When taking your company to the market, it may pay off handsomely to find the right buyer. The right buyer, is often one that is in the same or similar industry as your company, and may be willing to pay a premium in excess of what a simply financial buyer would pay. This blog post explores how a strategic buyer might determine the valuation of a target company in contrast to how a financial buyer would potentially place a price tag on the same target.
Let’s say we have a distribution company, ABC Distributors that has the following Profit & Loss Statement in the current year:
| For the Year Ended 12/31/2018 | |
|---|---|
| Revenue | $5,000,000 |
| Cost of Good Sold | (3,500,000) |
| Gross Profit | 1,500,00 |
| Expenses | |
| Insurance | (50,000) |
| Payroll - Office & Admin | (75,000) |
| Rent | (275,000) |
| Utilities | (65,000) |
| Office Expenses | (35,000) |
| Advertising | (40,000) |
| Total Expenses | (650,000) |
| EBITDA | $850,000 |
Financial Buyer
A typical financial buyer might look at this P&L and make a valuation calculation based on the EBITDA as reported, since they are likely to operate the business in a similar fashion to the way it is currently operating prior to the acquisition. Based on the risks associated with ABC Distributors, the financial buyer determines that the proper EBITDA multiple to use is 5.0x and as such, values the company at:
$4,250,000
Strategic Buyer
XYZ Distributors is a potential strategic buyer for ABC Distributors as XYZ is in the same industry. As a strategic buyer, XYZ would look at the P&L presented above and make some adjustments based on the potential future cash flow that ABC could produce once it is acquired. XYZ looks at the P&L as reported and adjusts it as follows:
| For the Year Ended 12/31/2018 | |
|---|---|
| Revenue | $5,000,000 |
| Cost of Goods Sold | (3,500,000) |
| Gross Profit | 1,500,000 |
| Expenses | (50,000) |
| Insurance | (15,000) |
| Legal & Professional | (125,000) |
| Rent | (110,000) |
| Utilities | (65,000) |
| Office Expenses | (5,000) |
| Advertising | (20,000) |
| Total Expenses | (390,000) |
| EBITDA | $1,110,000 |
We see an increase in EBITDA from $850,000 to $1,110,000 due to the decrease in some general and administrative expenses. XYZ can value ABC based on the marginal costs it expects to pay after the acquisition. If we look at payroll, although ABC functioning on a standalone basis needed $275,000 worth of administrative salaries, XYZ believes that it will only incur an additional $125,000 of administrative salaries due to the capacity of the people it currently has on staff. Additionally, XYZ already is advertising in the space, as it operates in the same industry as ABC, and knows that the marginal advertising cost is not equal to the $40,000 that ABC had to spend, but is around $20,000 after acquisition. Due to these adjustments to the P&L from XYZ as a strategic buyer, and using the same 5.0x multiple of EBITDA, XYZ values the target at:
$5,550,000
Finding a strategic buyer increased the valuation, and in turn, the selling price by $1,300,000. Having the right buyer can put real dollars in your pocket if you are looking to sell. Strategic buyers can come from the pool of your fiercest competition or from a company that is above or below you on the supply chain. It may not be obvious where a strategic buyer might come from, but it can make all the difference in the ultimate selling price.
