Maximise Your Business Valuation for a Winning Exit with Doug Lawson

Thank you, Darryl. Thank you very much for having me.

Yes, we are Mark2Market is a data platform that helps the advisors value businesses. So we don’t value businesses, we provide the data that helps our customers do that valuation. And what we specialise in is private markets data at the smaller end of the market. So if you’re an advisor or an investor in small companies and you want the best, what I believe is the best data on those companies in the market,

then Mark2Market I think is a pretty good tool. And you can use it for a multitude of use cases, analysing markets, identifying acquisition opportunities, finding buyers for your clients. But one of the absolutely key use cases that our customers use the platform for is valuing private companies.

Well, to be honest, if you were to look at our customer base, I would say that they will typically be dealing with companies valued at between one and 50 million pounds. So of course, everybody has different definitions of what small is, but I would say that’s kind of the sweet spot for our customers. And they’re very much there. There are other data tools out there, but they’re perhaps not as good at collecting that data at that end of the market where it’s harder to find that data. have to be a lot more about gathering it.

Yeah, a hundred percent. I think that’s a really good analogy. So it’s, it, doesn’t give you the answer because that’s what makes a market, you know, what something is worth to you might be different to what it’s worth to me. And that’s how you negotiate and then you find a price. But we always say that if you’re armed with the best information, the best data, then you’re probably in the most powerful position to have that debate to have that negotiation. If you’ve got a bunch of data that tells you that very similar, using your analogy again, if similar houses on the street sold for a million dollars, then I know that your house probably isn’t worth $2 million. There might be some special reason it is worth $2 million, the huge swimming pool, the tennis court, whatever, that’s fine. But at least I’ve got my benchmarks that I can use to base my conclusions on and have my negotiation with you.

Yeah, yeah. Okay, great question. it’s, yeah, that’s really interesting because I do hear a lot this this point that you make about, well, I want a million pounds or I want three million pounds or five million pounds, because that’s what I need to retire. And that’s what I need to buy the yacht. And that’s what I need to do this and to do that. But as you rightly say, buyer doesn’t care about that. A buyer is looking to buy your business for the best price possible. And they will determine that price based on what they believe market value is, you know, clearly they’re going to try to want to buy it for less than market value, but they don’t have your, they certainly don’t have your yacht in mind when they’re offering you a price. from a technical point of view, so I learned about a number I qualified as a charge accountant, then I worked in corporate finance and then I worked in private equity. So I did lots of valuing throughout my career. before I started MarktoMarket and I was taught the core techniques that you use for valuing a business. And if you open up a textbook about it, there are three techniques that they tend to talk about more often than others. The first one’s very straightforward. It’s like an asset -based valuation. And that’s basically where I say, right, Darryl, you’ve got this business and the net assets are a million quid that’s what I think your business is worth. So it doesn’t take into account really any goodwill or anything like that. It’s quite unusual. I mean, clearly there are some very kind of asset heavy businesses or maybe property back businesses where that comes into the discussion. But typically that would maybe be more for a kind of distressed type situation or yeah, if you feel there’s no goodwill in the business at all. So that’s the asset based methodology. Then you have the income approach and the income approach says, what do I expect over the period of ownership of this business? What kind of cash flows do I expect this business to generate? And what is my cost of capital? So to put that in kind of layman’s terms, if I’m buying something and I’m borrowing from the bank to buy it at a rate of 5%. My cost of capital is 5%. So I take those cash flows I expect the business to generate and I discount those cash flows back at 5%. And that gives me a present value. It gives me a number and that tells me what the business is worth on that basis. That’s highly speculative. I always think because you’re trying to model while you’re trying to figure out usually it’s not as simple as just going to the bank your cost of capital will be kind of your required rate of return as well. It’s like, how much do I, what kind of return do I expect to get from this asset? So that’s pretty subjective. Then of course you’re kind of modeling out the cash flows of a business that you’re buying for five years or 10 years or whatever, and modeling the costs. There are lots of very subjective inputs into that. So it’s useful as a kind of cross check with other methods, but in isolation, that there are certain assets, certain companies that maybe lends itself well to if you have a very predictable revenue stream and a very predictable cost base, know, something like, I don’t know, something where you have long term contractual revenues or something, it might work. So that’s the income approach. The last approach called the market based approach. And this is the one that is most common and most prevalent. And the market approach is all about applying a multiple to your profits. And the profit that you apply that multiple to, could be profit after tax, could be earnings before interest in tax, but the most common one, it could even be revenue actually, not a profit number. The most common one is earnings before interest tax depreciation, amortisation or EBITDA.

