In our last post, we started a multi-part series on steps business owners can take to enhance and improve both their business’ value and its salability with buyers. The series is based on a study conducted by the Cass Business School of the City University London and Intralinks. The folks at Cass and Intralinks analyzed 23 years of acquisitions and examined a global sample of 33,952 public and private companies in the process of their research.
Based on their analysis, there are a number of key things that entrepreneurs can focus on to improve their standing with buyers. Today we examine another one of them:
Some folks would say, really, is that so revolutionary a topic? But the facts are that quite a few people we encounter at our M&A seminars are under the belief that revenue growth is far more important than bottom-line improvement. As we discussed in our first article, revenue growth is certainly essential; however, buyers are also equally concerned with profit margin improvement. This is how the folks at Cass and Intralinks describe it:
"Private companies in the top or bottom deciles for profitability have on average a 20% probability of being an acquisition target in any given year – 41% more likely than private companies overall."
As pointed out in our last post, the dichotomy of this situation makes intuitive sense: Companies in a given industry that have higher profit margins than industry norms are attractive to buyers because they provide the possibility of greater immediate returns. Conversely, those with profit margins that are lower make acquisition targets as well, however, for a very different reason: The opportunity for tremendous improvement going forward.
Yet, under the latter scenario, buyers will not pay a premium and, in fact, will most likely offer a discounted value given that margin improvement may be risky to attain. This is how a few of the study’s participants describe the issue:
Bigger profits also mean faster payback, notes the vice president of M&A at a US public company: “High profit margins can help clear the loan for the acquisition at a faster rate, thus bringing added monetary benefits to shareholders and owners of the acquiring business.”
For the CFO of a Canadian private company, a target with a low profit margin may be attractive: “We would invest in a company that does not have a high profit margin if it adds value to any of the companies under us. We would invest in them if we feel it has the potential to grow with a bit of capital and help from our management. We would also invest if we wanted to enter a particular sector and want to diversify our portfolio.”
The managing director of a Chinese PE firm: “We prefer investing in businesses where we know we can fully use our management capability to turn them into profitable ventures. While acquiring a business with low profit margins, we can take advantage of negotiating on the valuation to suit our needs.”
Realize this: Buyers will analyze your historic and projected revenue growth as well as your margins when reviewing your company for investment purposes. The optimal scenario for you would be to focus on improving your bottom line in advance of entering due diligence with a buyer.
Doing so will enable you to obtain a better offer, with more favorable terms, than if your margins are declining and/or are below industry norms. This is especially true when you consider that most professional buyers that you approach will be likely looking at dozens of other opportunities just like yours. Your business needs to be as attractive as possible to move to the top of that stack of offers.
However, even companies with margins that do not meet norms can be attractive if there is a plausible reason why they are below norms AND if there is potential to eventually reach or exceed standard profitability. Under this scenario, which is less than ideal, you will need to document and explain not only why the numbers are low but also what a new buyer can do to improve them. Of course the first question any savvy buyer will ask is, “Why didn’t you pursue these potential improvement strategies already?” Your answer to that question will most likely make, or break, your transaction.
Bottom line is this: Focus on it! As you pursue revenue growth strategies, ensure that you are not doing so at the expense of your margins. As the old saying goes, don’t buy sales at the expense of your income. Doing so even in the short term can be tough in the long term.
Revenue and profitability go hand in hand. As the Cass/Intralinks study proves, ignoring one at the expense of the other can impact your company’s salability.
Stay tuned for our third and final part of this series where we will explore another buyer ready building strategy.
If you are ready for an intense full day of buyer ready building strategies, attending a Generational Group exit planning workshop is perfect for you. We hold these regularly throughout North America and they are designed to aid business owners who are contemplating their eventual exit. To learn more visit our website:
By Carl Doerksen, Director of Corporate Development at Generational Equity.
© 2016 Generational Equity, LLC. All Rights Reserved.
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