Mastering the Exit Strategy: What Makes Your Business Attractive to Buyers

Strong financial performance. This means revenue, this means profitability, and this means cash flow. Those are the keys to financial performance. When an acquirer is coming in, what they're looking for is opportunity to take this from consistent growth to can we crank this up? So what is the opportunity? If they doubled their existing customers, would the company be able to succeed and handle that? Private equity firms tend to come in and they look at it and say, can we do this for five to 10 years and can we exit successfully? And is there an opportunity for us to make a killing throughout the journey? Like can we double the value of this business? Good day and welcome to the Wealthy Entrepreneur podcast. I am your host, Bob Govreau. It is great to have you here today. Today we're going to actually talk about whether, if you're ready to sell, what are private equity firms looking for? But before we get started, I want to just remind you that this is the place where we dissect the elements that contribute to entrepreneurial success from mindset and, and leadership to profits and revenue. This episode is called what Private Equity Firms are Looking For. And you know, it's interesting. I currently on my desk right now in our professional services firm, we have eight acquisitions taking place. Eight acquisitions taking place, which is a substantial amount, likely the highest level that we've had. And what we're seeing is that there's a lot of people that are looking at selling, there's a lot of people that are looking at buying and you know, spending time at conferences and connecting with different people who have exited very successfully. You know, what are they looking for? You know that the eight that are on our desk are clients buying businesses. So not private equity buyers, but just regular buyers. But we work with M and A experts, we work with brokers, we work with private equity firms. And what I want to help give you the ammunition for is what are they looking for and when private equity comes in. So private equity really is a bunch of investors that have pooled their funds. Potentially one group that is is pooling their funds, but they raise capital or they have capital and they go out and they look at acquiring stakes, typically majority stakes and ownership in small to medium sized enterprises. So not necessarily looking at public companies, but looking at small to medium sized enterprises. And those can range anywhere from typically 2 to 3 million dollars of net income all the way up to hundreds of millions of dollars. And you know, the higher the deal, the the less likely. Well, you know what, it really depends the percentage of ownership that they usually try and take in the firm. But what they in the business and what they try and do is they try and look at maybe acquiring a majority stake, but still having skin in the game from the existing owner and managers and having continuity of the business without them or without the previous owner owning 100%. And what is the appeal for some of this? Well, the appeal is as a particular business owner, if you're looking at funding the growth of your business, but you're finding it challenging to continue to have the cash flow necessary to reinvest, that is typically a time where you see private equity firms come in and they, they focus on bringing capital into the equation. They typically require the seller who's selling the majority of their business and is still part of it to recontribute some of their proceeds back into the business. Typically, they want to make sure that you've got about 40% of the skin in the game that the private equity firm does if they're buying 60. And so that's sort of what it looks like. And then there's the opportunity to sell again your 40% in the future. And some of these private equity deals get really complicated because there's usually earnouts and milestones and you know how people are getting paid for their 60%. Sometimes they're taking stock in other entities and stuff like that. So it gets challenging. But what I want to share with you is private equity is obviously the most experienced, one of the, if not the most experienced buyer in the market space. And what I want to give you the ammunition is of what they're looking for. So what is a potential buyer looking for? And it really comes down to, I think I've got 10 items here that are associated with what buyers are looking for when it comes to acquiring a company. Very first one, strong financial performance. And before I even get started in here, I want to share with you that these are all areas that we focus on teaching inside the wealthy entrepreneur program. So if you are looking at exiting your business and you want to understand fully how to maximize these 10 value propositions, when it comes to making sure your business is ready for a buyer, then these are the things that you need to focus on. So, number one, strong financial performance. This means revenue, this means profitability, and this means cash flow. Those are the keys to financial performance. So whenever we talk about, whenever we talk about businesses and assessing their financial performance, we look at revenue growth. For sure, if you're not growing, you're dying. And if you're not growing, you've got challenges because your costs tend to, unless you're focusing on cost cutting, your costs tend to continue to go up with inflation at a minimum with inflation, if not higher. So we have to be conscious that if we're not increasing our revenue, we've got wages