Tom Zucker, president and founder of EdgePoint Capital, surveyed some 200 serial acquirers, family offices, private equity, SPACs, and independent sponsors, and asked them why they would pay a premium valuation for a business.
One of the top responses that came back from the survey is that management is one of the most desired aspects from an acquirer, and one that usually determines whether the business can get a premium valuation
Mark Jones, a partner at River Associates Investments, LP, says at the lower middle market, it’s rarely a complete management team leading the business, but more often a just founder, leaving some key disciplines uncovered.
“In an ideal world, we would have a CFO, a COO, a VP of Sales, succession to the CEO. But it's certainly not an ideal world,” Jones says. “In many of the platform companies, we do have to augment these teams. It's not uncommon that we have to add a CFO, maybe there's a controller in there who is not used to dealing with lenders in a leveraged environment, so that's a very common add. Augmenting the management team is one of the first things we do because ultimately if we're going to pursue a buy and build strategy and go seek strategic acquisitions, you need a complete team to do it.”
He adds that other things that are hard to assess because they’re somewhat intangible, especially in a sale process when face time with these people is limited, is the kind of partners the team would be. Jones wants to know if they’re ethical, transparent, whether they’re able to work with a private equity board, how decisions are made, all information they’re trying to glean in a limited interaction phase.
According to the survey results, the ability to find a differentiated product or services is another valuation driver.
Art Anton, former president and CEO of Swagelok says his former company held a lot of patents and proprietary products were core to the company’s business.
“In a valuation perspective, that is something that I look pretty heavily for,” Anton says. “It typically would line up that proprietary products and know-how should translate into higher gross margins and higher EBITDA margins. Of course, you typically will have to pay more for that. But building that moat and being able to operate in that space really gives you some competitive advantage.”
Sometimes companies have proprietary know-how but not products, Anton says. They might be a contract manufacturer, so they rely pretty heavily on their processes and can differentiate their processes, which sometimes a little harder for a buyer to get a handle on. While somebody can read a patent for you, understanding know-how it takes a little bit of a different twist.
Jones says when his firm encounters a business that has gross margins less than 20 percent, it tends to indicate that it's probably a commodity item or in a very competitive marketplace where the company has very little pricing power.
He also adds in businesses where there's a high cost of failure associated with their products, people are willing to pay more and that's a good type of business because people are not as focused on price because they're much more focused on performance.
“It's difficult whether you spend the money in advance of a sale process to memorialize or protect your intellectual property or you go through the sales process with know-how, depending on how small the company is and the cost associated with it, that becomes a difficult preparation discussion for business owners to deal with,” Zucker says. “It was not surprising to me when the survey was tabulated that management and differentiated products and services were the two reasons why premium value valuations were paid.”
Zucker, Jones and Anton talked at the recent Detroit Smart Business Dealmakers Conference about the factors that most often lead to securing a premium valuation. Hit play on the video above to catch the full discussion.