When it comes to mergers and acquisitions (M&A), a potential buyer will look at a number of factors to determine the value of a business. It’s about more than just the bottom line; a buyer wants to understand what makes a business strong, sustainable, and a good fit for their portfolio. Sara Burden and Bob Tankesley, seasoned M&A advisors at Walden M&A, recently shared their insights on the seven M&A value drivers they have observed from a buyer’s perspective.
1. Financial Performance and Predictability
Consistent and predictable financial performance is a primary concern for buyers. Buyers are looking for a history of consistent revenue growth, strong profit margins, and reliable cash flow, especially from recurring revenue streams.
Tankesley notes, “financial statements are a ‘report card’ on what owners have done with the resources available to them”. Buyers hope to see an upward trend in a company’s numbers, as this suggests future growth. While a downward trend may make a business harder to sell, a buyer might also see it as an opportunity to purchase the business at a lower price and turn it around. Buyers typically want to see a minimum of three years of financial history, but that has recently extended to five years. In some cases, a buyer may even want to review financial performance from as far back as 2018 to see how the business performed before, during, and after the COVID-19 pandemic.
2. Strategic Fit and Synergies
Synergistic buyers often look for a companion product or service, or they may want to expand their market share in a new geographic area.
Burden shared several examples, like when a company acquired a high-precision parts manufacturer because the buyer needed the seller’s specific technology and equipment. In another case, a commercial window cleaning company acquired a commercial window installation business to offer more services to the same customers. A third example involved a steel fabricator being acquired by an aluminum fabricator, enabling them to “cross-pollinate” their services across different metals. A seller’s well-trained tenured personnel can also be a strong attraction. While having a great team may not necessarily increase the valuation of a small business, it can make a deal much more appealing to a buyer.
3. Customer Base and Diversification
A diverse and stable customer base is another key value driver. Buyers want to see that a company does not rely too heavily on one or two clients, which would make it vulnerable to market shifts. A broad customer base indicates a resilient business with a sustainable revenue stream.
4. Management and Operational Team
Buyers place great importance on the management and operational team, as a strong team reduces the risk of the business being dependent on the owner. During due diligence, buyers will thoroughly scrutinize the team, from key players to hourly workers. The level of scrutiny has become more intense in recent years, as today’s buyers are more sophisticated and often have consultants to guide their evaluation process. Issues with a management or labor team can cause a deal to fall apart.
5. Scalability and Growth Potential
Buyers look for clear opportunities for future growth. This could be through entering new markets, launching new products, or using technology to scale the business without a proportional increase in costs.
6. Competitive Advantage and Market Position
A business’s “moat”—its unique selling proposition that sets it apart from competitors—is a significant value driver. This can include proprietary technology, a strong brand, or a dominant niche market position. For example, Burden shared an example of a construction services company that developed its own software to generate instant, error-free quotes, which attracted the attention of private equity firms. These firms were interested in the technology itself, not just the business, as it had the potential to be used in many other situations.
7. Clean Financials and Processes
Well-documented, accurate, and transparent financial records and business processes are essential to a smooth due diligence process and a successful sale. Burden emphasized the importance of a seller being prepared. A lack of preparation can put a seller at a disadvantage and lead to price cuts.
Tankesley notes some of the specific elements buyers look for in a company’s financial records:
- Consistency across all presented years
- All accounting adjustments have been made
- Audited or at least reviewed financials
- Accrual basis accounting
- Financials tie out to tax returns
Tankesley also added that due diligence exists to verify the numbers and data presented by the seller and their team, as well as to determine if they can overcome the inevitable setbacks that being the business’s next owner will create.
The Emotional Value Driver
While the seven value drivers are objective, Bob Tankesley and Sara Burden agree that a more emotional factor is often the most critical value driver for a buyer. As Burden puts it, “it boils down to the buyer believing enough in themselves to believe that they can do a better job”. This involves having the confidence to run the company and do a better job than the current owner. This fear factor is not always discussed openly, but is a significant consideration for buyers. M&A advisors address this by asking buyers if they can see themselves in the role, which helps identify potential fears that could cause them to back out of a deal at the last minute. This emotional readiness is a critical, though often unspoken, component of the M&A process.
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