And you, in order to derive a value for the business, you take the kind of clean underlying EBITDA of that business and you apply a multiple to it. the, the, so it, it, it, it’s also, think it has the benefit of being extremely straightforward in the sense that if you show me a business, Daryl, we can figure out what the underlying EBITDA is, what your underlying profitability is. That shouldn’t be too difficult. the harder part is figuring out what multiple do I attach to those profits. But fundamentally, it’s kind of conceptually, it’s pretty simple. You take the profit and you apply a multiple to it and you get an enterprise, what’s called an enterprise value for your business.

Yes, absolutely. So you are going to, if I’m the buyer and you’re the seller, Daryl, you’re going to try to convince me that the profits are as high as possible. I mean, that’s just, that’s what any seller will do. And naturally, so what you will be saying to me is, well, yes, this is the profit that we reported last year. However, there was this exceptional item and there was this non -recurring item and if you remove me from the business, you’re not paying my salary, etc., etc. And you’ll therefore be building that profit number up because the higher that profit number is, the higher the value of the business is going to be when you apply that multiple to it. At the same time, I as the buyer will also be coming to my own conclusions about what the underlying profitability of the business could be under my ownership. And that is not something that I’m going to share with you. So I may have a plan to say if your underlying costs are 2 million pounds a year, I may have a plan to remove a million pounds of those costs because there’s duplication, et cetera. I’m bringing you into a bigger group and we don’t need to duplicate all of these costs. So I may have that plan. I’m not going to share that, probably not going to share that with you. Because again, that if I say, actually your profits are much higher than you’re telling me because under my ownership, would, the profits would skyrocket because I’m going to be bringing the cost down. I’m not going to pay you for that. So yeah, so I make it sound very simple in terms of finding that profitability number and it’s, it is relatively straightforward, but it’s still subject to conjecture because your view on what an underlying, the underlying profit of your business is going to be might be different to mine.

Yeah, great point. Put yourself in the buyer’s shoes and say, right, if I were buying my business, what would I be doing to it? And by putting yourself in those shoes, you probably learn a lot, which helps you with your negotiation.

No, it’s not. you do what, what, this is kind of what we’re all about at MarktoMarket. And this is, this is such an interesting topic for a valuation geek like me. It’s like, yeah, okay. You’ve got that underlying profitability. You’ve got that number. What multiple do I attach to it? And what you’re looking for in order to determine what that multiple is, you’re looking for the best proxies that are out there for the business that you’re selling. So if I’ve got a precision engineering company that serves the oil and gas industry in the UK and Gulf of Mexico, and I’m doing 5 million of revenue and half a million of profit of EBITDA, what I really want to know is, okay,

Are there other precision engineering companies serving the oil and gas industry of a similar size that sold recently and what multiples did they sell for? And that’s kind of the first stage because that gives you a pretty good idea, especially if some of those businesses were sold to the buyer that you’re negotiating with, because you can then see,

For similar companies, looks like they’re paying five times profit, six times profit. I’m using profit and EBITDA interchangeably, Daryl, but you get where I’m coming from. So that…

