M&A – Value Enhancement

Value & Price Drivers of a Business

There are numerous factors that influence the value of a business and the ultimate price negotiated. Some are internal and some are external. Some are controllable and some are uncontrollable. Knowing these factors and the underlying drivers can help you highlight the business opportunity and negotiate the best price and terms.

Performance History

Many buyers focus on the historical financial statements because of the accustomed comfort in dealing with visible scorecards.

  • Quality of Earnings & Consistent Profitability
  • Growth Rates Higher than Industry norm
  • Gross Margins Higher than Industry norm
  • Consistency in Historical Margin, Pricing and Sales
  • Strong Balance Sheet
  • Healthy Financial Ratios: Liquidity, Turnovers & Return on Sales/Assets/Equity
  • Above Average Industry Metrics: Rev/User, Sales/Sq. Ft., Sales/Employee

Attractive Characteristics

These characteristics are also the end products of capable management that are not directly reflected on the financial statements.

  • Trendy or Socially Appealing
  • Balance in Variety and Focus of Products
  • Direct Relationship to End Customers & Diversified Customer Base
  • Good Labour/Employee Relations
  • Low Working Capital & Low Capital Investment Requirement
  • Facility & Equipment in Good Shape
  • Personal Goodwill Transferability

Industry Attractiveness

The attractiveness of the industry should be highlighted to prospective buyers if they fail to see the positive characteristics of the subject industry structure.

  • High Entry Barriers for New Entrants
  • High Mobility Barriers for Competitors
  • Weak Bargaining Power of Suppliers and/or Buyers
  • Weak Substitutes and/or Weak Competitors

Competitive Assets

Many of the qualitative assets may not be reflected on the financial statements, some of the assets may be in the process of being built and some of these assets may be quickly realized through a merger or acquisition. Management is the most important asset because it is Management that made the choices of assets to be built/acquired and that carried out the execution. It is important to highlight these assets to prospective buyers.

  • Leadership & Management
  • Brand
  • Installed Customer Base with High Switching Costs
  • Good Customer Relationships & Long-Term Contracts
  • Marketing Channels & Relationship Strengths
  • Talent: Marketing, Engineering, Sales, Finance & Operations
  • Technology
  • Facilities & Infrastructure
  • Size & Economies of Scale
  • Integrated Value Chain/Network
  • Access to Raw Material
  • Location & Real Estate

Competitive Capabilities

In order to have superior financial returns, an enterprise needs to present a set of offerings that is most desirable to some set of customers. The enterprises compete on price, quality, speed, performance, image, design and service – the offerings to customers. Low price, high quality or fast delivery in itself is not the competitive advantage. The key is whether an enterprise has the capabilities to offer lower price for the same quality or higher quality/image for the same cost. The competitive assets by themselves do not offer competitive advantage either but it is the ability to combine and use those assets that generates competitive advantage. The types of assets acquired determine the array of competitive capabilities, which in turn are the engines that drive offerings. For example, superior marketing and R&D talents will be capable of a faster introduction of a superior quality product at lower cost. To be successful, Management has to make the right choice on which position to take or capabilities to build because it is hard to be good at everything.

  • Marketing Intelligence
  • Lower Cost Infrastructure: Raw Material, Production, Delivery, Financing & Service etc.
  • Pricing Power & Flexibility
  • Speed of Customer Acquisition, Production, Delivery & Product Development etc.
  • Seamless Customer Experience System
  • New Products Development & Launch
  • New Designs
  • Production Flexibility
  • Logistics Reach
  • Supply Chain Integration
  • Information Systems

Prevailing Market Conditions & Outlook

  • Timing: Peak or Bottom of a Cycle
  • Geographic Risks
  • Financing Availability
  • Demographic Trends
  • Government Regulation

Types of Buyer

Different buyers have different objectives, criteria, cost of capital, hurdle rate of return, cash availability, valuation approach, preference of deal structure, risk tolerance and negotiation approach. All of these factors influence the ultimate price.

The Strategic Buyer is looking to buy for one or more of these reasons: additional capacity, new product line, new technology, talent, geographic expansion, vertical integration, industry consolidation and cost reduction synergy. The Investor/Financial Buyer is buying because it is a good long-term investment or a “flip” opportunity. The Entrepreneur/Job Buyer is looking to run the business himself/herself, perhaps with family members.

Buyer’s Knowledge, Skills & Strengths

  • Buyer Credibility & Financial Strength – Higher Cash portion & less Risk on VTB
  • Reputation & Enhancement Capability – Seller’s comfort on the Earn-out provision
  • Seller & Buyer Degree of Motivation
  • Negotiation Skills
  • Time Pressure – who has less time?
  • Number of Buyers – Does the buyer know how many are competing?

Strategic Buyer’s Motivation

The ultimate objectives for most buyers are basically profit and shareholder value.

The acquisition may provide the competitive assets and capabilities to enhance these objectives. Some of the benefits may be unit cost reduction, pricing flexibility by eliminating a competitor, enhancing product bundling, gaining new talents, accessing better channels, immediate capacity expansion and enhancement of bargaining power.

Quantifying the acquisition benefits or synergy will help the seller in negotiating a deal. The process of quantifying the benefits of immediate access to new customers, products, talent, technologies, processes and distribution channels may not be that easy without knowing the inside operation of the buyer.

Deal Structure

The total net proceed varies substantially depending on how a deal is structured.

  • Share vs. Asset
  • Vendor Financing & Earn-out
  • Management Contract
  • Non-Compete
  • Representations & Warranties