As financial advisor, I have met with numerous business owners over the past decade, sometimes on the sell-side, others on the buy-side or even pitching our services to them.
Some companies just project success in everything they do. A good business model, a solid brand, numerous customers and suppliers – all these stakeholders happy and none representing a significant portion of their sales – an organization following well-implemented processes and driven by a professional management team, etc.
Others are, well, not yet there. Omitting the occasional owner of a company in its last breath pre-bankruptcy, desperately trying to find a savior, I’ve seen a fair share of companies that do some things very well but have issues crippling their chances of success… and leaving their owners with no other options but to keep these hard to sell assets or dump them at a deep discount.
One clarification first, I believe that close to everything can be sold, just not always at a logical market value, so, for the rest of this article, we’ll define “sellable” as “sellable at a reasonable price”.
So, what factors might negatively influence price?
The website The Sellability Score can give you a good idea of the specific weaknesses your company has and how ‘sellable’ it might be. Ultimately, though, it comes down to a few recurring themes. I’ll address the most frequent ones below.
- Customer/Supplier Concentration.
Concentration is certainly one of the most frequent issues that we identify in companies. Be it customer concentration or supplier concentration, when a company’s profits depend highly on a single party, there’s a rather high probability you’ll see a steep discount in the premium offered… that is if you do receive an offer.
So, why is having a large customer or supplier such a big deal and why does it make the company undesirable?
Basically, because it places the future of your company in the hands of a third party. Things get worse when your key customer happens to be known for its constant changes of product mix (for example Costco for a FMCG company). That is why, for example, a private equity fund will generally discard any company with heavy concentration unless it is considered as an add-on acquisition for an existing portfolio company where that concentration could decline (typically, another time to consider such a transaction would be when that company is either very cheap or strategically aligned with the portfolio’s growth). Just think of it this way, would you be willing to spend 6-7 years of profits for a company that generates 80% of these profits through a single client?
Here’s a quick example of a candy company who managed to bring this concentration thing to the next level: the company’s top customer represented over 70% of its annual sales. As if it was not enough for the owner to lose sleep, that customer, a large retailer know to constantly cut costs, made the owner an offer he literally could not refuse (as in future purchases were conditioned to his acceptance). His customer would sell him his primary raw material – sugar – at a discount over his current supplier and he would, in return, lower his prices. Just like that, his top customer also became his top supplier…
… and here is another example, famous in French business schools. Intermarché – a french grocery retailer – was buying fish from a small producer. Little by little, they increased the volume of purchases, forcing the supplier to abandon other smaller clients and to concentrate on Intermarché. Years go by and growth continues. The small producer is now a fast growing company with a fleet of expensive boats heavily financed with debt. Then, one day, Intermarché announces that they would change suppliers, going with a competitor that offered lower prices. The fishery went bankrupt and was acquired as a result… by Intermarché. They even offered the ex-owner who lost it all a job as head of the fishery…
So, how big can a customer be for the company to fall in the “concentrated” category? I’d say 15%-20% is worth noting, 20%-30% is preoccupying and over 30% is an issue to be addressed. 50% or more usually makes your company unsellable right off the bat, unless usual in your sector. Such an example could be companies selling niche products with little competition to a small universe of accounts – e.g. government o regulated industries – or to highly concentrated industries. In those cases, however, you are most likely entering into long term contracts with minimum payments and other measures that provide the stability a buyer is looking for.
- Owner’s dependence.
Yet another form of concentration. Depending heavily on the owner is a key issue in small and medium businesses. The smaller the business, the more likely that the owner will be an integral part of its growth, operations and success.
As a buyer, this is a red flag for an obvious reason, especially in the Services sectors. If the business cannot function without its owner, then what will happen post-acquisition? A transition period is always an important part of an M&A transaction but if the company really is a one-man shop, how long can it take to transition all those activities to another person or, better yet, to a new team? Are customers loyal to the company or to its owner? Are they paying for its services or for the owner’s input and participation?
- Product Concentration.
Is your company a “one-trick pony” or does it generate income – and profits – across a number of products and services?
