Growth By Acquisition (Part 2) – Let’s Talk Valuation

Today, in Part 2, we’ll focus on something that I get asked about all of the time… valuation and what to look at when figuring how much a business is worth. This is a very common question and the truthful answer is not as simple as you would hope. So I will do my best to give you an idea of how a business is valued the right way in an M&A scenario inside of the IT Channel.

First, a caveat. I need to explain what I mean by M&A. Although an individual or group of investors can buy an existing business, I’m referring to valuation for an M&A transaction consisting of an existing company putting together a deal with another existing company to bring the acquired company into the fold through an asset purchase transaction. The other scenarios (investor or an individual with no existing company) have similarities in what you will read below, but are different enough to warrant not including them in this post.




With that said, let’s talk first about what sellers (the entity being acquired) should have in mind. As much as you don’t want to hear it, the value of your business is ultimately what another entity is willing to pay for it. Another thing to understand is that models and multiples are just ballpark items you can use to have an idea of what your business MAY be worth to another entity. It may actually be worth less or quite possibly be worth more to them.

Keeping the aforementioned things in mind, know that the following will be of high value in some way, shape or form to any buyer:

• Perceived Level of Risk
• Intellectual Property
• Unique Capabilities
• Revenue Model (which also ties to risk level)
• Cultural and Technical Fit (also ties back to risk level)
• Net Cash Flow

You can check with someone familiar with M&A valuations in the IT industry to help you out with “ball park” multipliers to have a general idea of what your Net Cash Flow is currently worth based on the type of revenue model for the services you provide (reseller vs time and materials/projects vs a mainly recurring revenue (such as MSP or hosted services)). And I encourage a potential seller to have an idea of their business value to another entity, but it really is a ball park.

Ultimately, the buyer determines what they are willing to pay and the structure around the deal as a whole. You, as the seller, get to listen to why the offer is what it is and decide to take it or not. Of course you also have the option to negotiate any part of the offer should you have a valid point to argue or bring into a different light for the buyer’s consideration.

If you are a potential seller, read on about how a buyer should be thinking so you can see the big picture.

So let’s move on to the buyer thought process on business valuation. When you are looking to acquire another business, your reasoning for doing so can be many things (see Part 1 of this post series). But your ultimate goal is to look at another business and see how bringing it into the fold of your business is going to boost your bottom line and value as an investment. So the thinking should be not the value of what is, but the value of what will be with this new company bolted on to your existing company.

It’s truly a return vs risk scenario coupled with deal cost vs deal price. So a great deal with a higher value will have low risk and high return. You should be more than willing to pay for that opportunity regardless of what the “multiplier” turns out to be as long as the cost of the deal doesn’t make it a bad idea.

Get multipliers out of your head since they are after thoughts in M&A except for dealing with enterprise value to determine stock price and a stock related transaction. Stock certainly could come into play if stock in the buyer’s company is in play for a deal, but regardless this is an entirely different conversation that we are not going into here. I would be happy to talk to you about it in another venue.

Let me give you a different take on how to look at what would be a good value for a transaction. Although some rather complicated accounting math like discounted cash flow (DCF), internal rate of return (IRR) and the like are necessary to check the deal, a good deal is all about if I pay X in Y manner, what does my return on that investment look like over Z time? I can’t get into the details behind X, Y and Z here, but that’s what it’s all about.

You’re investing in the assets of another entity to get a return on that investment. You’re looking at it not so much as what are the revenues, expense and profits as THEY run it, but what does all that look like when integrated it into YOUR company and how much can you afford to pay for it and still see the return desired.

Hopefully you have a better picture about how all of this works in terms of where deal value comes from when it buying and integrating another company. Next we’ll talk about some common deal structure options for financing the payment of a deal from buyer to seller and continue on from there.


To Your Business Success-

George J Sierchio