How to get a higher exit valuation

Dan and Jake

Last year, I worked with Dan and Jake, the founders of two companies going through an exit at the same time.

Financially, the companies were remarkably similar.

They were both generating around $2 million of EBITDA, on similar amounts of revenue and with similar profit margins. Both growing at similar rates, and in comparable industries. If you put the balance sheets side-by-side you would struggle to find major differences. 

Dan received an offer of just $6m (with much of it held back in an earnout) and turned it down. Jake successfully sold his business for a little over $15m.

How can there be a 3 times difference in value for two businesses that are so similar?

That came down to the valuation “multiple” that their buyers offered.

It's the biggest lever you have to get a much bigger exit.

A primer on valuation multiples

If you are new to this, I would recommend having a read of two other articles first too, where we dive into the topic of valuation multiples and how they are used to set a price for a business.

Firstly, in 'What is a 'multiple'?' we explain how multiples are calculated and what financial metrics are used.

Then, in 'How to get a higher multiple when selling your business' we dive into what drives a multiple higher and the actions to maximise your multiple.

What buyers are thinking

When a buyer is looking at your business, and deciding what a reasonable valuation multiple is, what are they thinking?

The core question which a buyer is always asking themselves as they size up an offer: 

Am I confident that this company will keep performing well, or might it start to struggle?

You want to convince a buyer that the answer is a clear and resounding YES, with plenty of supporting evidence to make the case internally.

If you are a safe bet to keep growing, increase profits, defeat competition, increase prices, keep key team members and avoid pitfalls around tech, IP or tax…the valuation multiple will be much higher.

This is similar to what a stock picker is looking for when reviewing a stock, so put yourself into that mindset.

So far, so obvious. Let’s get into the detail…

How to get a higher multiple

Let's explore what specific factors a typical buyer is looking for, and give you actions to maximize the multiple for your business on an exit.

We break these factors into five categories:

• Financial
• Buyer
• Market
• Risk
• Other

Financial

A buyer will take a deep dive into your financial data as one of the first steps in their analysis. They're looking for the absolute numbers, but also for trends and patterns which give confidence of good financial performance in the future.

Show them what they're looking for here, and you'll get a higher multiple.

👉 1) Fast growth

Of all the levers on your multiple, this is probably the most important.

Faster financial growth, over a longer time-frame, gives you a higher multiple. Period.

With fast growth and increasing profits, the buyer will get their investment back sooner and so can justify a higher premium today.

What constitutes 'good' growth is tricky to pin down. The buyer's expectations will vary based on their own growth rates, the maturity of your business and the norm of your industry.

If you've only started to see signs of growth, waiting a few years may help you get a much higher sale price (you'll have both better financial metrics AND a higher multiple). Only if you're confident of achieving that growth.

If you're growth rate isn't as strong or consistent as you'd like, but you think it's the right time to sell, here are a few tactics you can use:

• Show growth opportunities. If you can show convincingly that the company will grow in the future, this can help drive your multiple. Launching new products or in new markets, and increasing prices are all good levers. Your Information Memorandum is the place to set this out. Don't just leave this at a list. What evidence can you gather to make these opportunities more concrete and believable? Survey your customers about appetite for new products, write a market entry strategy, run some small paid ads tests in new countries... these give real data points to support a higher multiple in the absence of ideal historical growth.
• Explain slower growth. Are there reasons why your growth has been slower than hoped? Can you explain these clearly, without looking like you're making excuses? That might be a lack of capital (which you will have as part of the buyer's group), hiring mistakes, underspend on marketing...
• Pitch the synergies. How would joining forces with the buyer help your business to grow faster? This might be: bundling or cross-selling your products, using their biggest sales force to sell your product, doing joint marketing together. Showing these as credible and likely will make the case for future growth and so a higher multiple. The same point applies as above: do the work to give these some supporting evidence. On a recent deal, we create some mock-ups of joint marketing collateral and customer emails, which really brought these ideas to life.

👉 2) Consistent track record

This is one is clear. A rational buyer will pay a higher multiple for a company with a long track record of consistent revenue, improving margins, and so forth. It’s much easier to convince them that the next 3-10 years will see the same steady march to growth.