Yeah. Yes. Exactly. Exactly. So you then say, okay, I’ve got a bunch of other precision engineering companies serving the oil and gas industry. And they sold for, you know, I’ve got a bunch of deal. I’ve got 10 deals that look similar and the multiple range was between five times and 10 times. It’s like, well, is that really helpful? So I’ve got a median multiple maybe of seven or eight, but why have some sold for five times and why have some sold for 10 times? And you’re never going to know exactly why, but you can start to drill down a wee bit and try to understand that. So one of the reasons could be size. So there tends to be a correlation between business size and the multiple that’s paid. So the bigger the business, the bigger the multiple that you’ll get. So a great way of increasing the multiple on your business is to make it bigger. Easier said than done. But you do get a lot of people who apply a strategy which is to make acquisitions and you acquire businesses for a relatively small multiple and by adding them into your business and creating a bigger group you increase the multiple of the group as a whole. So that’s called valuation or multiple arbitrage. So size makes a difference.

Exactly. Yeah. Exactly, as well as yes, so there’s the, if you think about a chart, which is, you know, size on one axis and multiple on the other axis, you get that correlation larger, the larger the business, the larger the multiple. And as you put it down, you could put risk on one of those axes as well and say, the higher the risk, the lower the multiple because, and that’s just intuitive, isn’t it? Because the more risky a situation is, the less

you’ll pay for that situation. It’s a terrible way of putting it, but you get, you get my point. so the size, size is, is, it does, make a difference here. And actually just at last point on that size thing, this kind of multiple arbitrage, we’re seeing a lot of private equity firms doing this at the moment. So, so what they’ll do is they’ll go out and they will buy a company that has say 5 million pounds of profit and they’ll pay 10 times profit for it. I’m plucking these numbers out of there. So they pay 50 million pounds for a company and they call that a platform. They then use that company, fund that company to make smaller acquisitions and those smaller, let’s say they do 10 acquisitions of businesses that have one million pounds of profit and they pay five times profit for each of those businesses because they’re much smaller. So they spend another 50 million pounds buying buying those businesses, but they’re adding much more value because the group as a whole is valued at 10 times profit. So that’s a kind of practical example of that, that valuation arbitrage.

Yeah, yeah, I think, well, I think we have seen some examples of that recently. So if you look at industries that are consolidating, a great one actually is accountancy firms. So assets was the first one to do that. Lots of people probably heard of assets and they’ve just been gobbling up lots and lots and lots of small practices for relatively low multiples. they recently recently did a deal and we think it was at about where they sold half of the bit or the private equity backer sold half of the business to another private equity backer and that was for we think 15 to 16 times profit that deal was done. Now they have been buying small practices for kind of low single digit multiples so that’s a great example there and I always think that you that kind of buy and build strategy I think there’s a bit of a kind triple whammy there. So you get the cost synergies. So you increase the profitability of the business, number one, after you’ve bought it, because you could probably take some cost out somewhere. Number two, there’s the opportunity for accelerated top line growth through cross selling.

So let’s say you’ve, you know, you’re being bought by a group and you do something slightly different for the same customer base as that group, you know, they can plug you into their distribution. So that’s number two, revenue growth. number three is this multiple arbitrage as well. So you might not get all three of them down with every single deal that you do, but you’re, you have the opportunity to kind of win, I think in three different ways when you’re buying these smaller assets and plugging them into your group.

Yes, so the other area where you see a correlation between with higher multiples is growth. So if the business is growing quickly, you would expect a business growing at 20 % per annum to attract a higher multiple than a business growing at 5 % per annum, all other things being equal.

