Want to know how businesses are valued at sale? Find out by listening in to this episode with the trends man, Mark Ostryn of Strategic Transactions, where we talk about the statistics around key factors that influence the valuation multiples of businesses at sale. We also look into the importance of understanding buyer motives and discuss an approach that will help you achieve a successful transaction.
- Trends in business valuation
- Valuation multiples for different industries
- Working out the buyer motivation
- Build your business to sell
- What the numbers are saying
- Engage your potential buyers early on
Joanna: Hi it’s Joanna Oakey here and welcome back to The Deal Room podcasts brought to you by our commercial legal practice, Aspect Legal. Now today we have the fabulous Mark Ostryn from Strategic Transactions back again and today we’re talking about reviewing current trends in buyer motives and also just having a look at the stats about what has been happening in the market.
Joanna: Hi Mark, thanks so much for coming back on board!
Mark: Thank you for having me back, Joanna. How are you?
Joanna: I am fabulous. I’m absolutely fabulous. The sun is shining. We are getting towards summer. What else can you ask for?
Joanna: Let’s kick it off. Mark, you’re our trends man. How about you tell us what you’re seeing in the figures at the moment? How are our valuation multiples trending? What are we seeing out there?
Trends in business valuation
Mark: I guess I should start off by telling you something that is always on my mind when I have an encounter with a prospective client that wants to put their business on the market. I go into their office and they’ll look at me and they’ll put their arms together and they’ll say, “So what’s the multiple for this business? How much money am I going to sell it for?”.
In the good old days, you have this chart and this chart on the horizontal axis would say size of business and on the vertical axis it would say industry sector.
You go okay you’re a food manufacturer with a 1 million dollar turnover, therefore you can expect a three times multiple of profit. Or if you’re a five million dollar business, you can expect four times multiple. Or if you’re 10 million, it’s five times and then you can go all the way up to being an ASX business and you could be looking at 12 times for a small cap.
It doesn’t happen anymore. Charts don’t exist anymore. The averages have stayed roughly the same. But the variance between different businesses in the same sector has become significantly greater. And there’s another cool fact, most businesses don’t sell.
Joanna: Yeah right. And so, do you have any numbers behind that?
Mark: This is in health and beauty, technology, and food and beverage. I’m sort of seeing between about 50 to 60 percent. In the smaller market, we’re tending to see that up to 70 or 75 percent close their doors without making a sale and finding himself having to liquidate their assets.
Joanna: Wow! That’s massive numbers.
So then, tell me when we’re talking about where we’re seeing that current sort of pricing of business sales at the moment, are we looking here at 2018 figures? What period are we looking at here?
Mark: Okay. Well look, we combed through all the transactions within various markets sectors that have been recorded within 2018 where there’s been some form of public announcement. So obviously there’s going to be a slight bias towards slightly larger businesses, because they’re more likely to make an announcement.
We’re seeing sort of overall stable valuations. But what we are seeing is we’re seeing some spectacular sell prices and we’re also seeing some fairly dismal ones. We’re correlating that with first of all the amount of competitive tension, the number of buyers that are looking at a particular acquisition. But also, what it is that the seller has to offer the buyer and that’s really important.
There are also other things like the fact that the ABS released some statistics just this morning. New businesses are coming off the market at a rate of 5.7 percent per annum. Exits are only increasing by 0.5. They got a bigger population of businesses.
You also got availability of credit, which is getting more and more challenging. And also, just the fact that the actual cost of creating a business, a greenfield business rather than buying an existing one is getting cheaper.
Joanna: In terms of the amount of time that it’s taking for startup through to turning a profit or you’re talking here like just specific side of how much you pay for your company registration and your legals at all of that sort of thing?
Mark: It’s partly that. But the best analogy is simply to say that if you wanted to sell stuff to B2C 20 years ago you’d have to set up shop. Now you set up a website and you have the various sophisticated tracking mechanisms on it so that you know who’s buying what and when they’re buying and why they’re buying it and when they’re going to need some more. That’s just one example but the cost of getting into business are much lower.
Valuation multiples for different industries
Joanna: Okay. What is all of your review of the statistics over the last year showing you in terms of what the sorts of multiples are for different types of businesses in types of industries?
Mark: We’re only tracking three specific industries sort of an endpoint. But a low value technology-based business, it’s advisory, could be anything from sort of a multiple of two to three. Food manufacturer again depends on the size. It can go anything from two to ten.
