EXIT STRATEGIES: The strategic business concept

In the case of the strategic buyer, the value which the potential buyer places on your business will relate to what they are going to do with the strategic asset or capability, which may not be the same as what you are currently doing.

The value to them will relate to their market and their capability rather than yours. Thus their investment will be set against their projected revenue and profit from the acquisition not your historical or projected revenue and profit.

Even if you were to enhance your profitability, it may make no difference to the value of the acquisition to them and may have no effect on the ultimate price they are willing to pay.

In many strategic acquisitions, the asset or capability being acquired will be leveraged through the corporation’s existing distribution channel. In these situations, it may be quite irrelevant as to whether the acquired business is making a profit or a loss. In fact, the size of the business itself may be irrelevant to some extent.

The major consideration of the potential buyer will be whether the acquired firm has the underlying capability to support the exploitation of the strategic asset or capability being acquired. Many firms with strategic value make the mistake of putting their effort into growth in revenue and profit when, in fact, this is not the basis on which they will achieve their maximum sale value. In practice, seeking growth may, in some cases, reduce their strategic value because the acquirer then has to deal with legacy customers and staff they may not want.

The key consideration in a strategic sale strategy is to grow the firm only to the level of revenue and profit necessary to provide the critical size which would allow the acquirer to properly exploit the potential. Once that size is reached, additional surplus funds should be put into enhancing resilience and developing additional strategic value for a potential buyer.

While the pursuit of additional profit may not impact the ultimate sale price, some profit is useful to ensure survival and resilience. The firm must still generate cash to build out its strategic assets and capabilities and needs to have something in reserve to avoid mistakes. Also, it is not possible to predict when the sale might occur, thus the firm needs to plan to stay in business until a sale can be negotiated.

Since strategic value is coupled to an asset or capability, enhancing the underlying assets or capabilities may add more value to the sale price than additional revenue and profit. So instead of pushing the business to achieve higher levels of revenue and profit, you should be investigating how you can enhance the strategic value.

This logic flies in the face of conventional wisdom which says that valuation is based on revenue and profit. But if the maximum sale price is unaffected by revenue at the margin, you are far better to reduce risks in the business and concentrate on building resilience so that you can last long enough to be acquired at a hefty premium. Instead of funding more growth, the business may be better off selling off parts of the business and concentrating on further developing its strategic assets and capabilities.

In my case, I sold a 30 person software business which, at the time, was facing insolvency due to a sudden shift in the market and was making a one million dollar loss. The business was sold to Peoplesoft for six times revenue. What was clear was that the value to Peoplesoft was generated by their ability to sell my software products directly into over 1,000 of their existing customers. At about $500,000 per sale, this represented a very large revenue opportunity. The key to this deal was that our software products were well suited to exploiting this opportunity within their customer base. Furthermore, there were really no other alternatives available to them within the near term. If they didn’t step up to acquiring our business, they would walk away from the revenue opportunity and might be allowing a competitor to acquire us.

While profitability, customer base and growth may not be important to a strategic deal, size may matter. In order to deliver a platform from which the opportunity can be launched, the business needs to have the capability and capacity to provide the launch platform.

The asset or capability which is destined to provide the source of the revenue opportunity to the buyer must be in a form or structure which will enable the buyer to achieve the acquisition objectives. If the business is too small, or the asset or capability has not been structured for scalability or replication, the business may not be worth acquiring. Thus size matters to the extent that it allows the buyer to exploit the opportunity. However, beyond that point it may in fact reduce the value of the business. If the buyer has to discard parts of the business or close parts down, there may be costs, delays and risks in doing so.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. A series of free eBooks for entrepreneurs and angel and VC investors can be found at his site here.