How can Mergers & Acquisitions increase the value of your company?
- 29 July, 2014
- Posted by: Bert.Kroes
- Category: M&A IT
For many IT entrepreneurs the reason for a merger or acquisition is often an exit after years of doing business in the same company, but also because a possible joining with a third party can increase the enterprise value and future prospects of the company.
The enterprise value in a merger & acquisition process is measured by the value of the shares related to the deal via an IPO or private sale plus interest-bearing debts minus the cash. Shareholder value is the amount ultimately attributable to the shareholders. In case of a cash free debt free situation enterprise value and shareholder value are the same.
What matters most is the development of enterprise value and shareholder value over time. How do IT entrepreneurs keep track of this taking into account buyers perspective and how to manage the factors that determine the value of the company?
Experienced buyers and private equity firms evaluate an acquisition candidate on the basis of value drivers. By mapping the value drivers, IT entrepreneurs can get a grip on the valuation of their business. The focus on value drivers within the company gives IT entrepreneurs a toolkit to make their business ready for sale while optimizing the value of their company.
Within the current IT-related markets, we define the following top value drivers.
Analysis and breakdown customer base
The customer base of a company plays an important role in the valuation of the company. A good analysis of the customer composition gives insight in turnover, continuity and operational management. Buyers tend to ask the following relevant questions regarding the customer base of a possible acquisition target:
- What have the customers bought in the past five years in services and products?
- What is the scope of customer churn?
- How many new customers are acquired annually in recent years?
- How stable is the customer base? Are customers large, medium or small?
- What is the distribution of revenue from these customers compared to the total turnover of the company?
- Has the company’s 1-year or multi-year contracts?
The second and the most current value driver is recurring revenue. For many entrepreneurs this may be considered a very obvious value driver but recurring revenues is for many strategic buyers essential and moreover, it shows the status of the company’s continuity. More Important IT entrepreneurs gain insight into what percentage of their total revenue is recurring. This portion of the total revenue is valued much higher than the one-time or project-based revenue.
Will the combination of revenues from the buyer company and the acquired company result in higher recurring revenue percentage of the total revenue when the deal is completed? What is the cost of recurring revenue and what are, on balance, the “net recurring revenues”?
Cloud business model
Business “in the cloud” is a term that many IT entrepreneurs, private equity firms and potential buyers interpret differently. That Cloud services are hot and trendy is evident from several reports showing that:
Gartner says that “The move from premise-based solutions to on-demand cloud services is expected to make software as a service (SaaS) offerings the dominant factor in the industry within five years.”
In addition, how much Cloud DNA a IT company has plays a major role in the valuation of the company. Experienced buyers and private equity are asking questions regarding the status of Cloud services with companies and see this as an important driver for “sustainable growth”
Cloud services are becoming so important for many IT entrepreneurs that we see it as a separate value driver.
There are several ways in which cloud computing can add to company value. In addition to lowering IT costs, cloud can help you gain access to new markets and create new business models.
Sales & marketing effectiveness
A successful sale-side transaction depends for a large part of the selling company showing that it has a stable and effective sales and marketing organization. Are the necessary skills, experience and drive present and is there a proven track record of sales success? A just appointed sales manager who performs poorly can easily decrease the performance of the company rapidly with great potential financial loss that is often difficult to recover from. The same goes for the performance en efficiency of the current sales organization. Potential buyers must be confident that the organization is future-proof and can continue selling its services and products in the market.
A company with proprietary technology, products, trademarks, patents and copyrights, but also a “self-developed process” ensures that there is something offered what makes the company unique and thus acts a key value driver for IT entrepreneurs. This makes it interesting for potential buyers who will then determine whether the intellectual property fits within the business lines and vertical market strategy. Proprietary processes and software development will always need be further investigated and validated.
Management & staff
Ultimately, it is the people that make a company successful. Strategic buyers are looking for motivated management and key personnel who want to stay for the long term. Many mergers and acquisitions fail because the management and qualified staff leaves after the deal is closed. Longer earn-out periods give buyers more confidence that management and staff stays on.
In addition there are requirements and questions posed by strategic buyers about the quality and value of management:
- Does the management team of the company being acquired have in-depth knowledge of a specific product, process or market segment that is a prerequisite for the acquirer?
- Can the managers of the acquired company add value to the current management team?
- Will this (new) management team give the organization the ability to grow to the next level?
Of course there more value drivers but the above mentioned drivers are the ones we encounter the most in IT-related markets.
It is important to emphasize that mergers & acquisitions only contribute to value increase and value optimization if the value drivers of the company are managed properly taking into account the requirements of the possible buyers target groups.
It is therefore important that sellers identify these potential buyers in an early stage of a sales process.