Is Growth More Important Than Profits?
The value of your company can be measured by applying a multiple to your earnings. Your multiple is determined by an acquirer and can be driven by a number of elements. One of the biggest swing factors is how large your company is.
At SellabilityScore.com we've been looking at the offers business owners have received for their companies over the last three years. During that time, we've noticed companies with at least $3 million in revenue get offers that are about 25% higher than the average business (which is much smaller).
It turns out that size really does matter when it comes to the value of your company. Here are three reasons why big companies get richer offers:
1. Owner Independence
Buyers assume that companies with $3 million in revenue have found a way to scale their sales and marketing operations to the point where they are less dependent on the owner's personal salesmanship.
2. Private Equity Companies Want $3 Million Businesses
There was a time where private equity companies wouldn't consider investing in a company unless it had at least $3 million in Earnings Before Interest Taxes Depreciation and Amortization (EBITDA). As the private equity market has become more mature, and more money is chasing fewer deals, private equity companies have adjusted downward the size of company they will consider acquiring. These days, there are private equity companies that will consider investing in companies with as little as $500,000 in EBITDA. A $3 million business with a 17% EBITDA margin is likely to attract some private equity buyers but a $1 million dollar business with a 20% EBITDA margin is unlikely to meet their minimum criteria. Fewer bidders for smaller companies means lower prices.
3. The A-team Factor
When a big company buys a little one, the acquirer has a "deal team" that executes the transaction. This usually includes a buy side M&A firm or internal corporate development executive and a collection of $800-an-hour lawyers. Acquirers rarely have a "B" deal team for small acquisitions so they use the same ultra-expensive professionals to buy a million dollar business as they would a one hundred million dollar company. The frictional costs of deploying the A-team are easier to justify on a larger business.
Returning to the original question, which is more important to the value of your company: growth or profits?
Think of yourself as a pilot with air speed and altitude to juggle simultaneously. Focus on one at the expense of the other and you're in trouble. If your goal is to sell your business one day, it's important to balance both the profitability and the top line revenue growth of your business.
Focus too much on profitability over growth and you may end up with a highly profitable business that will only command a modest multiple of earnings when you sell it. Likewise, if you grow your top line at all costs, there will be very little profit to multiply.
Getting the balance right is what drives up the value of your business.
JOHN WARRILLOW | Columnist | Sellability
John Warrillow’s new book, The Automatic Customer: Creating a Subscription Business In Any Industry will be released on February 5, 2015. John is also the author of Built to Sell: Creating a Business That Can Thrive Without You and the founder of The Sellability Score, a company dedicated to helping business owners improve the value of their company.