I mean that there is a whole chart of statistic that we collate. I’m actually really happy to provide the statistics to anyone who is involved in the advisory business actually basically giving their clients some kind of idea about what they can expect for their business.
We also have on my website. We also have something called Quick Value where business owner can answer 15 questions on their business. It’s all confidential, free of charge and it will actually spit out a value for them.
Joanna: Wow. Okay. So, if someone wants to take you up on that Mark, do they head over to your website? What is your website? We’ll put a link through in our show notes obviously for people who are out there running.
Mark: Yes, StrategicTransactions.com.au and then just click on food or technology or health and beauty. It took me nine minutes and then you’ll get a fully confidential figure back to you.
That figure has been based on thousands of transactions. But it’s also looking on all the different uniqueness of your own business and trying to work out how future proof it is, how scalable it is and all the different considerations that an owner has to bear in mind.
Joanna: Okay, great. You talked about technology advisory that you’ve seen in the last year multiples of around about two to three. Food manufacturing businesses two to ten. I mean two to ten, that’s quite a broad range. Right?
Mark: It depends on the size of business. I can actually plot some kind of correlation between how strong a seller’s assets are, how strong the buyer motivations are and the actual sale value.
Joanna: And sorry, when you say how strong the buy motivation is, what do you mean by that?
Working out the buyer motivation
Mark: Let’s just look at this in terms of a simple formula. The first part of the formula is how strong the seller’s assets are. You look at the main assets of the business you say the relevance of their product, the quality of their people, how competitive the business is and how competitive it has been in five years’ time, how well the systems are developed, the level of intellectual property within the business, the financial management of the business and brand recognition of the business.
That’s the first pool of assets for the business. Obviously, the stronger they are the more valuable the business is. That’s the first part of the equation.
The second part of the equation is well what is going to be the motive of the buyer. What is the buyer looking for, because the buyer is going to make a decision which basically says they’re either going to buy a business or they’re going to build a business themselves or build a division themselves so that they’re weighing up between the two?
Joanna: Maybe if you could give us an example of say for example in our food manufacturing where we’ve got this quite large range between a multiple of two and multiple of ten at the high end. What does a lower end, like a multiple of two looks like? Do you have a case or an example of what these types of businesses look like that are at the lower end of the multiple?
Mark: Smaller business, products that can easily be recreated by themselves anyway. Maybe I’ll sort of break this up by giving a bit of an example. I was working on the buyer’s side for a large food manufacturer and the customer, the small food manufacturer that they eventually bought had spent millions of dollars over the previous year or two installing a new factory and putting in new production equipment within that factory.
And the buyer, although they wanted the business and although they wanted the branch, although they wanted the product from the selling company, they didn’t want the factory. The seller had unfortunately invested all this time and money into setting up these systems that weren’t valued by the buyer. It’s a sad but excellent example of the fact that when a seller is thinking of selling, they have to think to themselves first of all even before they think well how we make our business better is what does a buyer want.
Joanna: Yeah. That’s such a good example. We can all identify I think sitting here in the listening audience that that would have cost a bucket load of cash.
Mark: Unfortunately, yes. And it was a family business, which is sadder.
Joanna: I guess in one sense it’s sort of easy to say well in hindsight you know crap no one really wanted what they thought was going to be wanted out in the market. How do we turn that really practical? How do we work out what a buyer is most likely to want?
Mark: Here’s what I do. One of the first encounters I have with my client is we will sit down, and we will create a long buyer list. Let’s just think what businesses, what larger businesses (so first, strategic buyers) within your segment would be interested in the following and I’ll say to them, which business in your segment (may not necessarily be in this country even) would be interested in geographically expanding in Australia. We’ll do a bit of a brainstorm on who’s outside the country who may want to move in, or who’s inter-state and may want to go into New South Wales or something like that so where the motive is going to be for international expansion, firstly.
Secondly, what businesses could you consolidate with in order to achieve some kind of synergies, some kind of economies of scale.
Thirdly, what businesses would value your intellectual property. That can be, not just your patents and trade marks and those sorts of things. It can be your customer databases, your methods, your processes. What businesses would see your products and want to acquire those products in order to expand their own product range or in order to diversify their own product range, perhaps take it into new segments or new channels or something like that.
