In a strategic sale, does size matter?
Monday, August 13, 2007/
In a conventional business sale, profitability and growth are paramount. But in a strategic sale, value is entirely based on how quickly the buyer can exploit capability. Size may matter. By TOM McKASKILL
By Tom McKaskill
Most people confuse a going concern business valuation with what the business might be sold for to a large corporation. We are constantly told that our business is valued as a multiple of our net earnings.
The earnings multiple is determined by the industry with some adjustments for the quality of the business, as measured by its stability and efficiency, and the level of growth it demonstrates. Basically this is bad news for the business that is making a loss or those that invest heavily in research and development, market expansion or staff development. Basically, it is hard to get paid for potential.
However, when you look at value creation from the point of view of creating strategic value, you get an entirely different set of value creation characteristics. In this situation, profitability, size and growth may not matter.
What matters is whether you have an underlying asset or capability that a very large corporation can exploit throughout their organisation or across their distribution channel.
In my case, I sold a 30-person software business which, at the time, was facing insolvency due to a sudden shift in the market and was making a $1 million loss. It was sold to PeopleSoft for six times revenue. What was clear was that the value to PeopleSoft was generated by its ability to sell my software products directly into more than 1000 of its existing customers.
At about $500,000 a sale, this represented a very large revenue opportunity. The key to this deal was that our software products were well suited to exploiting this opportunity within PeopleSoft’s customer base. Furthermore, there was really no other alternative available to it within the near term. If PeopleSoft didn’t step up to acquiring our business, it would not only have walked away from the revenue opportunity but also might be allowing a competitor to acquire us.
However, while profitability, customer base and growth may not be important to a strategic deal, size may matter. In order to deliver a platform from which the opportunity can be launched, the business needs to have the capability and capacity to provide the launch platform.
The asset or capability that is destined to provide the source of the revenue opportunity to the buyer must enable the buyer to achieve the acquisition objectives. If the business is too small, or the asset or capability has not been structured for scalability or replication, the business may not be worth acquiring.
Thus size matters to the extent that it allows the buyer to exploit the opportunity. However, beyond that point it may in fact reduce the value of the business. If the buyer has to discard or close parts of the business, there may be costs, delays and risks in doing so.
Unlike a conventional business where profitability, growth and size matter, in a strategic sale, the sale value of the business is entirely based on how quickly the buyer can exploit the strategic asset or capability. The seller’s task is to prepare the business in such a way that the buyer can quickly exploit the underlying potential.
For more on smarter ways to sell your business, see our Growth Resources, Exit, section.