Acquisition Part 3 - The Price
This is the third in my series about acquistions focused specifically at SME tech sector business founders and owners. In the last two posts we discussed the process of selling a business and the people that need to be involved. In this one we get to the nitty-gritty of the price.
First a couple of definitions to set our context.
When you sell you business it is frequently to a larger competitor or to a Private Equity company. We call the former a ‘strategic’ and the latter either ‘PE’ or ‘Investor’. In either case these sales, or transactions, are labeled as ‘private’. If your company were listed on a stock exchange then any acquistion deal would be ‘public’ and we’d all know the details of the sale, because most of the deals we’re talking about here are private the details are most often kept secret and only the buy and sell side and their advisory team will know them.
This poses us a problem when we’re looking at valuations becuase, if all the similar deals that are going on in the world are private, then how do we compare our company to other companies out there?
The world of company valuations is not a science because we can’t get to a single, definitive, answer. But nor is it an art, because the process of valuation is not different each time, there are guides and principles that we can follow. I like the description by Aswath Damodaran that it’s more of a Craft.
This craft lives at the intersection of three circles on a pie chart. The finances of the company (which is the closest we get to a science), the desirability of the marketplace (is the company indemand) and the ‘synergy’ with the acquiring company (is this a good ‘fit’ for both buyer and seller?)
OK, with that context in place, let’s look at four aspects we should understand and consider for valuation.
Discounted Cash Flow (DCF)
The modelling of a DCF is actually a pretty simple and logical process. Money, as we all know right now, won’t buy you as much in a years time as it will today - this is the discounted part. And when you buy a company it will make a profit each year - this is the cash flow part. So we estimate the growth of the company profits, calculate the cash it will flow, discount this cash for the years in the future, and add it up over five years, you have the value according to the DCF model.
Multiples of Revenue or EBITDA
This is what most folks talk about when they discuss tech company valuations. ‘What multiple did you get!?’ will ring out across All Bar One on a Thursday evening in Shortditch. Multiples are more marketplace led than the DCF model. If the M&A industry knows that companies that make machine learning products are selling for 26x EBITDA and there are only three of them in London then no-one gives a hoot about your discounted cash flow, there is a market scarcity that will drive up the price.
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Public Company Values
As we discussed earlier, the values of private companies are rarely made public, but the values for public companies are out there in the public domain. It’s easy to find the value of a company (the market capitalisation is shown on the exchange that trades the stock) and the companies are required to release their financial results by law so it’s simple to know how much revenue and EBITDA they achieved. If you know EBITDA and value you can reverse engineer multiples and use these to value similar companies.
Synergy Driven Value
This is the hardest of our four factors to quantify because it depends on knowing the company that’s for sale how well suited it is to being a part of the potential acquiring company. This is called the synergy between the two companies. It’s actually a word that get’s a bad name because it’s often used as a reason for lay-offs when one company acquires another (if there are two people doing the same job, you only need one so one person get’s let go and it’s blamed on ‘synergy’). But synergy should be seen as a lot wider. If you acquire a company that does work that compliments what you already sell to all of you existing customer, that’s a synergy and helps you increase the lifetime value of each of your existing customers. Not every potential acquirer will have the same set of synergies so the same company is not work the same amount to everyone.
Hope that helps a few folks, I’ve linked some resources where I can in the article but also a reading list below which has helped me navigate these topics over time.
Jim
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Resources:
A great resource for aggregated multiple data for public companies from Aswath Damodaran - follow the navigation to the data section. Link
A good article on multiples by Aventis Advisors, includes change over time, and other factors that should be taken into account Link
Also by Aventis, a good guide on discounted cash flow with examples. Link
It’s good to invest in a guide to these terms that written in plain English. I have a couple of these and this one seems to get revised on a fairly frequent basis. Link