What businesses want your clients, because your clients may also potentially be their clients, particularly in the tech space. What businesses want to hire your key people and probably put them in golden handcuffs. What businesses may want to buy your business in order to be defensive and reduce the amount of competitors in the market thereby perhaps enabling market strength for them. What businesses may want to increase or obtain market share.
By the time I finished with the clients and we’ve gone through all these different things, we can say well there’s 20 or 30 businesses. Let’s just think about what they want and let’s just think about how we could restructure or reengineer your business so it’s going to be appealing to them.
Joanna: That sounds like a really solid approach. This is a bit of a leading question. I was going to say how long before a sale should business owners think about this?
But I guess the reality for all of us, from an advising perspective is we just say as soon as possible before a sale. Because the longer we have, the longer lead time, the more changes that we can make to the business to make it more saleable. But do you have sort of a magic figure in mind that you give as a minimum.
Build your business to sell
Mark: You’re going to hate this response, Joanna. It’s the response of a pedant. It’s a very unhelpful response I’m afraid. But I’ll give it to you anyway.
The most famous book that’s ever been written on exit planning is a book by John Warrillow. It’s called Built To Sell and Built To Sell basically implies that even when you are architecting a business, even when you are thinking about what products, services, niches you’re going to attack you’re doing that partly on the basis that you can generate positive cash flow. But also, partly the end of this process there’s a rainbow and the rainbow is the payoff.
You’re really thinking, strictly speaking, you’re really thinking about it to think while you’re actually growing your business. Rather than saying okay I’ve got to it now, who do I sell it to. Now that’s incredibly unhelpful to you.
Joanna: Because you know. I tell what, and I completely agree with you. I have this discussion often and the thinking many times around is the day you start your business is the day you should be preparing for exit as well. But the reality is that building a business is a lot of freaking hard work sometimes. Right?
Sometimes the skills that it takes to grow a business are very different to those skills that will give someone the best ability to work out an exit as well so there’s a skills difference, I think. But also, there’s almost an energetic difference.
I just see business owners who are really focused on the growth of their business just can’t get their headspace into thinking about their exit. On the flip side, when some business owners start thinking about exit suddenly, they’re out the door already. They find it very hard to distance themselves from the concept of thinking about an exit and the emotion of the exit and they just start thinking about it and then that’s it. They’re off on that beach in Tahiti somewhere in their mind. And now, it is drudgery trying to work through their business. Do you have thoughts are around that?
Mark: I started doing some work with a technology advisory business that actually helps startups exit. Because sometimes an innovative entrepreneur wants to leave the business as soon as they’ve got it to a certain point, before they actually commercialize it on the basis that they get more pleasure out of being a serial entrepreneur or a serial developer rather than actually worrying about HR issues or occupational, health and safety issues and that kind of thing.
But one thing I would do for all businesses, I’d start with a bit of theory. There’s a beautiful bit of theory. It’s called the SPICE quality model and it can be Googled and you can sit down with your own model in your office.
It basically asks you a series of questions about where the business is going over the next five years, where’s the market going in the next five years, who can come into the business, what competitive game can come into the business, what are the barriers to entry, what substitutes can be built which could potentially make you redundant, how will the market size or share shift, what a customer are going to be wanting for, how does supplier side issues change, what’s going to happen with legislation, with legal issues with. There’s a whole bunch of things.
And so, if you’re sitting down there and you’re working out and you’re asking yourself proactively all those questions, you’re planning how to build your business. But at the same time if you’ve got it right, then you’re actually going to have people that want to buy your business.
You can blend the two exercises if you want. But even if you haven’t done that exercise and you’ve got a business now that’s a mature business and you want to sell, you can still say okay what do I need to do to make sure that this business remains relevant for a new owner. And that could be something like offering extension services, subscriptions, annuities, all those sorts of factors and I’ve got a list of about 150 of them.
Another checklist that I work through with my clients where we say well what are these things are going to attract buyers to the table because what we’re going to do is we’re going to look at these factors and we’re going to put them into a financial model. We’re going to build that financial model out and work out the value of the business based on the annuities coming from future anticipated profits.
Joanna: And so have you got an example of any clients that you’ve worked with or any businesses that you’ve seen that have gone through a process like this and come up with some really good results out of it.
Mark: Yes. Look, I’m working with the business at the moment again in the food industry and their revenue sources were stable. They were specifically in the vegetable market, in the greens market. But they decided that they needed to become innovative in certain areas. And so, they looked around and said okay well what can we do where we can blend our capabilities, because we’ve got certain core capabilities specifically with research and development within hydroponics. How can we expand our knowledge of hydroponics and look in new markets?