On one hand, your numbers are your numbers. If you’ve seen a few choppy years, you should expect a lower multiple.

But there are some tactics which can help you here, beyond just waiting to put a few great years back to back.

• Prepare your arguments. Have a clear explanation of why you had a bad year, supported by evidence and what you have done to stop this happening again. If it was a black swan type event like COVID that helps too, but explain the specific impacts clearly (inventory delays, increase in input costs, hiring struggles). You want this to sound genuine, not an excuse.
• Move the numbers around. If you have leeway within the accounting rules, try to have revenue or costs drop into the right quarter or year to give the chart a consistent and smooth look. Be careful though! Dodgy accounting practices is a big red flag that will kill a deal stone dead, so get advice before you do this.

👉 3) High margin

High margin (relative to your industry peers) is a signal that you are able to charge premium prices and have good cost control and efficient management.

Buyers also get a buffer, meaning that if the market slows down or you have an increase in your input costs, you will still keep pumping out profits. That helps them to justify paying a higher premium.

If your margins aren't as strong as you'd like, or you suspect even lower than your peers, what you can do?

Look up to point 2) above – these points apply here too. Explain how your margins can improve, and how an acquisition might help this. Think about efficiencies from selling through their channels, lowering input costs with scale, shared services, and so forth.

👉 4) Recurring revenue

Businesses with recurring revenue get much higher multiples than those that don't.

Recurring revenue just means that you have customers who pay you regularly for your service. That's most obvious in a SaaS / software business with customers paying regular monthly or annual fees. It can also apply, although less strongly, to a service business with long-standing clients who pay to use the service regularly and low churn.

These businesses get bought for higher premiums because the buyer can better forecast future performance. This precision makes them comfortable that the risk is lower, and so a higher multiple is justified.

They'll ask for data on churn rates and average customer lifetime values, as well as data on your marketing funnel, to look ahead to what the next few years will look like.

This forecasting is much harder in a business where each new dollar of revenue has to be earned, without contracted repeat spend from your customers. Your clients pay you on a project basis or as and when they need you.

The classic examples of this are agencies (like web development or advertising), where most clients use your service once, or retail / ecommerce businesses.

There's a middle ground for businesses where customers are on contracts, but are charged for what they use. These are called consumption or volume-based pricing models. Cloud hosting (like AWS) is the classic example here. Monthly payments can go up and down from month to month, but if you can show you have long-standing clients with relatively consistent (or growing) payments, you can make a strong case that you deserve a recurring revenue mutliple.

Here are some tips to increase your multiple, whether you're lucky to have recurring revenue or not:

• Prepare your numbers. If you have great recurring revenue, gather your lifetime value and churn rates to show how bulletproof your growth plans are. If not, do you customers tend to come back or buy more than one product? Do you have case studies to share?
• Get some recurring revenue. This isn't a quick fix! If you can think of ways of moving some of your customers onto monthly plans, that will help. Or can you launch a side product which suits a recurring model? But a word of caution - only do this if it's the right thing for your customers. Trying to push plans or new products onto them just for the sake of chasing recurring dollars isn't putting the customer first, and may be a move you regret.

👉 5) Clean balance sheet and cash flows

So far we've focused on the profit and loss elements of your business. But the other two of the main financial statements are important in a valuation too: Balance Sheet, and Cash Flow Statement.

Your Balance Sheet and Cash Flow Statement need to look as 'clean' and simple as possible. What does that mean?

No massive debt overhang (especially if it needs to be refinanced at higher rates) which will drag on the earnings. No risky investments. No growing accounts receivable, which means you are struggling to collect money from clients. And no large accounts payable which means you are not paying your suppliers on time.

If you think you might have some of these issues, you may want to consider cleaning these up before you consider a sale. Not only can they drop your valuation, if severe they may turn buyers away entirely. If you work with an M&A advisor they can help here.

Buyer

Finding the right buyer, pitching your business correctly, and creating some competition can all significantly increase your multiple.

👉 1) Find a great buyer.