The reason for that is that people talk about, there’s an expression like you grow into your multiple. So if you, if let’s say you buy something for 10 times profit, but that business is going, growing at 20 % a year. If you model out the multiple over a number of years, that multiple is actually coming down quite rapidly. So if you look at it on a three year view, if you’re paying if you’re paying 10 times for a business with 1 million pounds of profit, but that profit’s growing at 20 % per year per annum and you can see really good visibility over that. Probably on a compound basis, you’re at 1 .8 or 2 million, I don’t have my calculator handy, of profit in three or four years time. So if you look out in three or four years time, you’re like, paid 10 million pounds for this business and it’s now doing 2 million of profit. So actually on that three or four year view, the multiples, the multiple is five times. Whereas if you buy a business, you might buy a business for the same, a very similar business that for whatever reason isn’t growing at all and you pay seven times profit for it. If that profit number isn’t growing, it’s always seven times. It’s always seven times. So, so there’s a really interesting correlation there when you start again drilling down, why did that business sell for 10 times?

Why did that one sell for five times? Well, the one that sold for 10 times was growing very quickly. The one that sold for five times had gone X growth was maybe even in decline. So growth is definitely another element to look for in terms of influencing your multiple.

Yes, yes, absolutely. I think that other word you use there, Darryl, that predictability, I think is also really key here. So if you can not only say to the buyer, look, I’ve grown at 20 % plus for the past five years, that’s a really good indicator that you’re going to continue to grow at that rate. You’ve delivered, you’ve got a track record of good growth. If you can underpin that, with and this is difficult except in maybe some certain industries like you know software is probably a good example. If you can underpin that with contractual income so you could say to the buyer look not only am I telling you I’m growing at 20 % you can see here on day one of the financial year I’ve actually got most of that growth already baked in through contractual revenues. Clearly that is going to influence because again it comes back to your comment about risk it’s like okay we are de -risking this massively because we can see this predictability of revenues. We can be pretty sure that what the vendor is telling us they’re going to deliver in year one, they are going to deliver in year one because it’s contractual.

Yeah, definitely, definitely become as dispensable to your business as you possibly can be so that the buyer can just pick up where you left off. They’re not reliant on you. not. can. That means that they can, know, that there is a, you know, that’s the clearest way to differentiate, I guess, from a, you know, a classic lifestyle business that is totally dependent on the founder, on the owner of the business and something which is enduring and sustainable. If that owner steps back, what happens to the business? And from a buyer’s point of view, the answer to that should be nothing happens to the business. We continue going the way that we’re going. And as I think you know, Daryl, I may be straying into different territory here, but the more uncertainty there is over that, typically the more of the consideration will be pushed into deferred and contingent.

So we’re paying you this on day one, but you you need to show us that this is an enduring business that can, you can put in place the mechanisms for it to survive and prosper without you, but we’re not paying you for that on day one.

Yeah, I guess that we definitely see with smaller deals with people type businesses, we will see a greater proportion of the consideration weighted towards deferred or earn out or whatever you want to call it. I think if you take examples like professional services companies of whatever description and media agencies, like that, businesses that are very people dependent will usually be structured with a reasonably large element of deferred consideration. Because the buyer just usually is just not really going to know a couple of things. First of all, the extent to which the customers will be sticky after a post deal. And secondly, actually the motivations of the sellers. If you give them all their cash on day one, but you’re depending on them to run the business after you’ve acquired it, then you just don’t know whether they’re gonna be motivated to do that or not. So, with those types of people businesses, you’ll usually see a reasonably chunky part of the consideration weighted towards an earn out.

Yeah, 100%, 100%. And for some businesses that just might not be possible, you also see situations where maybe it’s a second tier management team that is heavily incentivised to make it work post deal, whether that’s through options in the acquiring vehicle or some kind of compensation structure.

But yeah, just, think everything we’re saying here illustrates the importance of doing whatever you can to demonstrate that the vendors are dispensable.

Yeah. Yeah. Absolutely.

I’m not sure. think we’ve covered it off. mean, I guess that you, you know, everybody is going to want to put their business in the best possible light. I think that you do get more. think there’s a reasonably big industry, I think in the States about sort of exit prep and exit readiness that doesn’t exist to the same extent in this country. And you’ll know that better than me. Yeah.

