It’s really quite logical that an acquirer would want to buy a company with a reliable, long term stream of revenue and profits.
Let’s look at it from a buyer’s perspective. Why would you buy an IT consultancy business with a few big orders per year, reliant on one senior sales professional who wins the work and no guarantees it can be repeated. Compare that to an IT outsourcing company with 10 year contracts with a wall of business as far as the eye can see. Well it is possible that the apparently risky IT consultant has deep relationships with government departments that you cherish and therefore want to acquire. It may be that the apparently attractive outsourcing company has sold long term contracts at suicidal commercial terms and is sitting on some long term liabilities.
However on the whole as the owner of a private company it makes sense to build a business with some sales and profits visibility.
The basic valuation tool of an acquirer surrounds the Price Earnings ratio (PE) which represents a number of years of post tax profits. A buyer placing a PE ratio of 10 on your business is saying they believe your current profitability is sustainable for the next 10 years.
Therefore the psychology behind any business model designed to maximize your exit value is all about predictable sales and earnings growth. Remember many acquirers are on a 3 month treadmill to deliver results for their public shareholders so they need surprises from acquired businesses like a hole in the head!
Now whether you ever plan to sell your business or raise investment money or borrow long term finance from your bank, there is no downside in building a more reliable business.
So I’ve trapped some actions worth considering to add robustness to your projections and to minimize nasty surprises:
- Look for ways to add a subscription service to your business. It could be a version of the SaaS model sweeping through the software industry. It could be a maintenance stream from a contracting type business. Think of the monthly annuity streams earned by Bloomberg terminals compared with one off publishing products sold by analysts. How could you change the way you charge for services to bring annuity streams to your business?
- Look for ways to increase the change costs of your customers to lock them into long term relationships. Reduce their temptation to change suppliers as new management come and go. I’m talking about long term supply chain arrangements that benefits both suppliers and customers but also adds some robustness to the arrangement.
- Watch for great relationships dominating your sales ledger. It’s great to have plenty of business with say IBM but if that represents 45% of your business then you have a huge risk factor surrounding future profits. Dilute down dependencies. Try to keep your best customers to less than 10% of your annual sales.
- Put some framework arrangements in place which offer price breaks for higher volume being called down. Build partnership type arrangements that bring customers close to your business. It all helps to put some evidence behind the fact these relationships are special and you are not just a commodity supplier.
- Offer incentives for 3 year maintenance, infrastructure, help-desk type services as opposed to your normal 1 year deal.
- Offer to train your customers for free up to a set number of hours to get your product or service embedded and spread within your customer’s organization. (Free as in built into the price but not separated out as a line item).
- Offer to embed a key technical person on site to on-board the customer and wrap a small retainer around that and sell it as an assumptive close. This is how we well this service ie it comes with a technical director for 6 weeks and unlimited support for 12 months.
- Make upgrades to higher levels of service easy and frictionless ie easy to upgrade on the web without lots of conversations and red tape.
- Look for ways of attaching royalty type payments as the customer sells more of their product service. Poster child example of course – in 1980, Microsoft formed an important partnership with IBM that allowed them to bundle Microsoft’s operating system with computers that they sold, paying Microsoft a royalty for every sale!
- Build a robust sales pipeline system that wraps weighted probability around all your deals. Over time this will bring robustness to your sales forecasting. Consider managing pipelines using tricks like the Common 5. Each month compare your next 6 months sales forecast by division with the version from the previous month. You will have by definition a common 5 months to compare. How far apart are they? Why are they jumping around? Is there a credibility gap?
- Just to be clear, say today you are forecasting July to December. Next month you will forecast August to January. Thus you have the common 5 months of August to December to compare.
- If you have distribution or partnering arrangements you rely on, then ensure that if there is a change of control at their end that there is a minimum notice period needed to terminate your contract. You don’t want to be exposed overnight to a key distributor being acquired and cancelling your arrangement.
- Specifically with software businesses make sure if you are offering a rental/subscription/SaaS model that your product integrates with your customers IT Infrastructure. This also makes it much more difficult for the customer to flip flop around different suppliers.
- Of course outside of contractual arrangements to add robustness some would argue you can’t beat the human touch. No contract I’ve seen will stop a really unhappy customer leaving you and creating a legal nightmare. Establish many deep and relevant relationships between your organization and your customers. From the ‘C’ level suite to the shop floor, build trust and insight to ensure you are constantly exceeding your customer’s expectations.