that are going up, we've got utilities costs and overhead costs that are continuing to go up. So it's very important that we focus on continuing to grow our revenue. Second is on profitability. Now this would be in two areas, gross profit and net income. Gross profit is your profit margin on all of your sales of products and services. So very important that we focus on continuing to enhance our gross profit margin. If you have a buyer that's looking at your business and your gross profit margin is tanking, it's gonna be challenging, right? We need to make sure that the profit margins are continuously going up or staying stable. You know, they're intended to stay stable, but our prices have to go up and our sales have to go up in comparison with our cost of delivery. And that's important. The last one is net income or net profit in the business. We want to make sure that that's continuously going up as well. And the stronger the profitability in the business, the better. And then we've got cash flow from a couple different considerations. One, a buyer wants to acquire a company that's not going to require them to have capital investments at all times. So it's very important that we consider that. But cash flow, to know that it can constantly have a consistent cash flow so that it can pay any sort of borrowings or debt obligations that come up as part of financing these sorts of deals. Okay, so that is financial performance. The second one, the second one in here is market position. So this is really whether or not we've got a competitive advantage in the industry. Meaning that, you know, do we have something that other people don't? Are we differentiated? Do we have a low cost ticket item? Or we do, we have something that's super unique that no one else can offer and it's, it's high price. So looking at our competitive advantage and saying we have to have one, maybe our competitive advantage is having a high volume, low cost. And so we're, we're attacking low price points. So, and then the other competitive advantage could be just the deliverable, the experience is just world class. That's unique for everybody else. The second part of market condition is growth potential. Are you in an industry that is continuing to grow or are you in an industry that is shrinking? If we think of some of the industries that they would be looking at as far as growth potential, you know, know you've got healthcare and technology with demographics changing, with new infrastructure coming in and new technology, super good opportunities there. Companies focusing on sustainability is definitely one. Professional services firms, which is interesting, that is, is definitely an area where it's coming up as well. Like accounting firms, financial services companies, contractors. So they're looking at those industries saying these, these industries are all significantly growing and have opportunity to grow once they acquire the company. And then to say on the same sort of note, industry trends are there, favorable industry trends, increased demand, limited competition, things like that. Number three, scalability. When an acquirer is coming in, what they're looking for is opportunity to take this from, you know, consistent growth to can we crank this up? So what is the opportunity? If they doubled their existing customers, would the company be able to succeed and handle that? So they want to look at what, whether or not there's scalability. Are there efficiencies? Can we double down on how to be more productive in our business to ensure that, you know, that scalability factor is there? Can we produce more per man hour or per labor or per unit than we were previously? There's gotta be opportunity there for increased efficiency and productivity as well. Number four, management team. They are looking for a competent and experienced leadership and management team that can execute great growth strategies. They are looking for it to not be the owner. And if it is the owner, the owner is committed to being part of the, the entity for, you know, a longer period of time. Maybe they, the owner that sells 60% is still going to carry on as the CEO and just put some cash in their pocket. Totally happen there as well. So they need to have a competent management team. In some cases, private equity firms may bring in their own management or advisors to strengthen the leadership. But for the most part, when they're looking at it, they're. If you're a company that's selling, if you have a strong management team that can manage the operations without you and without the support of having to bring in anybody else or recruit anybody else, then that is going to show as a positive from the buyer's perspective. Okay, industry. So industry is important. Like I mentioned, private equity firms are looking at health care, technology, manufacturing, trades, financial services. They're looking for businesses within these verticals. So if you're in that space and you're considering exiting, private equity is maybe not a bad model for you. Keep in mind though, when we look at private equity, you know, private equity will pay you more based on how unique your business is and Unique being, do you have a unique selling proposition? But are you doing it at scale? Is your profitability high, which is unique? Is your revenue high, which is unique? They're looking at factors like that because, you know, Instead of buying five to 10 smaller businesses, they could buy one larger business. They're going to pay more for that larger business. Less headaches, more likely. Reliable management in place systems, processes, things