Strategic value or profit?

Often, a company will not have the necessary resources to achieve both goals of building profits and developing underlying assets. When do you focus? TOM McKASKILL has some pointers.

By Tom McKaskill

I often confront entrepreneurs with a stark choice – what is the best strategy to prepare your business for a sale – build up the profits or develop underlying assets and capabilities for a strategic sale.

You might well ask: “Why can’t you do both?” I am sure that some companies can, but when you look at the processes involved and the priorities that will place on where to use your surplus cash, you often see is a clear choice – you don’t have the resources to do both, so you need to decide which strategy is going to give you the highest exit price.

Companies that are sold on an EBIT multiple are those that provide the buyer with a platform that enables the buyer to generate a stream of future earnings through the use of the resources contained within the acquired business.

While these might be augmented by the buyer through the insertion of better processes, more capable management and better funding, essentially it is the same underlying business that is generating the profit stream. Thus any acquisition valuation will be based on net present value of those future earnings.

Most businesses fall into this category. Thus financial buyers typically buy retail, wholesale, light manufacturing, transport, property and services based businesses.

You increase the value of such businesses by reducing the inherent risks for the buyer, improving the visibility and reliability of future earnings forecasts, improving on-going profitability, building growth into the business and finding ways to create growth potential for the buyer.

By contrast, those businesses that appeal to strategic buyers have some underlying assets or capabilities that a large corporation can exploit through the buyer’s own organisation. Small companies will often develop products or services that can be sold by the acquirer through the buyer’s very large distribution channels.

In the right circumstances, a buyer might be able to scale the revenue by 50 to 100 times that of the seller just by having the right access to global customers. The key to a strategic sale is to find a large corporation who can exploit the underlying asset or capability of the seller to generate very large revenues.

In these situations the size, revenue, number of customers or employees or level of profits of the seller may be entirely irrelevant. It is the size of the revenue opportunity of the buyer that is the key to a strategic value.

Thus a business that has the right type of assets or capabilities that can generate such strategic value may be much better off by putting additional effort into developing those assets and capabilities to provide greater or earlier revenue generating power for the intended buyer.

A higher exit price will be achieved if the buyer can scale or replicate the asset or capability faster and can integrate the seller’s business quicker. The only size consideration for the seller is to be big enough to provide the launch platform for the buyer to fully and quickly exploit the strategic value.

Strategic sales normally generate much higher exit values. Take the time to consider how you might develop your business to generate more strategic value.