16 Critical Attributes for a High M&A or Investment Valuation

04 May, 2017

TECHNOLOGY SECTOR M&A GROWTH

From April 2016 to April 2017 the tech sector has experienced more buoyant growth than it has seen in a decade*. SaaS, both vertical and horizontal, is up over 20%. Infrastructure Software is up 32%. Cybersecurity and Big Data are both up 16%. These trends promise to remain strong into the near future, making it a good time for tech companies to be acquired or raise funds.

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The largest active buyers—companies like Alphabet, IBM, Oracle, Cisco and Microsoft—are seeking emerging technology companies at an accelerated pace to expand their portfolios. This has two important implications for the selling company:

First, you never know when a potential buyer will approach your company, so your senior team should be prepared for a rapid, comprehensive due diligence process now.

Second, it’s important to understand the core aspects of the technology buyer’s key valuation criteria and then use that criteria to scrutinize your company from the buyer’s perspective, or from the “outside in.”

As a selling company you have an enormous opportunity to proactively address those areas where acquirers will look to press their advantage, thus maximizing the value that the buyer assigns to your company.

16 FACTORS TO MAXIMIZING AN M&A OR INVESTMENT VALUATION 

We’ve assembled a list of 16 areas that most buyers and venture capitalists will examine before they make an investment in your company. Focusing on these areas and remediating any weaknesses, issues or liabilities before a buyer approaches will ensure your company attracts buyers that are willing to pay maximum value.

1. Large Total Available Market (TAM) or Market Share

How big is the market you’re addressing? In order to attract the most active acquirers your company must operate in a sector that has a large Total Available Market. Investors are looking at opportunities which offer a substantial upside potential (i.e. huge market size). Investors will also be interested in how much of the Total Available Market you can expect to capture. There are two subsets to TAM. SAM, or Serviceable Available Market, is the segment of the TAM targeted by your products and services within your geographical reach. SOM, or Serviceable Obtainable Market is the portion of SAM that you can capture.

The bigger these numbers are, the better. The exception is that investors can often be attracted to young companies that have a defensible share in a protected, smaller market that has the potential to grow into a much larger market.

2. Poised for Growth

growth.jpgAfter acquisition, your company will be expected to grow very quickly within the larger company. If you don’t have a succinct operating plan for the next three years that shows rapid growth, large buyers will not be interested in your company. This means understanding fluctuating economic conditions, minimizing risk and having a continued focus on pricing, product innovation and on emerging markets in order to boost operational performance and strengthen market position.

3. Management Team

The quality and depth of your management team will be a little more important to investors than to buyers, because buyers will often fold your company into another division that already has a management team in place. But for investors, it’s important to see a prior history of success and proven, superior leadership skills within the management team. They’ll want to see broad and diverse operating experience that demonstrates that the team is highly and rapidly adaptable to the many inevitable challenges that arise. Finally, they will want to see that your company has internal chemistry. Venture capitalists like to invest in companies where the management teams have worked together at prior successful companies. When an investor can see that your management team can work together in a unified manner, it reduces their risk.

TECH_TEAM-1.jpg4. Technology Team

At many startups, the technology team is the heart of the business. Buyers and investors will want to know how strong that team is. Do they meet deadlines? Do they work well together and across teams? Would other employees recommend them to a friend’s company? What are their unique coding and design skills? Are they invested in the company and share its market vision?

5. Valuable and Proprietary IP

Has your company developed valuable and proprietary IP? If your startup starts to grow quickly, a strong IP portfolio will be vitally important to its long-term success. Buyers and investors will assess whether you and your team are educated on the basics of trademarks, copyrights, patents and trade secrets. How well do your patents protect your IP? Have you established trademarks and do they protect your rights in other countries? A thorough understanding and execution of intellectual property law is critical to protecting your hard-earned creations and ideas from unfair competition and avoiding the theft of ideas, designs and other proprietary concepts.

6. First Mover Advantage

First_mover.jpgBeing the first to bring a product or service to market offers a significant competitive advantage. Among other things, being first typically enables a company to establish strong brand recognition and customer loyalty before other entrants to the market arise. Another advantage is the additional time a first mover business has to perfect, improve or expand its product or service.

Think about eBay. In 1995, eBay established the first major online auction site. Other auction sites have followed, but none have anything close to the brand recognition and scope of eBay.

However, in reality, it’s rare to establish yourself as a first mover. So, if you’re not a first mover, it’s critical to be a very fast innovator or follower. You need to be able to prove to the investor or buyer that you’re operating in a protected market with barriers to entry or other types of protection from competition.

7. Laser-like Focus

Can your team demonstrate a “laser focus” in a clearly defined product or services niche? Buyers and investors will likely inquire into the specific market you address. If your reply is too general, like financial services or retail, that could likely end the conversation. Show that you are focused on a specific market and demonstrate that you’re successful in that market.