A real life example here is a company that jumped early on the energy drinks wagon. They manufactured a drink that was affordable and tasty in a market that was still nascent. It got picked up by various retailers and drove solid growth year over year, with rather limited customer concentration. The company had very healthy margins and a solid track record. Nonetheless, we were not able to find a buyer due to its impressive 100% of its sales driven from a single product (not product line, product).
On the one side, Financial buyers did not show much interest in the opportunity as they considered the market a fad and, thus, the actual company without future as it did not have any other product in the pipeline.
On the other side, Strategic buyers did not show much interest either because the company – or in some cases the segment – was too small to be significant for them or because they could not justify paying a premium for a product that they could develop and launch for much less than that should the category become of interest.
The bottom line, here too, is to be careful not to depend too much on a single item.
- Sluggish Growth and Low Margins.
Low margins can actually be appealing to strategic buyers as well as sluggish growth, for example, in segments that are stagnant or declining where consolidating the two company would mean for the buyer gaining a dominant position or further diversifying the customer base. However, the main appeal here is the low purchase price that can be negotiated under such conditions.
When these conditions occur in asset-heavy businesses, the company becomes unsellable because the market price for the business just does not make sense for the owner who looks at the investment that has been made over the years to get there. I have seen such cases in industries where profits are highly driven by prices of commodities and investments needed to operate are high.
An example could be a company in the printing or plastics space. The equipment needed to start such a business is expensive and voluminous. You therefore end up with lots of assets on your balance sheet, large production facilities that amount to significant rental costs, your main raw material is derived from crude oil and/or other commodities with prices that fluctuates as the barrel does, and your utilities costs are significant as well. If you happen to be producing commodity products, such as disposable cups, plates or trays, your margins can be rather slim too. A few years back, when the barrel was trading at $100, margins for most of the player in this industry shrunk, often being hit twice with surges in raw material and in electricity costs as a result of the crude oil going up. Under such circumstances, an offer that could seem generous – say 6x or 8x EBITDA – would oftentimes not even amount half of the investment done in the plant in its last few years of operation. However, the limited growth prospects in this saturated, competitive market and the low margins of operation make it hard for a buyer to offer more and still be able to justify this acquisition with a positive ROI…
- Everything Looks Great But The Company Can’t Scale.
Sometimes, the issue is not something that you’re doing (or not doing) today but rather, something that you can’t do tomorrow: Grow.
You could have a company that has diverse streams of revenue, all very profitable, a solid organization where no one irreplaceable and efficiency levels at industry best, and still not be able to command a solid premium for your company, for example, if it is operating at capacity and the investment needed to continue its growth is substantial.
As an example, take a company that has had flat sales for 2 years in a row, by design. Demand is there but in order to increase sales – if only 10% -, you’ll need to build a new plant which will take 1-2 years to build with a cost equivalent to 2-3 years of sales, and will take 5 to 7 years to yield a positive return on investment under semi-aggressive sales projections (that might seem like an extreme example, but not necessarily that far out).
Interested buyers might show up, including competitors who do have that extra capacity, but the offers will be based – at best – on flat sales and declining profits or – likely – on moderate growth but where the purchase price is adjusted for the cost of the needed investment. In the asset intensive case presented in the previous paragraph, the math for this cash flows exercise might even lead to a negative value for the business today…
- The Market is Disappearing and/or the Products are Becoming Obsolete.
This one is a tough one and yet an issue that is more and more likely to be the root cause of not being able to sell a company as new tech companies have been doing a good job of reshaping pretty much all sectors of activity.
If your main products are becoming obsolete, there is no quick fix here. That’s why successful entrepreneurs and companies are constantly planning ahead and maintain an active pipeline of new products. In some cases, your market might shrink dramatically as a result of recent disruptions but will not die anytime soon. If that is the case, then dominating your niche could still make your company attractive and drive a reasonable price for you as owner. In any case, this point proves the importance of investing in innovations and of having ‘a finger on the pulse’ at all times not to be caught off-guards.
- Lack of Recurring Revenues.
