Loading summary
Transcript18 lines
- [00:02]
Host
Welcome to the Path to Exit, a podcast to help software and Internet founders understand the process to raise capital or sell their business.
- [00:19]
Mike Lyon
Hello and welcome, everyone. I'm Mike Lyon, founder and managing director of VistaPoint Advisors, and this is the Path to Exit. This show is dedicated to helping founders of software and Internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Scott Austin, managing director of VistaPoint Advisors. Scott's advised numerous SaaS, businesses on capital raises and M and A transactions. In today's episode, we'll discuss why valuation in M and A is more subjective than objective, and why different buyers may value the same business differently and how to leverage that subjectivity. Many founders tend to think about valuation as a formulaic measure of what their company is worth, but that's not really the case. This is partially because of how public companies are valued and partially because of the way investment bankers and private equity firms liberally talk about multiples, discounted cash flows, and other items that make it sound like there's a formula for valuation. In reality, valuation is in the eye of the beholder and you see vastly different outcomes with different buyers. Remember, buyers always want to pay as little as possible and the key is to understand who can and will pay the most. Public companies are a totally different animal because they're valued daily. There's lots of analysis around valuation and a lot of public information. Private companies are not in that realm. Scott, to get us started, can you talk a little bit about why there is this idea of subjectivity and why does it occur with these private businesses?
- [01:41]
Scott Austin
Yeah, appreciate it Mike, and thanks for having me on this episode. I think to start, there's certainly a lot of subjectivity because there's multiple types of buyers as well. You mentioned before public strategics. Not only are there strategics that are publicly traded in the market, there's also what we call the private equity backed strategics as well as just pure private equity firms who are making platform investments. So different ways that companies are acquired, which presents a bunch of different opportunities. A lot of this variation though occurs with valuation because you look at your business and you really have no one on one comparison with any other company. Not only do you not have any competitors who do everything the exact same way that you do, same metrics, say KPIs and they've all transacted in the past three to six months. It's also really hard to take public comps at face value because a company that's doing 800 million or a billion in revenue. That's a diversified software business that might have one product avenue that's close to yours. They have a lot different challenges than say a 10 or 15 million revenue business that's vertically focused or as a product suite that just overlaps with one piece of theirs. Rather than just trying to incrementally grow 50 to 60% year over year and adding a few folks to their sales teams, those larger public strategics are trying to grow 15 or 20% and right sizing their headcount and internal functions and doing M and A to grow their TAM. So it's hard to compare 10 million revenue business with a 600 million revenue business and get to a valuation that makes sense. Ultimately with a private equity firm you look at things a little bit different. They are longer term focused, ultimately looking at the addressable market. The various valuation metrics that we'll get into here, your growth, your gross margins, your retention metric, profitability profile. And those businesses are considerably different for your competitors and yourself. And that's just oftentimes based on how your business stacks up to them, but also the various intricacies of the buyer as well and how they will look at valuation.
- [03:33]
Mike Lyon
And sometimes we'll see founders of private businesses trying to use public companies as a valuation comp. And that can be really dangerous because typically as you mentioned, those businesses are a lot bigger. Usually there's a premium for scale, they grow a lot slower because law of large numbers and obviously there's a premium for growth. So the private company might be growing faster and they're just not always that relevant because all these different trade offs lead to a different story. And I think another thing to understand as a founder thinks about the valuation of their business, that's not the same as what any one buyer will pay for it. Different buyers have different considerations on what they're willing to pay for your business that's different than what you're worth. What you're worth is the sum total of all the potential buyers out there. And obviously what's that market clearing price. But just realize there's lots of impediments for why one buyer may value 50% lower than someone else who has a really good synergy. So it's important not to get too folks just on the public companies for sure. Scott, maybe talk a little bit about the differences in information that buyers have and how that leads them to kind of evaluate the opportunity differently.
- [04:40]
Scott Austin
We talk to buyers probably on a quarterly basis about what their strategic initiatives and where they're looking to grow. But you Never know until you have those conversations. And candidly, it's often amazing to us to look back on a deal after in terms of we're putting our mindset together with our clients about who we think the shortlisted buyer groups will be. But we're often surprised when there's an outsider at the end that we were just unaware aware of certain initiatives that they had or there were just certain, I'd say product growth areas that might not have met the eye immediately for an example there. And Mike, you could probably recall these pretty fondly. But when we sold software advice and Capterra to Gartner seven plus years ago, we never would have thought that a public research company would buy a lead generation business. Granted, those Companies provided more B2B review sites, but at the end of the day it was demand generation for SMB vertically focused software companies. However, once we started talking to Gartner that they had essentially no products to meet the SMB market. They couldn't just discount their billion dollar research to 10k and sell it that way. It made complete sense and it was similar to more recently when we sold form Swift to Dropbox. We knew Dropbox more of the kind of venture backed Silicon Valley darling wanting to acquire a hundred percent plus growth businesses. However, coming out of COVID they ultimately had a shift in prioritizing cash flow over growth and we didn't recognize that until we started having in depth conversations with them. That's just often the importance of having calls with these buyers, learning about what's important to them because their M and A initiatives can often change based on the information that they have internally that might not be available to the public.