8. Unique Knowledge

What is your unique knowledge that makes you competitive in the long term? Remember, unique knowledge is not the same as job knowledge. Job knowledge is necessary for employees to do their jobs. It is expected by employers and customers and is usually transactional. When a chef makes a soufflé using an established recipe and using the proper dish, he has simply executed a mandatory job function. There are plenty of chefs who can do that. But fewer chefs possess unique knowledge, such as that Antoine Beauvilliers is often credited as the “inventor of the soufflé" because his restaurant, the Grande Taverne de Londres in Paris, opened in 1783, had several soufflés on the menu. What is the specific target customer knowledge that you have? While employers and customers appreciate competent and efficient employees, they also value knowledgeable employees. The more unique knowledge employees possess, the more value they can add to the customer experience.

9. Proven Model and Robust Pipeline

business_model.jpgMost successful companies do not reinvent themselves when faced with internal or economic turmoil. Instead, they rely on a proven and repeatable business model that builds a robust, new prospect pipeline. This doesn’t mean that the business model is static. Smart companies learn to sustain their business model over time by constantly adapting to changes in the market.

The result is a simple, repeatable business model that a company can apply to new products and markets over and over again to generate sustained growth. Ensure that your business model can withstand diligence and that you can present it succinctly to investors.

10. Supportive Investors

When a company gets an offer to be acquired, there can be a lot of different opinions among the key players. The founders may have a different opinion about how to proceed than the management team. Early seed investors may think differently than the Series A and Series B investors. This type of discord can often cause deals to fail. When entering the due diligence process, ensure that all of the key investors are fully supportive of taking actions to complete an M&A deal. Be sure to address issues proactively, particularly in terms of who gets paid what when the deal is done.

11. Board of Directors

The quality of your board of directors is particularly important for venture investors. What is the stature of your board? Do you have seasoned, independent board members and industry advisors? Do you have what is known as the “gray-hair factor”? Have they experienced all the issues that can come up during an M&A event and can they help you through it?

12. Customers

What customers do you have? Are they high-profile? Will they provide a reference often and consistently? Many times the investor will call the same company 15 or 20 times during the diligence process and ask them very pointed questions. Will the customer respond favorably?

barrier to entry Watson.jpg13. Competitive Landscape

Does your company have effective barriers to entry? What advantages do you have over your competitors? One of the best tools to profile and compare your company against your competitors is a competitive matrix. A competitive matrix allows buyers and investors to see in a glance your company’s competitive landscape, your position in a given market and the possible opportunities to differentiate your company’s products and services from the competition.

A competitive matrix often highlights ways to customize products to meet the differing needs of customers and differentiate your products from the competition. By continuing to seek out ways to make your products and services more unique and distinctive, your company demonstrates that it is on the road to developing a profitable growth plan now and in the future.

14. Unique Execution Advantage

Do you have a breakthrough solution with early results, or a mature, existing technology or products with predictable market momentum? Breakthrough solutions are typically funded by the best venture capitalists, who want to see the potential to grow from 1 million to 20 million to 200 million, but have high risk. Private equity firms or later stage investors want a more mature, proven business model where the growth isn’t so strong, but the probability of losing money is very low. Do you have a new technology or delivery model? How do you crack the incumbent market leaders in order to grow your market?

15. Fiscal Prudence

fiscal_prudence.jpgPrudent cash management is a key component of ensuring a company’s financial stability and solvency. Your team, particularly the CFO, CEO and COO, should be able to demonstrate that you have a history of prudent, frugal cash management.

Prudent cash management is especially essential for smaller companies because they typically have less access to affordable credit and have a significant amount of upfront costs to manage while waiting for receivables. Wisely managing cash demonstrates to investors that the company is prepared to meet unexpected expenses and can handle regularly occurring events such as payroll distribution.

16. Recent or Potential Interest

If any strategic investor or buyer has approached you recently to invest in or acquire your company, this can attract new buyers. The best thing to do is to have a term sheet that’s non exclusive, so you can go out to the market and try to bring multiple investors or buyers to the table, thus maximizing the value, improving the terms, and enhancing the long-term opportunity of the term sheet.

Conclusion

Today’s buyers are ruthless when it comes to due diligence, so it’s imperative when entering into a potential transaction to be organized, thorough, and to ensure that nothing the buyer might be interested in seeing is inaccurate or missing.

Start by putting yourself in the shoes of the buyer and do an honest transaction-readiness assessment of your company. Are there any glaring red flags? Would you be impressed if you were the buyer?

Secondly, know a potential buyer’s business case and be prepared to articulate exactly how your business will add value to theirs. Set up a virtual data room right away, so it can be activated quickly when a potential buyer shows interest. Being prepared can make the difference between a good deal and a great deal, or even a deal that goes through versus one that dies. Don’t wait. Your company should always operate as if a buyer is right around the corner.

To find out how ShareVault facilitates and streamlines sharing secure documents during the due diligence process click here.

* David Stastny, "The Art & Science of Maximizing Value in Technology M&A and Fundraising," 2017

WHITE PAPER: The Art & Science of Maximizing M&A Value

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