Striking a balance between Growth and Risk

If you’re growing a business in readiness for a future trade sale, you will I’m sure be developing strategies to maximise its value.

For private companies, generally speaking, initial valuations are based on multiples of EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), unlike public companies which are based on a multiple of earnings – P/E (Price to Earnings) ratio.   In both cases what makes a difference to the multiple used is the proportion of value attached to transactional risk. In private companies that risk is deemed to be higher and therefore multiples are lower.

Without doubt the biggest driver of higher multiples is growth – prospective and historical – that can be evidenced by accurate financial data – in published AND current management accounts together with realistic forecasts.

The next biggest driver is RISK.

Yet Risk is, arguably, easier to manage.

So, without understating the importance of growth, business owners must strike a balance between growth and risk. You might think that this is only important if you plan to sell. However, I would argue that it’s closely linked to business growth (and in some cases, business survival!)

Let’s just consider just two points to illustrate what I mean.

Is the business owner-reliant?

In a sale situation, a business that relies on the owner, whether that’s for product development, client or supplier relationships, represents a quantifiable risk for an acquirer.  In order to mitigate that risk the owner would have to stay on in the business, under its new ownership, until he or she can be replaced. But owner-reliance can also stunt business growth.  The much-quoted Steve Jobs said “A small company depends on great people much more than a big company does.” Whilst we all like to think we know best, the fact is that sometimes the skills contained within the workforce can be higher and/or more current.

Putting a strong management team in place that will be able to run the business without the intervention of the owner offers opportunities for growth and increases the value and saleability of the business when the time comes.

An owner-reliant business is like a car without an engine – pretty much unsaleable.  One consultancy firm I knew of had built a £1m+ turnover business making £300,000 EBIT. Unsurprisingly interested buyers withdrew from negotiations because the owner, and main fee earner, didn’t want to remain in the business under new ownership (and, like most entrepreneurs, was pretty much unemployable).

Does the business have a diverse client base?

In a sale situation almost all acquirers would consider it a risk to buy a company where a small number of clients represent the bulk of revenue.  Take the example of one business I came across; it had a £5m turnover firm but 80% of its revenues came from one client, representing a huge risk to potential buyers.

Having a blue-chip client base is both a blessing and a curse, offering great revenue opportunity but often putting pressure on profit margins. There are numerous stories of small suppliers being squeezed by larger companies on whom they have become revenue dependent and consequently unable to generate sufficient profit to grow.

So whilst the revenue growth may increase business value, in a sale situation the associated risk of such revenues will reduce it! Creating a more diverse client base is another example of how to create strategic growth that will increase deal multiples at exit.

In conclusion, it is wise to consider growth in association with risk. You may not be considering selling the business for several years, but by combining growth planning with risk reduction strategies it is possible to strike a balance that will, ultimately, result in achieving higher deal multiples.

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