- [06:12]
Mike Lyon
Absolutely. Can you maybe talk a little bit about the differences we see in valuations? I think sometimes there's this perception that pretty much everyone values these private companies the same way. And that's true within certain bands of valuation. But give people a sense for how different the valuations can be from different buyers on the same transaction.
- [06:30]
Scott Austin
With public companies it obviously matters about how they trade. We've worked with some companies before. There was a private equity backed company owned by PSG that we sold a few companies to. Before that they were a great buyer of our businesses at 10x +ARR multiples and the second they went public they didn't become a great buyer for us because they started trading at 56 times revenue. And ultimately it's really hard for them to buy companies at a higher multiple than they trade for or else it's dilutive. So that's just one of those scenarios that based on their backing now, it altered the way that they were able to view valuation moving forward. And to where I went before when they were private equity backed. The PE universe is ultimately where we see the biggest variation. So whether that's just purely as a private equity platform acquisition or if a private equity owned strategic buyer is the one making the acquisition, some of those parties value retention over growth differently or they assume that their go to market playbook can create a drastic improvement in terms of new customer growth, while other firms may be more focused on stable cash flow and ebitda. So ultimately every firm to their LP base has a mandate that they've decided to pursue, which ultimately just creates whether they might look at a business through EBITDA based multiples or if they're ultimately trying to pursue maybe lower gross margin businesses that they can buy in the four to six or seven times revenue range versus some of the brand names out there you'll see that are willing to pay 10 to 20 times revenue multiples if they really believe in the growth, the TAM opportunity and how large they can grow a business versus ultimately just manufacturing their outcome over time really over the cash flows of the company.
- [08:04]
Mike Lyon
And one question we get a lot from founders is who's going to pay the highest price for my business? Is it going to be a strategic, which they usually think is the answer or a private equity firm? And that's become a really complex question. Ten years ago we would have said in 90% of situations always be the strategic buyer. Their synergies. That is no longer the case. So what I'd like to do is give you a little bit of a roadmap for when each buyer can be really competitive and what are the types of analysis they do when they're looking at acquiring the business. So on strategic buyers, the two, what I would call low valuation scenarios are build versus buy. So they're looking at buying your product or building it. So know that they're comparing you to what it would cost to build that product. That is not a good situation to be in. Those are typically low multiples. The second scenario is a aqua hire. Sometimes that's presented as like a pretty attractive, sexy alternative. It's really not. It means they're valuing you based on your engineers, not based on the full business that you've built. So are kind of the two value situations. The way strategic buyers think of it outside of those two are more like how accretive is the transaction that can be from a financial perspective. So they trade at 10 times revenue, they're buying you for less than that. That's an accretive deal. Or if you do it on earnings per share, you need to pay a lot of attention to what the strategic buyer is valued at because that will put an artificial cap on what they're willing to pay. Then there's other, what I would call true synergies, not just financial synergies, that product and cross sell opportunities. You may have the perfect product to fit inside this organization that can then cross sell and upsell you. That can lead to a really high valuation if they feel like they're missing that product. And there's things around pricing like you may allow them to charge more for their business. So there are what I would call true strategic synergies that can allow some of these strategics to pay a high price. One interesting scenario, we were selling a fintech business about eight years ago and the buyer that prevailed was spending about $8 million just to license the same product. And so you can imagine with that $8 million synergy value on what was like a 60 or $70 million deal, they could really outbid the other parties in the process just because they had more value. So that's the strategic view on the private equity landscape. We do see private equity firms prevail quite often. However, there are a group of deep value firms that will almost never compete with a strategic. So I'm more focused on the top tier firms and the reason why they can prevail against this strategic if they just see things differently. Typically this is a scenario where the product is pretty disruptive of some of the traditional incumbents and the public strategics don't want to admit that this disruption is taking place. PE firms see the ability to grow faster. What differentiates amongst PE firms in their ability to bid more or less is how they see the risk of the opportunity. And usually that's tied to other similar transactions that they worked on. If they see the risk is lower, they'll be able to bid higher. And also, do they have a unique angle on the business, which is what we're looking for, do they have a better sense for how they could grow it faster, increase retention or increase profitability? And then finally sometimes on smaller deals, usually in the 50 to $100 million in enterprise value range, they throw all that calculus out the window and they're thinking if I grow this business for two or three years, I can exit it for probably $300 million based on the TAM and if I buy it for less than 100, I can get my 3X return, which is what they're targeting. So those are the types of analysis these types of buyers go through. Again, you'll find some deep value buyers with strategic buyers and private equity firms. We're assuming you're not talking to them and you're talking to the upper crust of buyers, but that gives you a sense for some of the analysis they do to think through valuation strat. Anything else you want to add on that?
