How Acquisitions Add Value Before a Sale

Axial
June 17, 2015

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Savvy CEOs will prepare for an exit well in advance, aligning time of the sale with their operational peak to maximize value. But no matter how well-run a company is, the 3-5 years preceding a CEO’s desired exit window offer an opportunity to evaluate potential business improvements.

By then, any ROI from internal investment will be realized by a buyer. As a result, the most expedient means by which to build a business’s value before selling it is by acquiring value-adding companies. Below are a few reasons why acquisitions are particularly valuable planning the sale of one’s business.

Achieve higher multiples

The idea behind valuing companies on multiples is to ascertain their value by comparing them against similar businesses for which a valuation has already been realized. So what is it that makes companies similar?

Industry is the primary factor – some industries, like technology, are notable for their high valuation multiples. Others, like industrials, attain less generous valuations. For CEOs in industries where multiples lag, acquisition can be an easy way to reclassify their businesses. For instance, a contractor may seek to acquire a software developer and establish new online offerings for project management. While the new conglomerate should not expect to be valued as a SaaS, it could achieve a slightly higher multiplier that will ultimately translate into millions more in price.

Size also influences comparisons – for a company with high revenues, incremental additions to earnings will be valued more highly than those of a smaller industry counterpart. If nothing else, an acquisition should be expected to add to the top line, thus pushing a business into brackets where it can expect to get more for its financial performance.

Boost the bottom line

Whereas boosting revenue via internal investment necessitates up-front costs that typically cut into earnings, an acquisition can actually drive costs down in some instances, even as revenues continue to grow.

This is most common in cases where CEOs integrate horizontally, or buy businesses offering near-identical products and/or services. Horizontal integration eliminates some competition and typically widens a business’s influence, thus granting it added leverage over both customers and suppliers. That leverage can be used to drive up prices at which goods are sold while simultaneously shrinking the costs for which materials get sourced, delivering positive impact on both sides of the bottom-line equation. There’s no more efficient way to boost margins.

Additionally, as operations between the two businesses overlap, CEOs often will discover synergistic opportunities to consolidate. These keep costs down without hampering revenue growth, thus allowing a company to achieve scale it may have been unable to realize independently.

Expand the buyer list

Diverse buyer lists build bidding environments that force the price of a company upwards, regardless of industry, sector, or size. Thus, having the ability to make a case for being classified under a variety of criteria will prove critical when attracting acquirers’ attention.

For instance, think back to our example of the contracting company buying a software developer. Not only will larger contractors and financial buyers focused on industrials be intrigued, but acquirers traditionally beholden to technology might also have their interest piqued. Should even only a few make offers, the acquisition has done its job – it’s diversified operations sufficiently to rope in new types of buyers. Beyond industry, regional influence achieved through acquisition can be another magnetic factor, especially when the region in question is foreign. The global economy has not halted its influence at the supply chain – mergers and acquisitions happen internationally far more frequently now as well.

Of course, more buyers will be attracted to larger companies with higher margins as well. This goes back to the points made previously. As revenues increase at a company, multiples go up as well. Should costs stay close to steady, margins will balloon as each dollar they add gets valued by a greater factor. That alone builds a more valuable business with a more competitive buying environment, before any expansion into other industries has even been contemplated.

This is the cycle of added value catalyzed by acquisition. If you haven’t thought about acquiring as you exit yet, consider it something to discuss for the next time you sit down with your M&A advisor. You’ve hired one of those by now, right?