The tech and financial communities both measure the success of a startup exclusively by the same metric: sale value. Capture a high price at exit, and you’ll achieve legendary status in the tech world.
When a company gets acquired for a purchase price that significantly surpasses the valuation multiples of its peer group, then, it raises the question: How did this company manage to attain such an exorbitant valuation? Asked in a more practical way, how can you optimize your company’s value during a sale process?
Storm Duncan, founder of one of the leading technology M&A boutiques, Ignatious, ranks as one of the “top 50 M&A Professionals in the World”. He advised on two of the top ten ranked deals in history as well as an extensive list of high-profile technology transactions, including the sale of Careem to Uber for a staggering $3.25 billion, the sale of MySQL to Sun for the highest software revenue multiple at that time (and then sold Sun to Oracle following this), and the sale of Lycos for $12.5 billion.
Below are critical insights from Storm Duncan, one of the most successful technology M&A practitioners of all time, on maximizing your company’s valuation in a sale process.
The Misnomer
People believe high valuations stem from having multiple bidders vying to acquire a company. Undoubtedly, the simplest way to increase the purchase price is by having more than one bidder interested in buying the company simultaneously.
Nevertheless, it’s important to note that most companies, including those sold for high valuations, do not have multiple bidders — even in robust markets. In slower M&A markets in particular, most technology companies will find themselves without a competitive process.
Here are some strategies venture capitalists (VCs) and tech founders can employ to maximize the value of a company in an M&A transaction without significant competition.
First Things First: Understand the Most Important Driver of Excess Value for Your Company
An acquirer almost always has a strategic motive when they approach a company, yet most buyers have an underlying fear that secretly drives their strategic rationale. They might fear slowing growth, intensifying competition, or even simpler issues like missing a development cycle or failing to meet performance metric-related bonuses through organic means.
Once you understand what the buyer fears, you need to objectively assess your own company based on those fears. How can your company solve this problem? How can you tailor your message to resonate most effectively with this problem?
Most importantly, how can you offset the risks associated with your company’s solution to the problem? A buyer needs to have a high degree of certainty around your company’s ability to solve their problem — this can be as critical as the solution itself
Understand the Key Drivers of Valuation
here are sixteen key drivers of value for a company that’s being acquired. Five of these factors typically will have the biggest impact on value.
Growth
Growth typically drives valuation more than any other financial metric. Rapidly-growing companies typically trade at much higher multiples than their slower-growing counterparts, even if the latter have better profit margins.
Companies should showcase their own growth when it outpaces that of your peers as well as the buyer, and calculate the pro forma growth for the combined entity if this has a demonstrable impact. This can be amplified by adding synergies to the equation, as detailed later.
Contribution Margin / Unit Economics
The contribution margin represents the value your company captures after deducting the full cost of selling your product (typically the gross margin minus sales and marketing costs). This quantifies the economic value, both in dollars and as a percentage, that your company generates per sale. Companies with lower contribution margins require scale and market share leadership to extract higher values. Companies with higher margins generate more value quicker and as well as at scale, and therefore capture a higher value.
Burn
This popular metric is one of the more controversial. In down markets, potential buyers tend to steer clear of acquiring companies with high burn rates. However, during times of economic growth, there is a greater tolerance for companies with burn rates if they are growing quickly. Regardless of the market conditions, buyers only tolerate burn rates that drive high growth (reinvestment of contribution margin into growth). Conversely, companies with burn rates stemming from a low contribution margin are not valued by buyers.
Predictability / Consistency
The level of certainty associated with your predicted growth ranks high for valuation, as growth represents the opportunity for the buyer while certainty represents the confidence in that growth. Therefore, risk-adjusted growth represents a key valuation metric. Companies with a higher level of revenue growth certainty — such as recurring revenue, high retention, and consistent new customer acquisition — will have higher valuations than those with more variability or less predictability.
Market Size & Penetration
In a scenario where all factors are equal, a larger opportunity will result in a higher valuation. Buyers not only want to ensure that growth, profit margins, and certainty are not only attractive at present but also sustainable over the long term. This requires a sizable target market opportunity
Additional key drivers of valuation beyond these top five include competitive advantage/defensibility, capital intensity, market leadership, customer love/net promoter score, sustainable market/business, scale, brand, regulatory risk, culture/glass door, future-proofing, and team. In certain circumstances some of these might be more impactful than the five primary drivers above.
