5 Key Value Drivers When Selling a Company

Accessing the private capital markets can be tricky — especially for first time visitors. Whether you are considering a recapitalization, a management buy-in or buy-out, or a family transfer, there are key considerations that should be discussed and understood before any company is brought to market.

To identify the best buyer and maximize purchase price, the business owner and the investment banker should both be able to articulate the value drivers for the company. Clearly articulating these points can help a potential investor see the value of your business.

Below are 5 key value drivers that must be discussed as early as possible in the process so that all parties are on the same page:

1. Customers

One of the most important value drivers to discuss is your customer. An understanding of how a business makes money and who its customers are is essential for any PE firm and deal negotiation. Too often, I see write-ups or pitch books of a business that do not explain how the business makes money. You must be able to answer that question; you have to succinctly be able to tell someone how the company makes money.

You also have to be able to speak to how you acquire customers. What is the profile and size of your customer base? How do you engage with them? Having a more organized CRM and legitimate salesforce, while not necessary for a successful deal, can help demonstrate to an interested PE firm that you are working with regular, sustainable customers.

Last, but not least, you also have to be able to speak to how you lose customers. If your customers are able to abandon your business overnight with little to no switching costs, it will be a red flag for many private equity firms. If you have customers that can leave next week without pain and heartburn, that’s not a good thing. While it is not an insurmountable challenge, the deeper entrenched your business is in the customer’s life and business, the better.

2. Industry & End Markets

In addition to your customers, it is imperative to be able to comment on the size of addressable market. There is no need for detailed reports, but you must have a sense of the number of potential customers and trends in that space. Is your industry growing or shrinking? Is there heavy regulation? These types of extra-company factors can make realizing a successful investment difficult for most PE shops.

PE investors are also concerned about businesses that are highly discretionary. For example, if your business offers a completely discretionary item, that means the purchase can be put off during downturns and economic uncertainty. That is a big risk in future cash flows and, unsurprisingly, a red flag for many PE investors. Similarly, if a business is very cyclical, it can be challenging for an investor. Most PE firms use some form of leverage during an acquisition, and leverage and cyclicality is a very risky cocktail. It can go sideways on you very quickly.

To help assuage an investor’s concerns, you should demonstrate that your business tracks along with the general economy. If you can show solid financials from 2007-2010, that is a great sign that your business is not particularly subject to cyclicality or customer discretion.

3. Suppliers

We already discussed the addressable market and your customers, but now it is time to consider your suppliers. The two questions you need to address are:

Are their any supplier concentrations? If your business is being influenced by your supplier because of their consolidation or control of the market, that is not a deal killer, but it is something that must be disclosed to the PE firm as soon as possible. It is important to understand the costs and risks of switching suppliers.

Can a supplier go straight to your customer? If that is the case, it makes investors very nervous. Most PE investors want to see a fundamental, tangible reason why your business exists. If you are relying on opportunistic inefficiencies, there is a great deal of risk that your business will be squeezed out by larger competitors or those with vertical integration capabilities. You need to demonstrate that your firm will be around for a long time because it is addressing a clear need — and one that no one else can easily replicate.

4. Competition

As the interested investor gets the lay of the land, he will also need to know about the level and type of competition surrounding your company. You will need to effectively be able to address the presence of any competitors and how you differ from them. What are the variables? Price? Service? Location?

if there is no competition, then you still need to explain why the customer is buying from you. Are they buying from your firm because of the salesperson? Or because of the right price? It may sound like a silly question, but it is fundamental to why a company exists. The more and better you can answer the question, the more value you can demonstrate in your business.

5. Management & Financials

Only after understanding the full ecosystem in which you company exists will the investor begin to look into the company itself. Understanding the key stakeholders and management of the business is absolutely crucial to a successful deal.

Getting deals done in the lower middle market is so much more about the psychology of the stakeholders than actual financials. You need to make sure everybody is happy. This is why most PE firms will spend so much time getting to know the management team and making sure there is a fit. If you try and fit everyone into a predetermined box or equation, the deal will fail.

When it comes to financials, the numbers will be what they will be. At this stage of the process, the investor is probably most interested in seeing how organized your business is. The numbers need to be reliable. We don’t want to be in a situation where we’ve made a deal, then did some diligence only to discover that we were misled. In those situations we have to break the deal, which is disappointing for everyone involved. The more confident we feel in your ability to track numbers, the more confident we will feel about the deal. However, don’t worry about too many add-backs or no CFO — just be systematic with the process.