They’ve come across bush foods, and typically bush foods are foods that were typically gathered. There weren’t sort of produced on a massive scale. But they saw that there was a potential there. They saw the fact that some of these flavours were slowly creeping into both Australian overseas culinary experiences and they were saying there is a market for this. There is quite a substantial market for this. But that market is blue sky. Under the banner of a food company or business that has more marketing strengths, more money to put behind it, there is much more potential for them to grow that blue sky.
Joanna: And so, have they sold yet?
Mark: No, no.
Joanna: No. Okay. All right. What impact do you think that that will have on sale when they get there?
Mark: I think it will have a substantial impact. But there does need to be proof of concept. And so, in that particular company’s instance, we’re going to want to see a six to 12 month take up amongst prospective buyers of food, chefs, markets, those sorts of things. We’re going to want to see that. We’re also going to want to see a fair degree of PR and a fair degree of visible customer interest. How it could be the next wheat germ or something like that.
Joanna: Yeah. Okay. All right. Fabulous. So then looking back, can we step back into the trends?
Mark: Absolutely. Yeah.
Joanna: So we’ve talked about technology advisory, and what do you mean by technology advisory? What’s the type of businesses that you’re including in this category?
Mark: The businesses that I look after is specific to three sectors: technology, food, and health and beauty. All of which are undergoing very substantial shifts at the moment.
Joanna: Yeah. And sorry, when you say technology. Sorry, my mistake. I thought you said before technology advisory. But technology itself, as in software companies? Is there a particular focus in these stats that you’re pulling out of the type of technology business?
Mark: No. I mean really it could be anything from you know. If you’re looking at IT sales this year, it could be a group of information security consultants. Or it could be somebody that sells product or something like that. When I refer to it as technology, I’m using it in a generic sense, simply as tools that people use in order to basically make business more efficient.
Joanna: Yeah. Yeah. Got it. Okay. All right. Cool. So for the technology, the food manufacturing, the health and beauty. I don’t think we talked about what the multiples are there, so what is health and beauty looking like?
Mark: There are so many subsets of health and beauty. They range from medical practices to skin care to anti-aging to cosmetic or something like that. I think I probably have to fill your screen with an enormous spreadsheet to try to answer that question because the answer I’m afraid is it depends.
What the numbers are saying
Joanna: Yeah. Okay. All right. So what else are you drawing out of these statistics and obviously you’ve gone through a lot of data there.
I find data and the analysis of these sorts of things really can be incredibly insightful both in terms of where are we now in comparison to where we were things before and where do we see ourselves in the future. But also, in terms of the difference between industry focused. What are the statistics that you’ve reviewed telling you.
Mark: A number of things, but first is competitive tension gets the highest value businesses. If you know there’s more than one bidder, the value of the business will tend to skyrocket.
Joanna: Yeah. Do you have any of the stats behind that one? Do you have stats in terms of sort of the single buyer sale versus the competitive tension sale?
Mark: Really tough because you won’t know in private transactions the extent to which that’s the case and that you’re having an informal conversation with the business owner. I have had a number of those because I’ve got a book coming out early next year where we’re actually looking at buyer motives. From the private side of things, it’s very much hearsay. Whereas with the public transactions, you’ll tend to see that there may be several bidders. You can see there the impact of sort of the bids there.
Joanna: Yep. Okay. All right, and what else are the stats showing you?
Mark: I was hoping the stats we’re going to show greater globalization of acquisitions. But I’m seeing who base is pretty stable at the moment. I don’t know whether that’s because of what’s happened in the Trump era. We’re all becoming a little bit more fearful or something like that. But I’m seeing things stable specifically with the States, specifically with Europe maybe that’s Brexit. But I’m seeing an enormous growth in Asian interests, particularly coming from China and particularly coming in the food industry where we’ve got a rapid urbanization and increase in the number of middle-class Chinese consumers that basically want to buy from a quality source of food product. I think it’s described as a gourmet deli rather than a bread basket.
Joanna: I like that.
Mark: That’s the terminology. The other thing I’m still seeing as very intriguing is the fact that the number as a proportion of acquisitions that are made by public companies of private companies is increasing.
Mark: Okay. Now that could be because public companies have got lazy balance sheets and they’re looking at sort of low risk acquisitions. But I’m saying that the very best private companies, well run private companies are increasingly being acquired by public companies often at higher multiples.