like that, consistency, growth, all of that. So we want to make sure that, that, that is a consideration as well. Number seven, exit potential. So a lot of times when private equity comes in, and as a seller we want to be aware of this, private equity firms tend to come in and they look at it and say, can we do this for five to 10 years and can we exit successfully and is there an opportunity for us to make a killing throughout the journey, like can we double the value of this business? And that's really what they're looking to do in a period of four to seven years that they can hold at a higher valuation and typically sell exits, including strategic acquisitions, public offerings, recapitalizations, items like that. Number eight of an item that people are looking for when they're looking to buy a company is, is a valuation. So what they're looking for is they're looking for a reasonable valuation with EBITDA multiples. So we've shared this before, but typically if you're, you know, 2 to 5 million, you're looking at maybe 4 to 6 times earnings. And this is net or EBITDA earnings before interest, tax, depreciation, amortization. So 2 to 3, you're 5 to 7, you're maybe 5 to 7 million of EBITDA, you're maybe 6 to 8 times earnings. Once you're 5 million plus, you're likely 5 million to, let's say 10 million, you're, you're likely 8 to 12 times EBITDA. So you can see as the business value goes, goes up and the earnings multiple goes up, private equity is willing to pay more for that. Okay, so number nine is really looking at barriers to entry. So what this means is that if you have a business and it's really hard for competition to come in and to start up a competing interest and take away your market share. They're looking for businesses like that. You know, they're looking for an idea that somebody with a computer or an iPhone can't come in and start doing the business that you're doing. You know, it's going to take more capital, it's going to be more intensive, it's going to require greater human resources. So it makes them more attractive because it discourages competition. Right. And it protects some of the market share and the valuation that are there. So they, they do like barriers to entry, which is important. I think of the CPA firm world in this case. And I know a lot of times people say, yeah, the barriers to entry are low. You know, anybody who wants can, you know, set up a computer, they can start doing accounting related work. But there are, you know, some areas where I would say that that's not exactly true. You've got to have certain areas of expertise, if that's what people are looking for. You've got to have a certain ability to be able to deliver at scale. You've got to have a certain level of knowledge and experience. You likely want to have a certain level of reputation as well. Because it's not like anybody off the street can just come in and say they're a CPA or a tax expert. They can, but it would be fraudulent. And people should be working with experienced people in this space so that they can solve the problems that people have had because they've solved it in the past. So, you know, I think of my industry and think of how that relates to yours as well. Do you have significant barriers to entry? Otherwise, you know, you could, as any cpa, put your shingle out and say that you're now doing accounting work like I'm doing accounting work. So there are, there are some elements to it. But I guarantee you, when you look at, you know, our ability to continue to market and to share information, nobody would have the time to be able to and resources to really compete with what we're putting out there. Why? Because we invest a significant amount of money in making sure that we're constantly adding value and that helps our business. So thinking of this and reflecting on this in your own, in your own business, that helps prevent barriers to entry because nobody has the resources to do what we do, which is great. So smaller entities, yes, they can get in, but they can't penetrate the market in the way that we can. And then risk factors, so, you know, some of the risk factors that we want to make sure that we're dealing with as a business owner are also areas that private equity firms are looking at as well. To say we want to ensure that those risk factors aren't there. So reliance on key customers or suppliers, that's a major red flag for private equity firms. Regulatory issues, you know, if you're in an industry where there's tight regulations or there's a chance that the rules are going to change and it's going to impact the future value of the company. That's a challenge. Market volatility. If you would think of market volatility, you think of, you know, something that has a huge upside season when it's good. You know, think of COVID testing, for example. If people wouldn't have been buying pharmaceutical companies after Covid, thinking that all of their, all their, any vaccine or other vaccines that they were creating during that time, the revenue is going to go down, it's going to fluctuate based on the needs of the world. You know, that might be an area where there's a lot of market volatility and people might not want to invest. And then lastly, reliance on specified personnel like the owner, like key managers do you have one salesperson who brings in all the sales and your future of the business is dependent upon whether or not they stay with the company and they continue to be successful. So by analyzing all of these top 10 factors, private equity really reviews to make sure it aligns with their business and their risk