A company can have a track record of growing year over year at a healthy pace for decades and still not manage to convince potential buyers of its future growth potential. This is frequently the case of companies selling large, one-off projects that are not recurring by nature. Financial investors, like private equity funds, tend to be more cautious with these business models than strategic buyers for two reasons: (1) their typical model includes leveraging the investment with debt and (2) a strategic buyer is in the field and acn understand more in depth it’s cycles, benefits and limitations to get comfortable with the situation.
Predictability of revenues is one of those things that you don’t want to give up after you’ve tasted it. And many buyers are willing to pay a good premium for it while others simply won’t consider an opportunity that do not show some large percentage of its revenue streams as recurring.
If your company falls in that category, there’s no quick fix either or 90-day plans. However, not all is lost. That’s where strategic thinking and long term vision come in. More often than not, your business model can be tweaked to include a recurring component. Start with the easy – look at your competitors and broader ecosystem – what are they doing differently and why? If that does not answer the issue, rethink how you’re selling to your customers – what need are your addressing? Are you selling a product or a solution? Can you product become a service?
An overly simplified example of this last point: you can buy a hard drive to do your backups or you can rent space from a cloud storage provider such as DropBox which will allow you to maintain copies of your important files and add more functionalities. In the long run, DropBox is more expensive than purchasing a hard drive but it gives you more and you’re paying it over time. From Dropbox’ perspective, you’ve purchased a subscription making your payments recurring [less expected churn] and the more data and users you have with them, the harder it is for you to switch.
Another good example is in printer supplies. Selling toner has become harder over the years in this crowded industry as customers tend to see toner as a commodity product. Then, one day, someone changed a bit the paradigm and shifted from selling toner to selling peace of mind, adopting a strategy used in the adjacent equipment leasing sector. Instead of selling businesses toner cartridges and constantly competing with others for this business, they adopted a pay-per-use approach, charging pennies for every page printed for a service that includes toner, preventative maintenance and support. This became a trend then the norm for heavy users of printers. A win-win gir both customers – one less headache – and service providers who now have predictable revenue streams.
Oftentimes, you can offer preventive maintenance services versus as needed service calls where the customer receives the same service in case of an emergency but at a perceived discount or with perceived advantages (eg. 4h response time guaranteed). Sometimes, it may be advantageous to offer the products (or parts of it) under leasing arrangements where the customer avoids a steep upfront payment and your company benefits from stable monthly income for the years to come. There are other cases where the upfront investment can be reduced in exchange for annual licences. Then come the razor and blades business model where your main product becomes as close to free as possible because you’ll be making money on the consumibles down the road.
There is no universal answer for this issue… other than a business model generating recurring revenues is much more sellable than one depending heavily on non-recurring projects with lumpy income streams.
Why This is Important
The points listed above are only some of the many reasons why some companies cannot be sold. There are many other reasons but I think that having the above points under control should help to address various other points too.
More importantly, knowing your company, its strengths and weaknesses is key to running a thriving business, whether you’re planning on selling it or not. Especially because planning on addressing these issues the day you’re thinking to sell your company is a guaranteed failure. The issues highlighted in this post are structural issues companies face.
Lowering your customer concentration while still growing your top line and maintaining your profit margins intact is oftentimes an accomplishment done over years, not months. In fact, buyers beware when seeing such turnarounds done too fast as they are usually not sustainable over time.
For an owner to become less indispensable in the day to day operation of his/her company requires setting up an organization with a competent management team that can be trusted and with sufficient knowledge of the company and its trajectory to be able to take good decisions. This too is measured in years, not in months. Oftentimes, the first step is the hardest… delegate to others and trust they’ll perform as expected.
Reducing the weight of a single top selling product in the overall revenues requires having new products or services in the queue ready to be launched, launching them successfully, and supporting them for these products to become long term contributors to sales and to the bottom line. Once again, not a task that can be done in a couple of months.
Addressing market changes and steering the company through a market disruption is even more complex and oftentimes requires the above issues to have been previously address in order to have a remote chance of succeeding the required transformation.
I firmly believe that every business owner should measure how sellable is their business on a periodic basis if only to confirm the viability of their vision and strategy. Is reinvesting in this business model the best use of your money? What threats are you not seeing our addressing?
As a final thought, consider this: people are rarely throwing good money after bad consciously!