Here's another great story of how you can use value signals to improve your business and personal returns:
A 20-year-old contract R&D company with $9M in gross revenue received three unsolicited inquiries about their interest in being acquired. The interested parties were all strategic buyers, two backed by private equity.
The potential sellers were interested, but had no idea what terms were appropriate, having never seriously considered a sale before. Now, however, two were interested in retirement. All wanted sufficient return from the sale to top off their retirement savings, whether planning to depart or not.
We first evaluated the company and ownership using an assessment of the Four Value Signals (Team, Sales Process, Financial Strength, and Owner Involvement). Scores on a 10 point scale were:
- Team (Ability and Strengths in Leadership Roles): 6
- Sales Process (Reproducibility and Success Rates): 4
- Financial Strength (Balance Sheet and Free Cash Flow): 8
- Owner Involvement: 3
The owners managed operations at all levels and one was responsible for most of the sales, resulting in weak scores in these areas.
Next, we carried out a standard benchmarking analysis by NAICS code to understand key indicators of additional strengths and weaknesses by a peer level comparison. Working with their accountant, we determined that their revenue per lab employee and their fixed asset turnover were high for an R&D company with a heavy investment in instrumentation – a positive value point. As expected, their EBITDA exceeded benchmarks.
Finally, we carried out a market valuation analysis, comparing them with eight other companies with $5-$10M in revenue in their sector that sold during the past year. Even at their relatively small size they could expect offers based on financial strength at 8.7x EBITDA, with a potential return to the owners of up to $12MM.
Unfortunately, their failure to build a fully functional team, relying instead on their own expertise and abilities. Their high level of owner involvement meant that the owners were the essential feature of the business. They had never created a process whereby others could take over.
The costs to understand their situation were minimal, less than $20,000. When they sent initial disclosures to the potential buyers one dropped out without explanation, and a second deferred interest, saying they had other pressing business issues. The third issued a Letter of Intent with terms that were below the expectations of the owners.
Any buyer would be concerned that sales would drop during and post-acquisition. And that concern was reflected in the below-market offer. The owners turned down the LOI.
At present the owners are happy with the outcome, having decided that with another two years of work, particularly on building internal leadership and sales process, that they can command an even higher price and can personally exit in an acceptable time frame.