Recently I spent time with a business owner – let's call him Jack – who runs a 25-person engineering consulting firm.
He and his partners have been successful, generating more than $1-million (U.S.) in pre-tax profit last year before the owners divided the spoils.
Jack owns half the shares, and his five partners own the rest. Approaching 60, he is now starting to think about his exit strategy.
Jack was under the assumption that his business would be valuable to an acquirer because of his blue-chip client list, the team he has built and the seven-figure pre-tax profit the company generated.
But I think Jack's in for a nasty surprise when he puts his business up for sale.
In my experience, the most important thing to an acquirer is the predictability of an ongoing stream of future profit.
As business owners, we're rightly proud of things like our company name, employees, customer list and past financial performance. As a result, we're more inclined to want an acquirer to look at what we have done in the past to value our business.
But from what I've seen, acquirers don't really care much about the past. The only reason they even look at past performance is to gauge the extent to which it can be a predictor of future performance.
But the past is a rough indicator at best, so potential acquirers have their focus on the future. Acquirers pay most for businesses whose future is guaranteed in the form of long-term contracts. After contracts, they will look at your recurring revenue stream and model out what kind of revenue they can expect based on how frequently your customers have repurchased in the past.
Last and not least, they will look at your past financial performance – revenue and profit growth – as predictors of future results.
If the past is all you have to show for your business, you might be disappointed. Acquirers place a steep discount on businesses when the only way to value them is by prior performance.
This leads us back to my friend Jack who thinks his people, past profits and customer list are assets that will sell. Let's look at why each will be worth little in the eyes of buyer:
• People are worth something only if they are very hard to replace and guaranteed to stay. Jack has good people, but they are hardly irreplaceable, and any one of them could bolt on three weeks' notice. Even his partners own a relatively small equity stake in the business, the economic value of which could be matched by an aggressive outfit looking to acquire senior talent.
• A client list is valuable only if the cost for someone else to acquire those clients is prohibitive. In Jack's case, his contracts are typically five- and six-figure deals, meaning it would be worthwhile for a potential acquirer (likely a company larger than his) to simply invest in the sales resources to acquire his customers, not his business.
•Jack and his team have demonstrated past success, having generated more than a million dollars in pre-tax profit. Some potential acquirers might take this as a predictor of future success. But most would argue that success is dependent on Jack and his partners sticking around and, therefore, would offer them a deal with a heavy emphasis on an earn-out. Jack would be trading his equity for a job working for a big company – something he hasn't done in 20 years.
My advice to Jack was to stop thinking of his people, client list and past performance as his assets and to start making the future as clear as possible for an acquirer to see. Assuming his junior partners don't want (or can't afford) to buy him out over time, I suggested he create streams of recurring revenue and focus on migrating customers to longer-term contracts.
These are strategies that would help prospective buyers see a stream of profits well into the future – the thing an acquirer cares about most.
Special to The Globe and Mail
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He writes a blog about building a valuable – sellable – company. He is the author of Built To Sell: Creating a Business That Can Thrive Without You, which will be released in April.