civic and charitable activities. She made appearances at the company sporadically and left the operation in the hands of her capable management team. She had deliberately created plenty of diversification in her company’s customer base, knowing that one day she’d sell the business. She had thought about what she’d look for in an acquisition, so she included customer diversification as one of many attributes (i.e., Value Drivers) she wanted in her company. She understood that Value Drivers were necessary to maximize salability, the company’s sale price, and the amount of cash she could demand at closing. Interested buyers were delighted that she had changed her role in the company over the years so that a new owner could step in almost unnoticed.
In my next post, I’ll list 11 Value Drivers that are most important to today’s buyers. From there (but not in any particular order), I’ll discuss each of these Value Drivers and the reasons they are critical to transferable value.