tolerance, their investment criteria and expected return on investment. Now, the other thing I will say is they typically have a very structured deal where you as the seller aren't necessarily getting all the cash up front. Much easier to deal with a third party if you're looking to sell. What I would look at is either one working with a broker, which we have quite a few relationships with different brokers that we really enjoy. But the second part would be, you know, one of the things that even the brokers would do is go out and find your top five competitors who are in the acquisition space or would be someone that you feel would benefit from acquiring you and sign an NDA and have a discussion with them about potentially joining them or them acquiring you. And a lot of times when you've got a very successful organization, they will look at acquisitions as a growth strategy. Just happens to be the way it is. So again, the 10 factors that we need to be considering, if you're looking at exiting and specifically what private equity firms who are probably the largest volume buyer across the board, what they look at, strong financial performance, which is revenue, profitability, cash flow, market position, do you have a competitive advantage? Is your business in the position for growth potential and what are the industry trends showing? Is there an upswing or a downswing or what does that look like? Number three was scalability. Is your best business able to scale? If private equity were to come in or a buyer to come in, invest Some money? Could the company take over some more market share? Are there opportunities for innovation, productivity increases, stuff like that? Number four, management team. Do you have a solid management team in place? If you do not, the business is not a business. It is really dependent upon you as the owner. If you want to sell for a solid multiple, you need to have a management team in that would transition from one buyer to the next. Growth opportunities. Growth opportunities meaning are you having organic growth? Is there an opportunity for mergers and acquisitions in the space? What's the geographical expansion? What do those look like in your. In your industry and in your space? Number six is the industry. They Private equity firms often look at specific industries. I mentioned healthcare, technology, manufacturing. I said financial services, contractors, so plumbers, electricians, home builders. Private equity is looking for you guys. They see the industries as exciting and growing and they're looking for good opportunities to buy in. Number seven, exit potential that they would be able to come in with a clear exit strategy that they can invest, grow the company and exit. They want to see that valuation. They want to make sure that they're getting it at a reasonable multiple of EBITDA typically. And so just a reminder that the more your EBITDA is, the more more likely you're going to attract a higher multiple. So financial success is definitely a lead factor of exiting for a higher dollar value. For sure. Looking at barriers to entry was number nine, making sure that you know the industry that they're looking at is not overly competitive and that anybody could come in and take over your market share, that there are barriers to entry into what your business looks like. And lastly, some risk factors like dependence over dependence on owners, key employees, suppliers and in other specific personnel that are on there. If the business is fully dependent on one or two key people, that's a problem. We need to make sure that we eliminate that risk. So as we finish up 2024, if you're looking at exiting your business, one consider these factors, right? The Wealthy Entrepreneur, which is our coaching program. We also walk people through. We call it the eight Ways to create Business Value. But inside there we do some trainings related to how you can focus on each of these individual areas to make sure that you're maximizing your value and increasing the likelihood that you will be able to exit. Secondarily, we've got eight mergers and acquisitions on the go right now. We do provide a lot of support for businesses who are looking to exit, ensuring that due diligence is is there. We also, if you're a buyer, we do support and making sure that the due diligence is completed. On the acquisition side, we also do the tax planning to make sure that we can support you there. If you're in Ontario, we can also support with the legal aspect of a share or asset purchase agreement, we're here to support you. And so for whatever services you're looking for, check us out at Govro Sen, CPA ca. You can see our full list of things that we can do to support you as a business. But ultimately what we're looking to do is increase the probability that you can exit successfully with a nice paycheck so that you can enter into your life of financial freedom. My name is Bob Govreau. I hope this has been extremely insightful for you today. If you like this podcast, give us a like give us a follow. Make sure you're ready for next week. We're always excited to bring you new content and new information and if you feel like there's some information in here that would benefit someone that you know. We are on a mission to empower entrepreneurs to have good financial information, to ultimately have the confidence to make informed decisions and change the world. We can do that together by you sharing some of this information with those that we can support. Thank you again for tuning in. I look forward to seeing you next week. My name is Bob Govro. We'll see you then.