What is Your Business Exit Strategy?
– Part 3 of a 4 Part Series on Exit Strategy
Valuation
The exit strategy will elucidate many important aspects of the decision to exit.
- Is there an optimum time to exit?
- What is the current estimated market value?
- Does the business currently look attractive to new investors?
- Will the business exit on a rising level of profitability?
If it is apparent that the owners wish to sell as soon as possible and the current market is strong, it may be attractive to market the business sooner rather than later. For many owners the exit decision is more complicated and involves balancing competing objectives. Often these revolve around the current valuation, in particular if it is less than the owner would like to achieve. In many ways this can act as a catalyst to the value creation process as an owner looks to pursue a strategy to improve the exit valuation. The conclusions reached during the evaluation of the exit strategy can potentially influence both the timing and likelihood of any exit. It will also identify any gaps between the current valuation of the business and the value sought by the buyer.
There are a myriad of valuation methods that are currently used to value companies. Valuation methods are asset based, earnings based, market based, or a combination thereof. A detailed discussion of company valuation methods is beyond the scope of this article; however, listed below are a few common valuation methods:
Discounted Cash Flows (DCF) – Valuing a company by projecting its future cash flows and then using the Net Present Value (NPV) method to value the firm.
EV/EBITDA – is a ratio that compares a company’s Enterprise Value (EV) to its Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). EV stands for Enterprise Value and is the numerator in the EV/EBITDA ratio. The EV is a measure of a company’s total value, often used as a more comprehensive alternative to equity market capitalization. Enterprise value is calculated as the market capitalization plus debt, minority interest and preferred shares, minus total cash and cash equivalents. The EV/EBITDA ratio is commonly used as a valuation metric to compare the relative value of businesses.
Net Asset Value (NAV) – Is an asset-based approach business valuation method that focuses on a company’s net asset value (NAV), or the fair-market value of its total assets minus its total liabilities, to determine what it would cost to recreate the business.
Comparable Company Analysis – Evaluating other, similar companies’ current valuation metrics, determined by market prices, and applying them to the company being valued.
Precedent Transactions – Looking at historical prices for completed M&A transactions involving similar companies to get a range of valuation multiples. This analysis attempts to arrive at a “control premium” paid by an acquirer to have control of the business.
Leveraged Buyout (LBO) analysis – Valuing a company by assuming the acquisition of the company via a leveraged buyout, which uses a significant amount of borrowed funds to fund the purchase, and assuming a required rate of return for the purchasing entity.
These valuation techniques are the most commonly used, other than in valuations for specific, niche industries such as oil & gas or metal mining (and even in those industries, the aforementioned valuation techniques frequently come into play). Which valuation method is used depends on many factors, including:
- Is it a public or private company?
- Is it a small/medium/large business?
- What industry/sector is the company in?
- What stage of growth is the company in?
Frequently more than one technique will be used in a given situation to provide different valuation estimates, with the concept being to triangulate a company’s value by looking at it from multiple angles.
Determining a reasonable valuation range for an owner looking to exit is a critical step in the process. If an advisor thinks they can achieve a valuation range that isn’t acceptable to the owner, the process should stop right there. Too many deals get derailed by sellers and buyers having completely different expectations about business value. While it is the job of the adviser to close that gap with negotiation prowess and transactional expertise, immense gaps cannot be bridged no matter how skilled one is. Valuation technique ranges from the highly academic and analytical methods of DCF to the more pragmatic comparable company analysis valuation methodologies. Unfortunately, none of them is a replacement for the actual process of engaging with high quality and relevant buyers. Analysis and number-crunching is necessary but not sufficient, and will only take you so far. In the end, the price is determined in the market by the buyers and the quality of your engagement with them.
Examples of Various Ways to Increase Valuation
Profit Improvement
- Acquire businesses on lower valuation multiples to boost profits
- Increase product/service turnover by adjusting selling prices
- Expand margins – for example, bringing in sub-contract processes
.00in house or reducing less profitable work - Reduce costs – manage overhead costs and cut out excesses or minimize increases
Price Ratio
- Reduce reliance on key customers /suppliers
- Demonstrate the business has growth opportunities in new markets or products
- Establish employee contracts with key employees
- Ensure intellectual property (IP) rights are secured and protected
Resource Improvements
- Reduce working capital to free up cash and improve equity value
- Delay non-critical capital expenditures and increase return on capital
- Generate cash from the sale and lease back of major assets (e.g. property)
Each value creation opportunity has a timescale and one of the key things to consider at this point is the desired exit horizon of the owners. It may be impractical to consider an acquisition, for example, if the business does not have time to fully merge the two businesses to gain the synergies of the merger. Essentially, an owner is left with a list of what they believe to be achievable targets that becomes the exit strategy of the business prior to exit. Without proper implementation, the likelihood of any significant change/benefit is small.