Newsfeeds and papers often seem full of deals where innovative small companies have been acquired for seemingly insane valuations by large corporations. We have all heard of Facebook’s purchase of Oculus or Apple’s acquisition of Dr Dre’s Beats Electronics, but can small companies pull off an exit where the buyer pays a strategic premium for the business?
Ascendant has analysed technology sector M&A deals since the start of 2015 where value was disclosed and multiples could be determined. The table sets out the results:
As a proxy for strategic deals we have identified transactions with revenue multiples (i.e. value/previous years revenue) in two groups: >5x but <=10x, and >10x. We appreciate the limitations of this approach especially when applied across the whole technology sector (i.e. software to semiconductors, internet services to telecoms, etc.), but we believe it is sufficient to give useful indications of market trends. The overall message from the analysis is clear – less than 16% of UK/Irish tech companies achieve a strategic premium on exit and this shrinks to a miniscule 2% when looking at deals with a value of less than £20m. So, it would appear that SMEs do struggle to attract buyers who will pay a premium for their business.
“Strategic” deals rarely seem to be supported by the financial evidence and normal expectations of multiples of sales, EBIT, earnings or book value. So why do they occur and are there any lessons that SMEs can use to maximise the value of their business?
On a fundamental basis companies buy other companies because they believe that the target will generate more value under their ownership than the price paid. The exact nature and timing of that value generation in Strategic deals is not always apparent to third parties at the time of the acquisition based but many research papers and our experience suggests that it is driven by the following underlying themes (the “Magic 4”):
- Special/extended access to markets and customers;
- Unique and high value technology/IP;
- Unique and specialised technical/market talent; and
- Blocking competitors accessing any/all of the above.
Strategic acquirers will often justify a deal by stating that the cost of developing, and/or time it would take to develop, a particular technology or enter into a market would have been prohibitive and so it makes commercial and financial sense simply to acquire a business that has those things already. By extension, acquiring people with rare skills and knowledge through the purchase of a company may also deliver a commercial and/or financial benefit if those individuals can accelerate a strategic plan or initiative even if the acquired business is subsequently closed down. Finally, the least common Strategic reason to acquire is to stop (a) competitor(s) gaining an advantage via the purchase of a company with unique technology or special market position which could potentially disadvantage a potential buyer if it fell into the wrong hands.
Corporate Finance Advisers are usually instructed to prioritise strategic buyers when given a mandate to sell a business, but if the business has not been developed with an exit plan based on the Magic 4 then the only tool they have is to create a competitive auction between potential buyers. This will maximise value for most businesses but to get a “super” exit multiple, the executive team and the shareholders need to have been steering the business to align it with the strategic direction and needs of buyers with the cash to pay a full price.
Ascendant advises its clients and their shareholders to spend some thinking about who will buy the business and why it would be strategically important to them. This simple exit planning exercise along with an analysis of recent M&A/IPO activity in the sector should be undertaken regularly (i.e. at least annually). If there is drift away from strategic buyer alignment then remedial work based on the Magic 4 themes should be considered. The closer the Company gets to perfect alignment to a real strategic need of one or more potential buyers, then the more likely an unsolicited approach will be received and “Abracadabra” a buyer prepared to pay a premium is found! However, as any member of the Magic Circle will tell you, the real Magic occurs at the preparation stage not in the finale!
Ascendant advises companies and their shareholders on M&A and exit planning. Get in touch if you would like to talk about any of these issues.