Illuminating Strategic Value When You Sell a Business

BY Basil Peters

Another reason a well designed and executed exit strategy can increase the business valuation by 50% or more when you sell a business is the ‘strategic value’. The only reason any company buys another company is because they believe:

  • they can increase the value of the company being acquired, and/or
  • the acquired company will increase the value of their company.

Different prospective acquirers will have different elements in their businesses which will allow them to increase this strategic value. The most successful company sales are where the combination of the two businesses increases the total business valuation faster than either company could achieve alone. In other words, when 1 + 1 = 3.

How strategic value increases business valuation

One of the most obvious examples of strategic value is reducing competition. This was a very popular driver for company acquisitions a hundred years ago. Many of the most successful entrepreneurs of the 19th century created enormous wealth by concentrating ownership in business verticals, thereby reducing competition and allowing price increases. In some cases, the railroads and steel industries for examples, the concentration of ownership was so egregious that these business people were often referred to as ‘robber barons’.

More recently, many of Microsoft’s company acquisitions have been viewed as Bill Gates reducing competition. The American government, and some in Europe, dragged Bill Gates  into court in an attempt to reduce his monopolistic influence in the global economy.

Today, the US government tries to prevent mergers and acquisitions that will reduce competition. Often, when you sell a business today the company being acquired, and the acquirers, will have to complete a Hart-Scott filing to show that what they are planning will not result in reduced competition.

But let’s be realistic, acquisitions to reduce competition happen all the time. Even today, one effective way to sell a business is to sell it to a competitor. This type of company sale requires some significant skill and protective tactics, but it’s still a great element in an exit strategy.

A better example of how strategic value can increase business valuation is when companies have complementary products or services. A classic situation is where a larger company has an existing customer base who could be users of a target company’s products. Some familiar examples are eBay’s acquisition of PayPal, Yahoo’s acquisition of Flickr, or just about any of Google’s acquisitions. Other good examples are the acquisitions here.

Another excellent way to unlock strategic value when you sell a business is to find a company that would like to develop a similar product or service, but will pay to reduce their ‘time to market’. Big companies grow more by company acquisition than by internal R&D. Part of the reason is because big companies are not very good at innovation. The other part is that being fast is often better than being good. Big companies can usually get to market fastest by buying one of the established leaders in a market vertical. For a big company, a one or two year lead can often be worth tens, or hundreds, of millions of dollars of increased business valuation.

Why should the buyer pay the seller more? Good question, but in practice they will

An important part of the marketing and sales job when you want to sell a business is to discover, and communicate, the full strategic value to the buyer. During this discussion, the prospective buyer will inevitably say something like: “Sure, I see the additional value your business will bring if we acquire you, but we are not going to pay you for that.” In other words, the buyer doesn’t see why they should pay you more for the extra strategic value they will generate in the business, post acquisition.

It’s a fair point, and the best response is to concede gracefully. But the reality is that once the prospect sees this ‘extra’ strategic value, and they realize the business is worth more to them than to another bidder, they will be willing to increase their offer to acquire the company.

Another way to look at it is that once the buyer realizes that 1 + 1 = 3, they will be willing to pay more than ‘1’ for the business. They might even split the difference and pay ‘1.5’. (Obviously the math here is way too simple, but I hope it illustrates the point.)

It usually takes the prospective buyer months to fully appreciate the strategic value

Helping discover and communicate this ‘extra’ strategic value to the buyer is one of the most valuable skills required to sell a business well.  In most cases, it is the selling team that first discovers and fully appreciates the strategic value and it’s fair impact on the business valuation. In my experience, it often takes the selling team weeks, or even months, to get the prospective buyer to appreciate this ‘extra’ strategic value.

There are several reasons the sellers usually see the value first and that it takes so long to communicate. The buyers are often very large companies, with many tightly focused divisions. The people in the ‘M&A department’, for example, are usually not technical or industry people. It’s not at all unusual for the senior team in the company being sold to have a better understanding of the technology, industry dynamics and future trends than the ‘professional business buyers’ in the M&A department. Fully developing an appreciation of the strategic value and fair business valuation in the collective mind of the buyer generally requires consensus building among a number of people in several different departments. In a Fortune 500 company, building that consensus might mean getting the M&A team, CFO, several VPs and division heads, the CEO and some board members onside. Even with a concerted effort from an excellent sales team, and a high level champion inside the prospective acquirer, this process can easily take three to six months.

Discovering and communicating the strategic value of an acquisition is one of the most significant reasons that well designed and executed exit plans often take six to eighteen months to sell a business well.

It’s also a big part of the reason that a well designed and executed exit transaction can often increase the price received when you sell a business by 50% or more.