NEW: Tom McKaskill

It is acquisition mania with big companies eyeing off small businesses all over the place. But why are some small businesses getting low prices and others attracting the big bucks?

Move your business from a financial sale to a strategic sale

It is acquisition mania with big companies eyeing off small businesses all over the place. What is surprising is the growing gap between the small businesses getting low prices and others attracting the big bucks. Some companies despite making losses or little revenue have acheived significant prices.

But many businesses that achieve these prices achieve a sale based on some underlying asset or capability that a large corporation wishes to exploit.

The reason the big companies are prepared to pay such a large premium is because they have worked out how to generate many times the revenue and profit of the seller. They achieve this, typically, by selling the seller’s product or service through their own distribution channel, which is likely to be 10s, if not 100s, of times the size of the seller’s.

Financial sales, on the other hand, only represent what the seller’s business can achieve on its own. Even if this has significant potential, it will fall a long way short of what a national or global corporation can achieve with the same product or service. So the business that sells to a financial buyer is lucky to get several times EBIT for its business whereas the strategic sale can often generate large multiples of EBIT or many times revenue.

The key to a strategic sale is to provide a large corporation something that can generate large incremental revenue through the buyer’s existing distribution channel or to enable the buyer to open up new markets for significant revenue. The basis of such an opportunity lies in exploiting an asset or capability the seller has.

The opportunity for the large corporation is to throw significant resources at leveraging the asset or capability where short term revenue can be readily generated. Even if longer term opportunities exist, the short term revenues are the ones that will justify the premium on sale.

The task of the business owner is to identify those assets (patents, trademarks, licenses, copyrights, brands, customer base, locations, specialised plant, deep expertise and so on) or capabilities (the things you do that you do exceptionally well) which a large corporation could exploit.

The target asset or capability then needs to be protected in some way so that the buyer has some reasonable time to exploit it without it being copied or eroded by its competition. Lastly, the asset or capability needs to be put into a form where it can be readily scaled or replicated to provide the revenue generating capability and/or capacity required for larger scale operations.

You need to imagine that you are building a launch platform and vehicle for the buyer. The buyer is going to provide the launch site, fuel, crew and landing site.

Work out what it would take to generate significant revenue from your target asset or capability and then to construct a launch capability from which a new revenue strategy can begin. At the same time, you need to build protection through patents, brands, trademarks and expertise to slow down the erosion of the competitive advantage that the buyer is acquiring.

Strategic value does not depend on your profitability or growth. Even size may not matter if you can provide the right scalability capability.

David Knowles, a partner with accounting firm Pitcher Partners, writes: improving the value of a business by positioning for a strategic buyer is very good advice but I think he underplays the impact that positioning a business by reducing risk can have on the price. Value is a function of risk and return: there is too much emphasis on return and not enough on risk. What we see is most of the deals that get offered to the people with the money get rejected because they have not addressed the risks rather than the opportunities. (posted 12 April 2007)


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