by Tom Metz, Author, Investment Banker, Founder, T.V. Metz & Co., LLC.
One of the primary reasons that a technology company sells is that it has reached an inflection point. A company may require greater sales capabilities to effectively address its market. The company simply can’t grow fast enough with its current resources. The business may be getting low on cash and cannot raise additional capital.
Financial transactions are different from strategic transactions. If a transaction will be valued on the seller’s financial metrics, such as operating earnings, then a company should sell when earnings are high and the projections are rosy.
A strategic transaction is one in which value is based on the strategic fit with a particular buyer. The strategic value is different from one buyer to the next. When is strategic value the highest? It depends on to whom the value is strategic. Strategic value is extrinsic, not intrinsic. Strategic value exists only in the minds of the buyers and it is different for each buyer.
Contrary to what many think, the best time to sell may not be when the company is at the top of its game. Rather, it is when the market realizes that it needs your technology or key assets. This is when a buyer will pay the maximum price for your company. The market may be on a different time schedule than your company’s growth curve. If a firm waits to sell until its profits or revenues have peaked, there may be little growth left. Buyers will figure this out and will not pay top dollar. Market timing is the primary driver for receiving the optimum price when selling a company.
What about Selling When Revenues Peak?
The problem is that no one knows when the peak is, or, the peak keeps changing. There is no lack of optimism in the minds of entrepreneurs — they believe that revenues will always improve. Thus, companies typically delay the sale which can be detrimental to getting the best price.
Revenue multiples are bogus most of the time in strategic transactions. It is profit that counts in business, not revenues. In strategic deals it is the technology, intellectual property or other key assets that count. People love to talk about multiples of revenues. It makes them sound smart.
People do not enjoy the uncertainty of not knowing what something is worth; they crave a number for value. In a strategic transaction it is the strategic assets that matter. Yes, higher revenues are better; they prove that the market exists. Revenues give credibility. But your technology is the same whether your revenues are $4 million or $8 million.
Talking Versus Thinking
Buyers may talk in terms of revenue multiples, but buyers do not think in such terms. Buyers think in terms of how much value they can create with an acquisition. What additional operating profits can they produce? How will the acquisition speed entry into a new market?
A buyer does not think in terms of revenue multiples. A buyer will calculate the cost to develop the technology themselves and add a time premium. They will project the additional operating profit that your company can generate and work backwards (usually by discounting) to a range of values that make sense for them.
Sometimes revenue multiples are interjected as a negotiating ploy. A buyer may cite the revenue multiple to make his offer appear attractive. Don’t be fooled by a buyer who quotes revenue multiples. Valid comparisons cannot be made from one transaction to another using revenue multiples.
A recent example is Intel’s acquisition of CognoVision for $17 million. CognoVision had revenues of about $1 million. Was 17 times revenues the appropriate revenue multiple? Were similar transactions completed at 17 times revenue? Did Intel ask its investment bankers what the appropriate multiple was? Of course not; Intel determined the price by figuring out how much value CognoVision would contribute to its operations. Multiples of revenues had nothing to do with it.
Deciding When to Sell
So, back to the question—when to sell? The answer is external to your company. It depends on the market and the needs of the buyers. You want to sell when you can get the best price. You get the best price when buyers desire your company the most.
Many larger firms will acquire technology and expertise for a speedier market entry. The best time to sell is when the larger companies decide to enter your market sector. How can a company know when this situation exists? The buyers may be in the market already or they may be in an adjacent market with plans to move into your sector. Pay close attention to the players in your market, especially the big companies. Ask some key questions:
- Is a large firm expanding into your sector?
- Do you see a gap in their product line?
- Are they missing a complementary service that your company provides?
- Has one of your competitors been acquired recently?
The acquisition of a competitor may indicate the first move by a large company into your market. If a company with sales muscle acquires your competitor, it could be a potent force in the market, even if your technology is superior. If two competitors are acquired, that is a signal to seriously consider selling.
Selling too late can have a negative impact on value. If the best buyers have already acquired targets or developed their own technology, there is a reduced incentive to acquire your firm. The market situation is the primary driver for obtaining the best price.
For a more in-depth discussion about optimal market timing, please see my book, “Selling the Intangible Company—How to Negotiate and Capture the Value of a Growth Firm” (Wiley & Sons, 2008). See www.intangiblecompany.com
Tom Metz has a diverse corporate finance background. He founded T.V. Metz & Co., LLC in 1983 and has been an investment banker for more than 28 years. Previously he invested venture capital for an investment firm and managed new business projects for the Gramark Co., a private holding company. He held positions in finance with the DeLorean Motor Co. and computer sales with IBM. Mr. Metz has degrees in Mathematics and Computer Science from the University of Oregon and an MBA from the University of California at Berkeley. He was an Adjunct Professor of Finance at Lewis and Clark College and is a frequent speaker on mergers, acquisitions and entrepreneurial topics.