By Steven Newell
Selling your business is one of the most important decisions that you will make in your professional career. If you want to achieve the highest valuation possible, it is recommended that you begin positioning your business as soon as possible for an eventual sale (whether that be 1, 2, or 10 years down the road). Not only will this increase the attractiveness of your company to a potential buyer, but it will help you maintain discipline as you are faced with tough business decisions.
It is also important to understand the different types of buyers. The two most common types of acquirers are strategic or financial buyers. Strategic acquirers are companies that already operate in the industry and are seeking to grow through acquisition. Financial buyers are most commonly private equity (“PE”) firms that are seeking to invest in a number of privately-held businesses for financial gain.
The criteria below are a few of the characteristics that private equity investors consider when evaluating a business.
- High recurring revenue – Maintaining a book of business is easier than having to constantly sell to new clients. Unlike one-off sales, this revenue is typically predictable and can be counted on to occur at regular intervals in the future. It also makes for an easier transition of ownership to a potential buyer.
- Customer concentration – PE investors have a strong preference to avoid businesses that have significant customer concentration. As a rule of thumb, you would prefer your top customer to represent less than 20% of revenue, or your top 5 customers to represent less than 50% of revenue.
- Recession-resilience – Many PE investors focus on service lines that are not dependent on economic growth to survive. Recession-resilient service lines include segments that provide maintenance or repair work. Further, in a recent survey done by the National Association for Business Economics, 72% of economists predicted that a recession would occur by the end of 2021, which has only accentuated PE investors’ focus on recession-resilient businesses.
- Positive sales growth momentum – PE investors will consider investing in a business that is a “turnaround situation,” or one that is slowly declining, but will pay a premium for one that has experienced an increase in sales over recent years.
- Predictability of cash flows – PE investors tend to be attracted to businesses that do not have significant swings in EBITDA from year to year. As a result, figuring out how to best mitigate any unpredictability in your business can boost the valuation of your business.
- Strong manager / management team – PE investors prefer that an owner is willing to continue operating the business post-acquisition, and “roll” a portion of their proceeds for 10-30% equity ownership in the newly-capitalized business. For situations where an owner is unable or unwilling to remain with the business, you can expect a slightly lower valuation.
- Focus on EBITDA – PE investors care far more about the EBITDA of a business than its revenue. So if your company is growing top-line sales at a strong rate, but EBITDA is declining, do not expect a positive response.
Private equity firms are not always the right buyer for your business, but they represent an additional source of liquidity for business owners once they reach the point that they are looking to sell their business.
Steven Newell is a Managing Partner for Lindale Partners, which is an investment firm that targets services businesses that generate less than $15M of revenue. Lindale is different than most groups in that they will consider acquiring or investing in a business where the owner is looking to retire, or would like to remain involved but recognize some of the value that they have created by selling a portion of their business. For more information about Lindale Partners, or for general inquiries, please contact Steven at email@example.com.
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