George Sierchio is Executive Vice President and Sr. Partner, Cogent Growth Partners, LLC
Q: Valuating a business is not a simple exercise. What are the first steps an MSP must take to determine what their business is worth?
SIERCHIO: No, this is not a simple exercise where you take a random financial based seller number and multiply it by a non-applicable factor, as many are led to believe.
The first thing to understand is that “valuation” and “purchase price” are not the same thing. Each buyer, for purposes here being those coming from outside your business, is contemplating a transaction for distinct objectives. The purchase price they put on your business reflects the value it has to them and what they believe they can do with it. Hence the saying “your business is worth what a buyer will pay for it.”
An owner must think like a buyer that would realistically be attracted to their business in order to achieve that buyer’s goals. Then envision what that buyer can truly get from a transaction in terms of the most common factors: consolidation savings, synergies, and growth opportunities starting from your company’s own proven continuable organic growth and what they can conservatively add. The greater the difference between your trailing twelve adjusted free cash flow (FCF) and the buyer’s forward adjusted free cash flow (we call this difference Opportunity Delta©), the more value you have to that particular buyer.
Q: Is there a tried and true valuation method one can apply to an IT sale?
SIERCHIO: There are a variety of methods used by valuation professionals. In reports I’ve seen by those attempting to apply these methods to this space, they come to the same conclusion… except for the discounted cash flow (DCF) method, which requires conjuring a litany of variables that can produce wildly different results, none of the other methods apply.
The best way to value an IT company is in the form of a simplified, yet more realistic, DCF. Believe in your analysis of seller’s FCF, determine buyer forward adjusted FCF, understand the costs and risks of the transaction including paying for it (i.e. deal structure), and use all of this to determine the annual yield on investment needed. The yield will correlate with the investment horizon, meaning the time it takes to break-even. We typically see buyers with total investment yield/return needs between 27% and 18%. Translated into time, that’s a 3.7 to 5.5 year horizon. Simple math on an example using typical yield need of 23%, factoring in seller riskiness and how I can pay for it, says a good purchase price is around 4.3X my forward adjusted FCF.
Q: How do business owners create a clear vision of where they want their company to be in future years in terms of selling?
SIERCHIO: A clear vision to getting your company where you want to be to sell is in part a function of what it may be worth right now and the timeline you are giving yourself to get to the value you would like it to become. Inside of the current value are numerous factors that can looked at as “levers” to move over your timeline to effect the change needed to achieve future value. These levers include KPIs common to the industry as well positive and negative company attributes that buyers typically look at in a company’s infrastructure and processes. Some changes ma be achievable, others are like turning the Titanic, especially if you have a short timeline of a few years.
Don’t forget your personal goals for the outcome of sale. Retirement after a required transition period? Carry on as a minority equity holder? New position at a bigger company with no ownership pressures? A new entrepreneurial adventure?
That leads to a vision of who would be an ideal buyer. Something twice or ten times your size? Private equity? Keep in mind to be “strategic” requires being truly special and a PE platform necessitates lots of FCF among other factors. Both difficult goals.
Q: Are there any central concepts that factor into the buy-sell transaction?
SIERCHIO: There are a variety of commonly known central concepts of any M&A transaction such as the need for a fair price and deal structure, risk mitigation for both parties, due diligence, lots of documentation, and integration. However, what gets forgotten is none of these things occur when there is no opportunity and fit realized by both parties.
Additionally, whether the old owners are staying on or not, a deal happens because it is built on some level of trust by both parties and a relationship is fostered. A deal that takes many months or years to even get to a letter of intent is a sure sign of a weak relationship and limited trust by someone. When trust and goodwill are sporadic or eroding, the most important word in a potential deal, “reasonableness,” goes out the window. Make no mistake, when you have a buyer laying out cash from their pocket or are personally responsible to pay it back and a seller that’s parting with ownership of the thing they put everything they have into, there will be emotions happening. It won’t be all business, and likely it will be personal reasons for walking away.
Q: Do you have any further ‘Buyer Beware’ advice?
SIERCHIO: There are a couple of big “buyer beware” items that are common.
First, never take a seller’s word on their adjusted FCF. Often not intentional, and sometimes through prompting from an inexperienced advisor, FCF may have everything plus the kitchen sink removed, including owner salaries and necessary capital expenditures. This scenario won’t reflect what may be your true forward costs. Do your own analysis and make sure the owners and employees have a salary commensurate with that role, which may not be what is on the books.
Buying a business because you can afford it, and/or you think you can make something out of nothing, is generally a bad idea. A cheap company comes with lots of time and energy invested, which will surely cost you more money, and potentially your existing company. If you don’t have “turnaround” project experience, it’s a much safer bet to be prepared for a solid opportunity and fit while heeding Warren Buffet in buying “a good company at a fair price rather than a fair company at a good price.”
Lastly, buying a company is a great way to grow, but not easy. If it’s too easy, you might want to run away…fast.
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