Joanna: Yeah. I think that’s a really good. I mean it’s an interesting observation from the statistics, something anecdotally I would say I’m seeing quite a bit of and you just can’t argue with the fact that your listed companies are great buyers quite often. They can be a pain in the butt, but quite often they pay very well.
Mark: Absolutely. Yes. There’s an arbitrary process in there which is too complex to go into at the moment. But basically, an acquisition of a private business at a multiple lower than the PE ratio that they’re trading in basically is something called value accreted for.
Joanna: Yeah. One thing I’m actually interested in drilling into in these stats is, are you seeing any changes in 2018 from the position that we’ve been in previous years? Are there any trends that you’re seeing changing over time?
Mark: Nothing really significant other than the ones I already talked about. I mean of course I’m noticing things like for example. I operate across food and health and I’m noticing that there’s a merger between good food, organic or something with health benefits and health-based solutions. There’s a sort of a product synergy going in there.
There’s also a growth in the number of SAS, software as a service type solution, that are selling for higher multiples and the other thing in terms of the transaction is that there is a lot more transactions that don’t finish in terms of owner responsibility when their business is sold. There is a lot more times where the owners are required to stay on, earn some form of earn out. I mean that’s probably what you see. I mean I guess you’re negotiating all the time, earn out structures and those sorts of things. Are you sort of seeing an increase in the number of earn outs that buyers are demanding?
Joanna: You know what we’re actually not seeing an increase. I’m not seeing a decrease. For us, it’s been what we’re seeing is fairly stable so fairly consistent with what we’ve seen over the past. It doesn’t surprise me that you’re saying the stats are showing that and I find it really interesting. Obviously, there’s lots of drivers behind that but just anecdotally. Certainly, we see a lot of it but not necessarily more than in the past.
Mark: Okay. That’s interesting.
Joanna: Yeah. Well this is why it’s useful to get a feeling on stats as a whole because I guess we’re just dealing in our little microcosm here. That’s why I like to hear about what’s going on across the board.
Fabulous. Well, are there any other parting comments Mark on anything else you’ve seen in the stats or the concept of buyer motives for successful transactions?
Engage your potential buyers early on
Mark: The other thing that owners often ask me is to say well it’s all well and good doing this long buyer list. But once you’ve done this buyer list, I’m a year or two away from making this transaction. What I do in the meantime?
But we’ll often actually work to think about how we get in touch with the buyer without the buyer actually knowing that business is for sale or the business could potentially be for sale. A lot of the work that we do actually involves the beauty of a planned serendipity, where at certain meetings or conferences or something like that the seller may have the opportunity accidentally to come across the buyer. Maybe have some conversations with the buyer about the potential for certain alliances, potential partnerships in order to sort of strengthen the various product sets of the two.
Even though you are going through this cycle, it’s still very important to engage the buyer or the potential buyer at sort of an early point just to really make sure that the seller’s impression about where they’re going with the business is how the market perceives the value of that business as well as.
Joanna: That’s a really good idea. I like that planned serendipity. We might have to make that a tweetable.
Mark: Okay. Thank you for that.
Joanna: Planned serendipity, I love it.
Mark: Yeah, absolutely. Yes.
Joanna: Fabulous. Well look. Thank you so much Mark for coming on to talk to us today about the trends and the statistics. We also got to drill into buyer motives as well, so great episode! Thanks for coming to talk to us.
Hopefully we’ll have you back again soon Mark maybe to talk a bit more about these tech side. The technology businesses are I think a keen interest to many of our listeners. I have actually had lots of listeners contact me that have tech business as well so it’s quite interesting. I know that there’s a few out there listening to this. Maybe we can come back on another episode, drill into what the trends are looking like in relation to these businesses and then drill into some elements further there, Mark.
Mark: Look I’d love to come back and talk you through. I mean there’s basically seven key assets that we believe that business owners need to strengthen before they go to the market: the product, the people, competitiveness, the systems, the IP, the financials and the brand. I’d love to go through each of those with you and with the advisors and sellers that are looking into it and see where we need to strengthen our business prior to sale.
Joanna: Yeah. Fabulous. Well look, thanks Mark. We’ll talk to you again soon. But until then, have a fabulous day and thanks for coming on The Deal Room podcast.
Mark: Thanks for having me Joanna. Lovely to talk to you. You take care.
Joanna: You too.
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