You want a buyer who is keen (maybe desperate) to make an acquisition, and whose business is well-matched to yours. They will pay significantly more.

The tricky part is to find them. We're planning a separate series on finding and evaluating buyers, which we will link here once it's live.

But in the meantime, here are some factors to consider:

• Obvious rationale. There are a number of reasons why companies go through the risky and expensive process of M&A. That might be to enter a new market, get some valuable tech, remove a competitor, integrate up or down the value chain... In any event, it should be clear which of these applies to you and the buyer. The pitch should be an easy sell.
• Strong synergies. It should also be obvious how the two businesses will work together after the deal. Cross-selling each other's products, saving costs and so forth. The stronger these are, the easier the justification for a higher valuation.
• Keen to buy. You want a buyer who has a strong motive to buy NOW. This urgency can lead a buyer to pay more (or over pay?), especially if there's competition in the deal. This is hard to ascertain from outside, but you might hear about other deals they've done or that fell through recently. Or maybe they've just hired a bunch of ex-M&A advisors to create a "Corporate Development" team...
• Themselves growing strongly. If your buyer is in a strong financial position (healthy share price, rapid growth, lots of cash on the balance sheet) they are more likely to be able to pay a higher price. But a desperate buyer can also be a good thing...
• Existing partnership or relationship. If you've worked with the buyer before, or at least had a friendly relationship, this really helps. Trust levels are already high and they the basics of your business already.

👉 2) Get your pitch right.

If you have buyers with a clear rationale and strong synergies, you need to make sure these points are clearly made in your pitch.

Do a great job in that pitch, and your on the way to a higher valuation.

The Information Memorandum does much of the work here, along with your preparation for the first meetings with the buyer.

Most companies will create a single pitch document, and use this for all buyers. This document is generic, and talks mostly about yourself rather than the impact you can have on the buyer's business.

We recommend creating a separate document for each buyer. Add a final section called "Working with [Buyer]" and document the ways in which you can help them achieve their strategic goals, and how the two businesses could work together after the deal.

👉 3) Make it competitive, maybe run an auction.

In the research for this article, we came across a number of 'outlier' deals where the buyer paid huge multiples.

In every single case, there was more than one bidder trying to buy the business.

You need to create a bidding war. That's what drives a price sky high.

That means doing a lot of work to get as many interested parties as possible, and getting the pitch right for each of them. You will need to start this process early to give you enough time to cast the net wide. And you'll need to meet with each of them to get them interested.

It's a significant amount of effort, but the payoff in terms of multiple can be huge.

The ultimate implementation of this is running a competitive auction process. Bidders are invited into a process, given a set of information and timeline to make initial bids. The top 3-5 bidders from the first round are then invited into a second round, with interviews with management and further DD, before making a further bid.

You will definitely need an M&A advisor to run the auction process for you. It's a tonne of work and stress, but it can pay off handsomely.

Market

Thirdly, your multiple can be heavily impacted by the state of your market or industry at the time you sell.

Of all the areas, this is the one where you have the least amount of influence. The factors are much wider than within your company, and there's not a lot you can do to change sentiment.

If the market is really weak, you might want to wait a year or more for things to turn around.

👉 1) Strong market.

We think of the market as being 'strong' or 'weak'. A strong market is one where confidence and optimism is high. Companies in the market are making good money, the market is growing rapidly, and so many companies want to join the party.

That means confidence is high, there are likely to be many buyers, and so the multiples are high. A weak market is the inverse.

The best example of a very hot market in 2024 is AI, where any company with a mild flavour of AI will get a mark-up on their multiple.

👉 2) High recent comparables.

Along with a strong market, you ideally want example of recent deals done at high multiples.

If you can point to a similar company in your market who sold for a 25x EBITDA multiple, that's a great starting point for your negotiation.

M&A buyers follow the crowd when it comes to setting a multiple, so will use that data feel comfortable that they are not overpaying.

👉 3) Stable macro-economic situation.

Lastly, a healthy and stable environment in the economy in general helps.

Risk

Let's come back to the question we shared earlier – the core question that a buyer is answering as they set their offer price: Am I confident that this company will keep performing well, or might it start to struggle?