- [11:52]
Scott Austin
No, you hit the nail on the head there. You can just think about it with a public buyer where they're just thinking about valuation on a current and 12 months and how this is going to affect our P and L, a private equity firm buyer that has a five to seven year investment timeline horizon. They can think more about how am I going to grow this 10 million ARR business to 100 million over that time period. And ultimately it allows them to squeeze a little more juice out on valuation if they're really attracted to the assets.
- [12:16]
Mike Lyon
One of the things we've seen with private equity firms is this concept of pattern recognition and how it impacts their ability to pay more or less for a company. Scott, do you want to talk about that a little bit and what we're looking out for there?
- [12:28]
Scott Austin
Ultimately, if there is a partner at a private equity firm, let's say, who made a killing with a compliance or tax software business before, you can imagine that the next time an attractive business in that sector comes around, they're more than able to justify paying a higher multiple to run it back. Likewise, though it can be viewed the other way too. You can guarantee that even if you have a great legal tech business, if a partner at that PE firm was burned by another legal tech deal before, he's likely not going to dig in much. Even though it has no bearing on how great of a business that you've built. There's heard within the private equity firms and that's why you oftentimes see a run on transactions within a certain sector where let's say an Insight or Thoma Bravo buys a company within a certain vertical, you oftentimes will see two to three transactions in that vertical happen over the next six to nine months just because of that herd mentality and following smart money.
- [13:16]
Mike Lyon
And I think as you think about these businesses and how they're valued, just trying to understand the lens that private equity firms look with and trying to understand the risk mitigant and risk profile is just a super important element of how these businesses are valued. One thing I did want to highlight around valuation in buyers is you'll get lots of feedback from other founders, other board members who are worked on transactions, and they'll say very declarative things like, buyer X will always pay more or buyer Y may always pay more. That may be true on average, but there are many times you could leave a lot of money on the table by making assumptions about who's going to win and why they're going to win. So, Scott, maybe talk a little bit about that and just how it's dangerous to assume you know what's going to happen and how you can be wrong. A lot of times we very often.
- [14:04]
Scott Austin
Go into processes where our clients say, hey, it's going to be one of these three buyers at the end of the day. And lo and behold, two months later, they might all three be out, because you might not know what they have going on internally. They may be acquiring another business. They might be implementing another acquisition that they made recently that might prohibit them from pursuing further at this time. So you never quite know. And you don't always want to time up a problem process around what might be going on with a buyer or potentially going on with a buyer. So I think that just every deal is unique and you want to go in with a broader mindset about who can acquire your company and what type of deal you want to pursue.
- [14:39]
Mike Lyon
Scott, I think that's a good point. For example, even later in the process, you don't always know what's going to happen. We were recently working on a deal where we were in the late stages of a process. We've had first, second in third place, and the day before the final bid deadline, actually, the day of the bid deadline, third place looked pretty distant in terms of valuation. They were like a 10 to 15% discount. I don't think our client thought this prospective buyer would win. I think we were skeptical. We knew them, so we thought there was a chance, but they dramatically closed the gap and went up significantly above the other bidders the next day as we really started negotiating. So even very late into a process, you don't necessarily know what someone's maximum bid is, and you want to use the process and the leverage of having multiple people involved to be able to get them to their maximum bid. But I do think just assuming you know who's going to prevail and what they're going to pay can be very dangerous. Sometimes buyers come and go because of other things going on with them. So I think being thoughtful but nimble is definitely the way to get the best valuation during the process.
- [15:41]
Scott Austin
Yeah, and you never know too, if it's a private equity firm. You never know who they have a good relationship with, who they're already in discussions with. When we sold Nepris to PSG a few years ago, we had no idea that they were in deep conversations with Virtual Job Shadow and then they closed those two transactions in tandem two months later. You never have that insight until you start having the conversations.
- [16:00]
Mike Lyon
Absolutely. Today we talked a lot about how valuation can be subjective, how to take advantage of that subjectivity and some things to look out for with the higher quality buyers and how they may value the business. But Scott, thanks for your time. I appreciate it.
- [16:14]
Scott Austin
Thank you.
- [16:15]
Host
VistaPoint Advisors is a founder focused investment bank that advises software and Internet founders through M and A and capital raise transactions. We are fully unconventional conflicted investment bank who only works for founders on the sell side, so you know that we're always representing your best interests. Security is offered through VistaPoint Advisors member Finra Sipic. This has been provided for informational purposes only. It is not intended to address all circumstances that might arise. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. If you have any questions about the process of selling your business or raising capital, reach out to a member of our team or check out the four Founders section of our site by visiting four Founders Guide.