Ever wondered about what it takes to maximize a company’s value in the eyes of investors and acquirers?
Business owners want to focus their limited time and resources on the few metrics that deliver the highest ROI.
But what are they?
For nearly 40 years, we’ve performed hundreds of valuations and fairness opinions (determinations, requested by a target’s board of directors, of whether an offer for the company is “fair”). We mostly serve US tech companies with revenues between $10M - $100M.
In that time, we got pretty good at predicting a target’s value based solely on its operations or performance.
(That said, you can realize further substantial gains in prediction accuracy by considering the M&A deal values of similar companies, and by considering the synergies (or disynergies) between unique pairs of buyers and sellers.
Nonetheless, the operating performance factors we’ve identified explain about 75% of the value of a tech company in the eyes of an acquirer.)1
Our Batting Average
Said another way, our median value estimates correlate with actual value for an R2 of .72. (The measure of correlation is called R2, and it’s measured on a scale of 0 - 1.0 with 1.0, or 100%, being a perfect, positive correlation.)
Lurking in the remaining 28% of unexplained variance is a catch-all rogues gallery:
Premiums paid by strategic acquirers for expected synergies (sadly, not always realized);
Black Swan events like pandemics;
Factors we may have missed (Donald Rumsfeld called them “unknown unknowns”);
Unexpectedly competitive bidding (sometimes driven by empire-building CEOs);
Randomness and outliers;
Unique IP.
The Six Factors That Predict Value
See below for our most important predictive factors and the relative contribution each one makes toward the estimated value. The good news is that these factors aren’t complicated – in fact, they make common sense. They’re all about strong, reliable and growing margins.
The Factors and Their Weights in More Detail
Cash Flow/Profitability: 27%
Consistent profit generation and cash flow stability over at least several years is the single most important driver of high multiples. Companies with EBITDA histories above their peer-group median command premiums.
As you might expect, models that predict value expressed as a multiple of EBITDA multiple are more accurate than those using a sales multiple. That’s because EBITDA is closer to the holy grail of value – cash flow.
But in cases where a company is too young or growing too fast to generate substantial EBITDA, predicting value as a multiple of sales is still useful. The loss in correlation accuracy is surprisingly slight – 70% for sales multiples versus 73% for EBITDA multiples.
Growth History and Prospects: 13%
The second most important predictor of value is growth in revenue and/or EBITDA, along with a clear path to continued growth, particularly for SaaS and recurring revenue models.
Size & Age: 10%
Tied for third place with revenue reliability below, a company’s greater size and age correlate with higher multiples due to their greater perceived stability and scalability.
Customer Quality & Recurring Revenue: 10%
The quality, diversity, loyalty, and retention of the target’s customer base, as well as recurring revenue models (e.g., SaaS, subscriptions), make for higher multiples. So do low client concentration and long-term contracts.
Management Strength: 7%
A well-developed management team, with low dependence on the founder or owner, leads to higher valuations, again due to perceived continuity and reduced risk. ~7%
Macro/Market Conditions: 5%
Broader economic backdrop (interest rates, GDP growth, inflation, capital markets), investor appetite, and sector sentiment affect the multiples buyers are willing to pay, but by surprisingly little.
Wrapping Up
In sum, the greatest single positive impact you can make on a company’s value is by increasing sustainable EBITDA. That’s followed, in order of declining impact, by: A) growing strongly, B) getting big and old, C) fielding a competent, self-sufficient management team, D) attracting a loyal, diversified customer base, and E) selling when the economy is good or improving.
These are simple things to describe, but they’re not easy to accomplish. In fact, some of these requirements are even more difficult to satisfy simultaneously, like growing fast while remaining profitable.
(For clues about how to do that, see my article, “How to Grow Fast and Profitably – How to Scale.”) Achieving other factors requires the entrepreneur to consistently apply effort over time. Example: building a strong management team.
Meanwhile, for a list of micro-projects to enhance your company’s “curb appeal” starting six months before going to market, visit our Quick Ways to Increase Value Before Sale.