This week, I thought I would mix it up a little and get the “buy-side” M&A perspective on what buyers look for in an acquisition. Since I only focus on “sell-side”, I reached out to my friends at IT Valuations for their perspective on this. They work with buyers to find the perfect seller, and this is what they shared with me:
Cultural Fit
Buyers will be scrutinizing how well their firm aligns with the target on management of employees, customer service and general approach to business leadership. Without a reasonable level of cultural fit, they’ll be hard-pressed to integrate the target successfully, let alone complete a smooth due diligence and definitive agreement negotiation process. Even from a sellers perspective, we want to know if there is a good cultural fit right from the beginning. If not, the purchase price doesn’t really matter.
Strategic Fit
Buyers are targeting firms whose services, verticals, geography, and customer base are either complimentary or pose an accretive opportunity. An IT Services firm in Atlanta that primarily supports the healthcare industry would likely be ill-equipped to integrate a Portland firm focused on manufacturing and distribution. But they could seek an advantage by linking arms with a Savannah-based firm focused on pharmaceuticals.
Killer Performance: Growth & Profitability
A buyer will want to see financials reflecting both healthy year-over-year growth AND strong profitability. Many buyers size firms up initially using “the rule of 40”: They add a firm’s year-over-year compound annual growth rate with their EBITDA as a percentage of revenue (for either the current year, or the average of those factors in a look-back period). The closer the combination of those percentages is to 40, the healthier the firm’s performance. Best-in-class firms have growth rates of 25% to 30% and EBITDA percentages of 10% to 15%.
Acceptable Risk Profile
Risk is inherent in the acquisition process – buyers know that well. But they will be picky about what kind of risks they are willing to take. Some buyers are likely to change the terms of the deal (or walk away altogether) if the due diligence process reveals a shaky customer base, a handful of key employees who pose a flight risk, or even an owner-centric delivery model. Others anticipate risk and hedge their bets by building in deal terms such as multi-year deferred payments, conditional seller notes, or a much heavier earn out than guaranteed payment.
Attractive Revenue Mix
Recurring revenue customers are very desirable for buyers, but customers on monthly or annual contracts are especially attractive. The more contractually-based recurring revenue the target has, the more confident the buyer can be in the rate of return on their investment. Product and project sales are, of course, valuable – especially as pathways to embedding themselves with the customers. But if a firm is generating less than 25% recurring revenue, they will likely hear a “thanks, but no thanks” from a buyer.
While I am sure much of this doesn’t come as a surprise, especially if you have either read my book or follow my posts, it is always good to be reminded of what the buyer is thinking. An educated seller always puts themselves in the buyer’s shoes and tries to view things from their perspective.
A special thanks to Heidi Miller, Business Analyst & Project Manager at IT Valuations, for sharing this content. She can be reached at heidi@itvaluations.com, or connect with her on LinkedIn at www.linkedin.com/in/heidimilleritv.
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