As an advisor to mid-sized technology companies that are mostly owned and run by electrical engineers, there is one question I am asked almost every day. It’s not whether to sell the company, because everyone exits some day. The question is how to get the best valuation for the company for when the time does come to sell. Even if an exit is a long time off, business owners should always plan ahead.
There are academic texts that go into painful detail about how to maximize the value of a company based on a variety of financial metrics. On the flip side, there are seemingly insane business deals that are sometimes based on no metrics at all. Take for example, Facebook’s US $1 billion acquisition two years ago of Instagram, a photo sharing company with zero revenue at the time. But as engineers, we like math, so let’s stick to what works most of the time and skip the exceptions. (Plus, if you do get that lucky, you don’t need my advice anyway.)
There are some basic truths about how a potential buyer might value your high-tech business. If your business is headed toward a successful buyout someday, odds are it will look something like this:
It is clear how the buyer will make money after acquiring your company.
If a potential buyer can’t figure out how to make more money from acquiring your business, then you’re going to have a hard time getting a deal. Buyers are constantly seeking out alternatives and weighing the pros and cons. They ask themselves questions such as: Why can’t we just license the technology instead of buying the company? Are there other reputable companies that we can license this technology from without having to acquire a company at all? If we buy it, what are we going to do with it? What would it cost us to reproduce this product on our own?
Sometimes the answers are as simple as the buyer wanting to acquire your customers and contracts, and supply additional products and services to those customers or integrate one product into another. One common example is chip companies acquiring software companies in order to integrate the software onto its chipset platform. The buyer might make a case that it will sell 10 times more chipsets with the new software features.
Your company is an expert in the right market with the right customers at the right time.
This sounds like common sense, and it is. But it’s a very important factor for buyers valuing your business. If your company isn't a leader today in a desirable market segment, you should probably shift your strategy now to become one before thinking about an exit strategy. Here are some examples of recent deals that illustrate this point:
- Google acquired NEST, a maker of smart thermostats, for $3.2 billion. Simply stated, this gives Google a strong foothold in the growing market for Internet-connected household devices.
- Last year Cisco acquired Sourcefire for $2.7 billion. Sourcefire is a leader in developing hardware and software in the growing cybersecurity market.
Your company has strong financials.
Everyone hates to hear that revenue and profit matter for technology companies, but they usually do matter a lot. Ignore financial results at your peril. There are a lot of reasons why a bigger company might want your business, but financial performance almost always matters. If nothing else, it proves that your product or service works. Want to prove to buyers that your design does what it is supposed to? Sell a lot of the product to people who will pay real money for it. Additionally, large companies may see hundreds, if not thousands, of potential companies to acquire each year. The larger your revenue and paying customer base is, the easier it is to attract attention from those big companies.
Your company is protected, and not just by patents.
In the technology world, patents are important. Patents can be very valuable in showing that the company is protected from competition, and oftentimes companies are acquired for the value of their patents alone. But there are a lot of other ways buyers look to see whether your product or design is protected.
One key way a buyer will analyze the health of your company is by looking at gross margins. How do your margins compare with other companies in the same industry? Are they increasing, or at least holding firm? Decreasing margins are a red flag and a sign that competition is increasing.
Another threat is customer concentration. Your successful company probably has several key customers that are profitable but it shouldn’t have one customer generating 80 percent of the profits for your business. If it does, then that’s also a big red flag for a buyer.
Your company has a strong engineering and management team.
Your company should not be overly reliant on you. Buyers want companies that will function when the CEO is no longer there, so the capability of the team that will remain is a major value driver. High-tech companies acquire smaller companies all the time in order to bring in quality engineers with unique expertise. They place value on specialized experience, advanced engineering degrees, certifications, security clearances, and years of experience.
I’ll leave you with one more key tip: Plan ahead long before you are ready to look for a buyer. If you can make decisions now with the end in mind, it will make your future acquisition go more smoothly.
Brent Lorenz is an IEEE member and a vice president with The McLean Group. He got his start as a technical sales engineer for Texas Instruments.