If you are considering selling your company at some time in the future, the uppermost question in your mind is probably: What price can I get? Much of the answer is bound up in your company’s P&L performance history and current financial condition. If it has been increasingly profitable over the years, and has a strong balance sheet, your company will be more valuable than one that has struggled. That much is obvious.
What is less well known is the impact of the kind of acquisition it is. By that, I don’t mean what formula was used to arrive at a value – often a multiple of revenue, earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortization (EBITDA) or net profit before or after taxes. Rather, it’s about whether the acquisition is put together based on financial value or strategic value. The potential difference in price can be very significant. Why? The answer is found in the relative return on investment.
Say that Big Company A buys Small Company B and sets it up as a wholly owned subsidiary. Nothing else changes for either Buyer or Seller. In this “financial” acquisition, the entire return on investment to the buyer comes from the after-tax profit and cash flow that the seller continues to generate after the sale. Therefore, the price must be low to allow the buyer to get a reasonable return on investment.
Note that most industry “roll-ups” are structured in just this manner. What the buyer is trying to do is to acquire a number of successful local or regional companies in a particular industry on a financial basis and, then, sell or take public the larger, more diverse national powerhouse based on strategic value.
In scenario #2, however, the seller brings valuable strategic assets to the table, such as geographical location and reach, a product line that is complementary to that of the buyer, one or more key customers, a strong position in a valuable market niche, technology and/or technology infrastructure, etc. In this new setting, both buyer and seller can generate increased revenues and earnings simply because they are together. This phenomenon used to be called “synergy” but whatever the name, the important point is that the return on investment to the buyer comes from the seller’s earnings (as before) plus the increased earnings that both now generate.