And I think that’s, it’s really important actually, because it’s, if, if I came to you and said, right, Darryl, I want to sell and say, okay, fine. When? Well, now I want to get going now. that’s probably not the right way to do it. You know, you need to be thinking about these things years in advance and you need to be getting all these things lined up, you know, whether it’s your, things we’ve talked about, you know, the processes, the systems, the, the succession, all of those things so that when you, if you can imagine your advisor sending an information memorandum, which is kind of the key sales document, it’s like the particulars for the house that you’re selling, sending that information memorandum to prospective buyers. What does that look like and how do you make it look as attractive as possible? And I guess that you maybe think about the end point. How do I want that to look and what do I want it to say about my business?

And then you work back and say, okay, so what do I need to do to get to that point? And look, there are always things that are not going to, you can’t just sort of, you know, if you’re a, you know, if you’re a, an accountancy practice, you can’t suddenly just say, well, software multiples are better than accountancy multiples. So I’m going to become a software business. know, you that that’s, that’s just not really practical. there’s always going to be stuff that is outside your control. That’s going to influence the multiple of your business. You you mentioned strategic acquirers, Darryl. It could be that you’ve just got something, you’ve developed something that somebody really, really, really wants. And when that happens, multiples can just be thrown out the window. It’s like, okay, we’re a huge business. They’ve developed a piece of technology or whatever it is. We really want that because that will transform our business and we’ve got to do whatever it takes to buy that.

Those situations are always going to happen. It’d be lovely as a seller if they happened all the time. They don’t. They’re very unusual. They’re very unusual. But I think it’s just in terms of things that influence your business, it’s just about saying, OK, what do want this business to look like when it is being marketed for sale? How far away is that? What are the things that I can do over that period of time to get it into that state?

Yeah, absolutely. Absolutely. And you know, you just do the maths of today, my business is doing 1 million of profit and its characteristics suggest that I get a five times multiple. It’s worth 5 million quid. If I can grow that 1 million over the next three years to one and a half million, and I can do things, some of the things we’ve talked about to try to push that multiple to seven times, then it’s worth over 10 million quid. So it’s just, you know, it’s just pulling those levers those levers that can improve your profitability and increase your chances of getting a higher multiple.

I would say maybe at this point, I would sort of bring in the advisor who can help with this. And I think that, you know, you have to pay an advisor and there’s maybe sometimes a reluctance to do so because you think, well, this is what I might make out of this. And some of that has to go out the door to the advisor that helped do that. I would think about it a different way. I would think about, whether you, you know, that advisor, a good advisor should be able to improve the price that you get for your business. And that they do that in a number of ways, I think. And I have skin in the game here because our customers are all the advisors right now, but I really do believe this. What they can do, they do this for a job. They do this for a living. You run your business for a living. So if you expect to run a successful sale process of your business on your own, you’re going to be, you, your attention is going to move away from your core business. And, know, that can have implications on how the business is performing, which is going to affect your, your valuation. that there is a lot of work to do. There’s a lot of work to do. There is the preparation of that information memorandum that I mentioned, and you’ll have to get involved in that. You’ll have to help, but to have somebody coordinating that I think is very important. There’s the discussion about valuation. know, what would be a good price and what is undervaluing your business. There’s the discussion about buyers. You know, you will have an idea over who you think might buy your business. The advisor should have ideas that can enrich that, that buyer list.

Then there’s the contacting the buyers to have a third party doing that. I think is a much better look than you doing it yourself. So you want a third party that knows how to do this, can put NDAs in place, can make sure everything is legally watertight in terms of the information that you’re sharing. Then there’s all the data room stuff. You know, you need to put all your information into data room. That has to be managed. Anybody that’s interested in buying your business.

It’s going to be pouring through the books, pouring through contracts. They need to manage all that. Then there’s managing all the legal stuff. There’s managing, you know, it’s a big process. It’s a long process. And I think advisors earn their money in those processes by taking the hassle away from you.

Yes, 100%.

Thank you very much, Darryl.

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