Mar 13, 201812:38 PMExit Stage Right
with Martha Sullivan
The crux of multiples continued — One company, many multiples
(page 1 of 2)
In our last blog post, “The crux of multiples in business valuation,” we discussed how the multiples used to value a company fundamentally represent the buyer’s view of the business’ risk profile. It’s easy to get caught up in what the multiple is. Was it a “3” or a “5”? If that company got that, then my company should get this. This approach fails to ask the most important question — “Why that multiple?”
Multiples tell a lot about the state of the company. They represent the potential opportunities and threats a given investor believes they face in getting their desired return on investment.
The previous blog post illustrated how the multiples for two seemingly identical businesses could be drastically different. In today’s discussion, I want to talk through how a single company may be offered wildly different multiples. Now, if the multiple is a proxy for a company’s risk and opportunity profile, and you’re only looking at one company, why would they be different? After all, it’s the same company!
It boils down to what type of buyer is involved and their unique circumstances.
Types of buyers
There are three primary categories of buyers: strategic, financial, and inside parties.
Strategic buyers see a market or operational advantage to adding the company to their existing business. They seek synergies across markets, product lines, customers, and cost structures. They are industry players or companies that want to move into an industry. Strategic buyers tend to pay more because they perceive greater upside through these synergies.
Financial buyers are those that are first and foremost investors. They generally do not want to operate the business, although they may strongly influence its management and operational decisions. Private equity groups, family, offices, angel investors, and venture capital funds are common examples. Financial buyers, particularly private equity groups, will offer competitive multiples. Nonetheless, financial-buyer multiples are generally lower than a strategic buyer since they will not achieve the synergies.
Inside parties are those buyers that are known to the seller — family, management, or employee groups. There is a personal connection compelling the seller to transition their company to this buyer. Prices are frequently lower or discounted for inside parties so it’s affordable while still achieving the owner’s personal priorities.
There are many factors within any given type of buyer group that influence their proposed multiple, including:
- Deal structure and financing;
- Return on investment targets;
- Risk tolerance; or
- Potential synergies.
Consider three different buyers looking at a technology company. The private equity firms both have the same size fund and hold investments in the industry. The strategic buyer is also in the industry. The technology offered is cutting edge. The target’s existing management team is in place and runs the company operationally, but is still developing its long-term strategic skills. The VP of Sales and VP of R&D are on the fence about whether they want to sell and be owned by someone else.