Understand How Valuation Methodology Works
Buyers can use many different valuation methods, either extrinsic or intrinsic. Extrinsic techniques involve applying the valuation of comparable companies or comparable acquisitions, while intrinsic techniques calculating the present value of all future cash flows the company is expected to achieve over its lifetime (a “discounted cash flow” or “DCF”). Due to the high growth and low profit margins of most early-stage technology companies, DCF is less commonly used than comparable companies and transaction methodologies.
When using the comparable companies and transactions approach, the method calculates the ratio of a company’s public market or sale value relative to the value of a core operating metric such as revenue or EBITDA. This ratio, or multiple, is then applied to the same operating metric for your company to estimate its implied valuation.
Additionally, it can be “growth adjusted,” meaning it can be increased or decreased based on your company’s growth relative to the comparable company or transaction.
Buyers also consider their own multiple when determining the value they are willing to pay for a company. They also assess the potential impact of your company on their future valuation by analyzing the pro forma impact of your company on their growth and profitability
Identify and Quantify the Synergies You and the Buyer Each Bring to the Combination
Synergies provide another source of value in a transaction. To fully extract the maximum value from synergies, it’s imperative to ensure they are tangible, clearly defined, both in qualitative and quantitative terms, and — most importantly — agreed upon by the buyer and factored into the pro forma model of the company.
Revenue synergies hold the greatest potential for valuation, as they imply a unique product with competitive advantages that sustain the growth rate. Think of Google’s acquisition of YouTube and Cisco’s acquisition of Jasper. However, it’s worth noting that predicting the impact of revenue synergies with confidence can be challenging.
Cost synergies not only require time and financial investment to be realized, but also only provide a one-time boost to the bottom line. This limits their impact on valuation.
Be aware, however, that while many investors and sellers believe synergies drive significant value, there are limitations to consider. First, synergies are predictions rather than certainties, so they are valued lower. Second, many buyers believe that they are the source of the synergies, so therefore should not have to pay for them. Finally, they will rarely agree to pay for more than half of the agreed synergies.
Risks
Founders must not only focus on highlighting the strengths of their company but also be prepared to address any potential concerns related to perceived risks. Organizations buy companies to fortify their position in the market, and they want to have a high level of confidence that the acquisition will successfully meet their objectives.
Public markets, boards of directors, and senior executives detest risk, as it carries a direct economic cost and potentially even liability. A company that adds great strategic value will be worth less if it has a higher risk profile. Sellers should strive to eliminate, minimize or address all risk factors, whether they’re perceived or real.
Make Them Like You
One undeniable truth about human nature holds even at the largest scale mergers and acquisitions: buyers will not purchase a company if they don’t like the team. Buyers know they have to work intimately with you to drive the value of the acquisition. If they do not see eye-to-eye with you, or don’t like or trust you, they will be far less compelled to move forward with the transaction.
Hiring an external M&A advisor to represent their interests throughout the selling process can help with this. Selling a company is a significant event both financially and emotionally, especially when the company is closely tied to one’s identity. Advisors can handle the tough conversations and deliver the hard messages, allowing management to keep a cool head throughout negotiations and not be perceived as overly demanding or confrontational.
Understand the Other Important Drivers of Value for All M&A Transactions
While it’s important to maximize value, it’s equally critical to maximize certainty that the deal will actually go through. Predictions of great fortune are appealing, but just like buyers want certainty, you should also focus first and foremost on certainty as well.
Founders should also concentrate on reducing the risks involved and minimizing the time it takes to reach a definitive binding agreement with a buyer. Your main four objectives in selling your company should be to maximize certainty and value, while minimizing risk and time
Be Realistic
It can be easy to fall prey to success stories from other companies that amplify one’s deepest desires for a huge valuation, but remaining realistic can mitigate negative emotions and disappointment.
If a platform company merely needs to fill a gap in its product offering, for example, and your company provides one of the many point solutions able to fill this gap, extracting an abnormal valuation will be difficult. The company will compete to be the chosen target amongst many options, as opposed to being perceived as unique and having multiple buyers compete. In the scenario in which a company is one of many options, a successfully completed transaction will be the singular measurement of a great outcome.
A lot of founders romanticize what they’ve built. It makes sense considering the immense efforts and personal sacrifices it takes to build a company. But at the end of the day, buyers don’t necessarily care about your story. Instead, buyers are primarily motivated by three things: their desire to grow and innovate, their concerns about what might happen if they don’t, and whether your company uniquely solves this problem for them.
Maximizing Value On Every Sale
Sale value is the most important metric by which success is measured. As a leading M&A practitioner, Storm Duncan’s perspectives are rooted in his time-tested expertise resulting in high-value acquisitions. VCs and tech founders who understand key valuation drivers and how valuation methodologies work can maximize the value of a company in an M&A transaction, even without significant competition.