As published on Forbes.com
I have the honor of working with many CEOs and managing partners to grow their business. As someone who successfully sold his companies years ago, I often get asked “What should we be doing to make our firm a good acquisition target?” Ironically, what you might think would be important, might not be the same things that the acquiring company would see as important. Keep reading if you want insight into how to attract a merger, or acquisition.
The Big Mistakes
When I ask CEOs what they think they need to do in order to be an attractive acquisition target, they often tell me that they just need to hit $X in revenue or a specific level of profit. Though revenue and profit are certainly valuable measurements, I had similarly focused on those measurements when I first tried to sell my prior companies. It wasn’t until we shifted our focus that we attracted the company that ultimately acquired us.
All Revenue Is Not Equal
Which company is more valuable: 1) A company with $20 million in revenue; or 2) A company with $12 million in revenue? Let’s assume they both make the same profit. The fact is that you don’t have enough information to determine the valuation.
What if the first company earns their revenue by doing one-off projects, and the second company (with less revenue) earns its revenue with monthly recurring revenue as a subscription? At that point, if the renewal rate of the subscription is high (for example, over 85%), then the smaller company could be more valuable than the larger one. Why would that be the case?
Acquirers evaluate risk of the existing revenue stream, and the potential for growth. Monthly recurring revenue with a high renewal rate helps the acquirer feel confident in future revenue. High renewal rates also indicate that you deliver value to your clients since customers keep reaffirming your value by renewing.
Companies Buy Engines, Not Heroes
In my prior company, I was proud to be part of every major sale we made as a company. For an acquiring company, however, my involvement was a red flag. Our ability to grow/expand was limited (specifically, by me, the CEO). I needed to build a repeatable process that anyone could run.
If you build an engine to grow revenue, then an acquirer will see that they can just add more fuel to the engine to accelerate growth. Build systems and processes for how you grow your business. Systems drive value since they are not dependent on one individual.
What Problem Do You Solve
It’s easy to group your customers by demographics like industry, size, or geography. But, what really matters is why those customers are working with you. What problem are you solving for the market? What can’t your customers accomplish without your assistance? These might seem like simple questions, but don’t just skim over the answer.
In my prior companies, our solutions solved the similar challenges across industries. Our research shows that when approving a purchase of a product or service, executives first ask, “What problem does this solve, or why do we need it?” If you clearly articulate the problem you solve for your clients, then an acquirer can quickly evaluate if their customers could benefit from your offering. If you can show that you solve that problem across industries, then the acquirer can see how to scale the business. They might have clients facing the same problems in another sector.
How To Allocate Revenue
If you make the mistake of overlooking the problem you solve, you might mistakenly allocate revenue by industry. We’ll use a law firm as an example.
Let’s say you have several practice areas: life sciences, construction, healthcare, technology, and infrastructure. Your clients come to you because you address a variety of matters for them. In each project, however, allocate revenue based on the problem you solve.
For example, if an investment fund is financing a new highway in a developing country, should you allocate the revenue to finance or infrastructure? Your client needs to solve an infrastructure and coordination issue with that country. Simply having the finance background would not qualify you for the business. The common mistake in revenue allocation and reporting is to focus on your view of the world rather than your client’s perspective of the problem you solve.
The Real Goal
If you want to attract a potential acquisition or merger, remember to
- Recurring revenue is worth much more than one-time revenue
- Focus on the problems you solve
- Build a growth engine that goes beyond one individual
- Allocate revenue based on the problems you solve
If you can accomplish these tasks, you’ll be well on your way to attracting potential acquirers. You’ll also be building a business that is valuable to any shareholder… even you for as long as you own the business.
It’s Your Turn
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