By Jason Purcell
Conventionally in M&A processes, buyers will typically value the business they are acquiring on a multiple of its profits. In technology deals, however, things can be different, and revenues (and more importantly revenue growth) are frequently used as the valuation benchmark.
In an ideal world, if you are seeking an exit, your company would have both rapid revenue growth and strong profitability. Realistically, technology businesses more often have either one or the other.
If you are thinking about planning for an exit, then it is worth understanding how your buyers will value your business, as this will affect the decisions you make in the 1-2 years preceding the sale. A decision to focus on profitability means you will likely cut back on investing in sales and marketing and growth will come under pressure; decide to focus on revenue growth, and profitability will suffer.
There are a multitude of factors which impact whether revenue or profitability will be more important to your buyer in a deal, but here are three common ones:
Maturity of the market, and of the company
Revenues reveal a lot about the market you operate in and how competitive your products are. If you’re growing strongly that’s usually a good sign, and generally the higher the revenue growth rate the more attractive the business and the higher the value you can command (as long as you are not pursuing growth at all costs and burning way too much cash as a result). However as the business (or the market) matures, buyer focus then turns towards profitability.
How your buyer is valued
How much profitability matters to buyers may equally depend on the industry and how companies in that sector are viewed. Companies in more stable, lower growth industries, like insurance or utilities, tend to be valued on a multiple of their profitability. It is hard for them to pay a higher multiple of profits for an acquisition than their own multiple, as it is dilutive, or to agree to a revenue based multiple. However in technology deals, if the business to be acquired is innovative and in a high-growth sector, and there is an opportunity for the buyer to become the market leader, or to capture competitive advantage, or to gain new revenue opportunities, you can often argue for higher valuation metrics than the general market valuation would indicate.
Type of buyer – financial or strategic?
The type of buyer may also influence how they value your business. In particular there tends to be a big difference between a private equity buyer and a strategic acquirer.
Profitability is fundamental for the vast majority of private equity buyers, who are looking for sustainable investments with good financial return as a standalone case. These buyers almost always value deals on a multiple of EBITDA.
By contrast the strategic buyer will typically be from the same industry as the business they are acquiring, and may be able to bring additional assets to bear to improve the return on investment, and possibly a longer-term perspective. These factors would often enable them to prioritise revenue and growth as the basis for valuation if the company is growing fast in a desirable sector that fits their strategic priorities and there is a good opportunity for the buyer to accelerate growth and drive revenue through their own distribution channels and sales resources.
This does not mean that profitability does not matter to strategic buyers. Many strategic acquirers will be discouraged by a company losing substantial amounts of money and would prefer to invest in a profitable business or one that at least breaks even, even if it is growing strongly. In this instance, being able to show a path to profitability and strong unit economics is key to successfully explaining your story and driving valuation.
The key thing in any negotiation on value is to be able to show that the business is performing well in the context of its maturity and the market opportunity, and to understand the priorities and objectives of your target buyer group.
Stating the obvious, it is important to note that every company and every buyer is different and very few can be wholly predictable. M&A decisions are taken by people, and even during the negotiation process large changes in valuation can be achieved through a well-run and competitive process. This is one of the parts of an M&A process where expert guidance and support can deliver significant value. Read more about how FirstCapital supports sellers at the deal negotiation stage here.