So far we've focused on your financials, the market and the fit with their business.

The last hurdle to clear is risk.

Your buyer will be worried about protecting the downside. These are the 'what-ifs' that will stop them from offering you a full price for your business.

The more of these they find, the lower the price they will pay.

Frustratingly, these issues tend to come out later in the due diligence process. They give the buyer an excuse to 'chip away' at the price they've initially offered.

The argument goes: We offered you £10m on the assumption that X was true, but now we have the data we can only offer you £9m.

These factors will vary by company, but let's get into some common examples which we've seen come up regularly on deals in the past.

• Customer concentration. Do you get over half of your revenue from one client? Or >80% from your top 5 clients? If so, a buyer will be nervous that you're only a few cancellations away from a major drop in revenue. If that's the case, you might want to work on widening your client base before you sell.
• Weak customer relationships. Do you have high (or rising) churn rates, low (or dropping) NPS, rising returns or complaint rates? These can be the 'canary in the coal mine'. They are early signals to the buyer that there are unhappy customers, which can lead to cancellations, slow renewals or reduction in pricing power.
• Competitive threat. Are there new competitors in the market with impressive products or much lower pricing? Are they doing a great job of PR? Buyers will do a competitor scan, and will be worried if they see someone else getting traction. You need a strong argument as to why your current and future customers will choose you over them, and what your ongoing competitive 'moat' is.
• Clean ownership, history, tax and books. Your buyer will want a simple, clear history regarding your ownership, financial history, tax payments and nice clean books. Red flags include: lots of change on the cap table with conflict between shareholders, a super complicated ownership structure, complex debt structuring, past unpaid payroll or tax bills, and generally disorganised documentation around the business. Getting yourself organised ahead of time really helps here, getting a neat and well-organised data room and explanatory documentation around these issues to explain why they happened and how they are now under control.

For many of these, you might throw up your hands and say 'it is what it is'. Sometimes the past can't be changed, or these trends can't easily be reversed.

That doesn't mean that your company is unacquirable. It just means that you might have to accept a lower price than if these factors weren't in play.

Other

Finally, there's a laundry list of other factors which come into play. These tend to be less important, with lower weighting than the factors mentioned above on the overall price.

They are worth calling out so that you are aware that a buyer will be looking at these.

Where you have strengths in these areas, call them out clearly in your Information Memorandum. If they are weaknesses, you might want to address them head-on to explain the history and how they are being managed.

• Strength and expertise in the management team
• Commitment of the owners to the business after the sale
• Ownership of unique and valuable technology or other IP
• Ability to do a deal quickly (if this is a factor for the buyer)

How to use the Valuation Scorecard

There's a lot in here. So, where to start?

In nearly all cases, you will have some factors in your favour and some against. It's a see-saw of positives and negatives.

For example, you might be:

⬆️ A fast-growing, high margin business in a booming market with some unique IP and a great management team

But, on the flip side, you have:

⬇️ No recurring revenue, only one realistic buyer and a short financial track record.

We've put together the Valuation Scorecard. You take the factors listed above and categorise them into Strong, Weak or Neutral to see where you end up overall.

You can then use the Strengths as key points in your discussions with buyers, and use the action points above to manage the Weaknesses.

If you have many of these factors in your favour, you can expect a valuation multiple towards the top of the range. But if you're struggling to show many of these you should prepare yourself for a lower multiple.

We hope it's a useful prep exercise as you start readying yourself for an exit.

[COMING SOON]

Back to Dan and Jake

So, which of these factors were most signficant in helping Jake get triple the multiple that Dan did?

The businesses scored equally in the financial areas, and neither had any major risk or red flags.

Jake was able to find three 'Perfect Buyers' and ran a great competitive process to get them to bid the price higher and higher. His market was considered 'hot', with recent deals at very high multiples.

Dan got a cold approach from one buyer, and just continued the conversation with them. He didn't want to reach out to other bidders, as he was worried about distracting himself from running the business. Over time, that buyer knew they were going to be the only offer and so he got his low-ball offer and turned it down.