By Stephen Goldberg, EO New Jersey member and managing director of Sun Mergers & Acquisitions, LLC.
Typically, the market will establish a price range for a company, just as it determines a price range for products and services; however, value maximization can only be achieved when the universe of qualified and motivated prospects fully appreciate a company’s future growth and earnings potential.
A critical requirement of maximizing the value of a company entails a professional and organized presentation of both tangible and intangible business attributes to potential acquirers. Moreover, a professionally prepared presentation improves the efficiency of the business sale process, and proper execution enables a business owner to achieve a premium value for their company.
A business is very different from a tangible asset, such as a building. Prospective acquirers of real property can see the bricks and mortar, review comparables from similar buildings sold in the area, understand the rental earning capacity of the building, and then apply accepted valuation formulae to these tangible parameters. Business value is more intangible. For example, a business with $1 million in net tangible asset value can have a market value of over $7 million.
Tangible assets including equipment, inventory, and accounts receivable are necessary to generate earnings, but typically do not drive valuation in a thriving or growing business. The perceived value of a company is largely a function of presenting and educating acquirers as to a company’s intangibles, while demonstrating its future earnings capacity. A business owner spends years establishing intangible elements such as name recognition, operational and production systems, personnel, marketing and distribution channels, supplier relationships, reputation, and customer longevity to name a few. These factors must be presented in a way to educate potential buyers of their importance and impact on company value and in turn increase their confidence and comfort level in pursuing the business transaction.
A professionally prepared memorandum presents a confidential, in-depth review of a company’s strengths, weaknesses, and opportunities to validate and defend its future earnings potential. The memorandum is commonly referred to as an offering memorandum, confidential descriptive memorandum, CIM, or simply, “the book”. Its purpose is to maximize the initial impression of a business, educate as to the specifics, and excite qualified potential acquirers to further explore the acquisition opportunity.
When acquirers evaluate a business acquisition opportunity, they expect the records and facts to be properly organized and documented. There is only one chance to make that all important first impression. Improperly presenting a business will compromise the overall validity of the book, and turn away strong acquisition candidates or reduce value perception.
The book must optimally present the business from both an operational and financial perspective. The operational portion of the book focuses on a few core components including:
- strength of the foundation in place
- mitigating risk factors, and
- presentation of expansion opportunities/future potential
Foundation – The foundation of a company reviews initiatives and unique attributes that can continue to be built upon. It includes things such as competitive advantages, management team, operational processes, product lines, repeat client base, and vendor relationships.
Risk Factors – Factors that may cause doubt as to the sustainability and predictability of future earnings under new ownership may include: dependencies on employees, customers, owner relationships, or vendors; market uncertainty; competitive developments; regulatory actions; and, impact from changing technology to name a few. The extent to which the descriptive memorandum addresses and mitigates these issues directly impacts the perceived value of a company.
Expansion Opportunities/Future Potential – Growth opportunities can include developing new markets, technologies, or expansion into new products or services. Expansion opportunities and future potential include growth prospects that have not been pursued under current ownership. There are many reasons a company may not have pursued these opportunities including lack of capital, limited desire due to the owner’s age or financial comfort level, and limited management capabilities; however, with the foundation in place, it can be pursued by acquirers. In presenting these opportunities, we assume that the acquirer will have the financial strength and motivation to implement and capitalize on these initiatives. It is important to provide a buyer with a growth plan, or “road map” that could realistically be achieved under new ownership.
In most instances, acquirers seek to buy a business with the intention of expanding the company. They are willing to contribute the effort and resources needed to expand; however, they want to know that the business provides an avenue to channel their efforts and resources to achieve desired growth. Maximizing this aspect of the presentation requires persuasively presenting the answers to the following growth considerations:
- What are the likely sales projections given the current products and markets?
- What new products and/or markets can be added to profitably increase sales?
- What changes can be made to pricing policies or improved efficiencies can be implemented to increase the company’s gross margin?
- What new marketing and sales resources can be added to profitably build sales?
- What operational assets can be added to increase capacity or earnings?
- What past extraordinary or one-time expenses will not be required in the future?
- What expanded management capacity and talent is needed to grow?
The answers to the above questions form the crux of the growth plan. It enables the potential acquirers to appreciate the value drivers, intangibles, and latent opportunities that have yet to be harvested and drives home the synergistic benefits that are likely to materialize post transaction.
While this article focused on maximizing value through the presentation of a company’s intangibles, foundation, mitigation of risk factors, and growth plan, it is also critical for the M&A negotiator to properly present the recast cash flow potential of a company. Corporate buyers are experienced negotiators that are typically interested in acquiring to grow and maximize future earning. The price they are willing to pay is a direct function of their understanding of the recast financials of a company along with an anticipation of the firm’s growth potential. Financial statements are prepared for tax purposes, not business valuation or business sale purposes. It is imperative that the acquirer can “read between the lines” of the financials to understand the true earnings capacity of a company. It is then up to a merger and acquisition professional to artfully guide and motivate buyers to submit their best proposal.
To read more of Stephen’s article, click here.