Reaching acquisition value for future profits

I went to A last weekend was the real estate agent’s open day and…knowing the house prices in the area quite well – I asked the agent why the house was listed at such a high price. The agent’s enthusiastic response, pointing to the undeveloped yard and rooms screaming for updates: “Well, just think of what you can do with this place!”

The thing is, I wanted to invest in current value home, not the future value that I will have to achieve with my capital and time.

Sometimes our company feels the same way about how sellers perceive their company’s value. “Well, just think how this land could be transformed into a covered space. There is room for a truss factory there and outside salespeople can be hired.” They may add, “We won’t sell unless we get an acquisition value that reflects what it can be done here under new ownership.”

The problem is that buyers pay multiple times past efficiencynot what could be done with the company in the future. Buyers are certainly not blind to a company’s potential; that’s why they’re interested in the first place! (In some cases they will actually pay a premium for this powerthallium. I will discuss this below.) But buyers are completely unawareat the appropriate time about the acquisition valuation process. As Michael Corleone from The Godfather tells Sonny, “It’s nothing personal, it’s just business.”

The fact is that acquisition values ​​are based on multi-year trends and past 12-month performance across five leading KPIs: revenue; gross profit margin; OPEX as a percentage of sales; EBITDA as a percentage of sales; and EBITDA. You will immediately notice that all these KPIs are checked historicallynot as forecasts.

No one should ever diminish a seller’s pride in what they have built, often over many decades. That said, any expectations the company has yet to live up to potential should be rewarded with a higher acquisition value, acquisition value today is typically viewed by buyers this way: “By all means achieve this increase with your own capital and time, and we will be happy to look at it again in the future.”

I mentioned that in some cases, buyers will pay a premium for the potential of the company. Here are two examples:

1. The dealer/seller has a long-time home builder in the manufacturing business Client. They are extremely loyal and typically open 250 homes a year. With the certainty of lower interest rates, and having land options, they warn the dealer that they will do 500 starts in the next 12 months. In this case, the prospect of higher earnings is high; Moreover, this increase in turnover was the result of years of building this relationship. In this case, it is reasonable to expect that the buyer will offer a profit where the dealer/seller will receive an additional amount in the form of a performance fee equal to the purchase value, say 12 months after closing, if the profits on this 500 start to become a reality.

2. The dealer/seller has a facility that produces components. They have invested in improved saws, makeup tables and software, all of which is work that will benefit the buyer almost immediately after the deal closes. Once this gear is introduced, the dealer adds a second shift and considers a third shift, but continues to run one shift while talking to the buyer. The seller should expect an increase in the purchase value to reflect this investment. However, no buyer will pay in advance for unrecognized profits. Pay for performance is appropriate here because profits will be realized or, if the profit exceeds the dealer/seller’s risk tolerance, the seller’s investment banker may negotiate a “goodwill” amount at closing that largely compensates for the work/time/capital the seller has invested in the plant.

Consistent themes here? Acquisition value no linked to growth potential and opportunities; Instead, they are based on earnings. It’s nothing personal, it’s strictly business.