What determines the selling price of a company?

In our blog of November 12 we already indicated that the market for selling your company is good at the moment. Regardless of whether you are ready for that yourself, many tech entrepreneurs wonder what their company is worth now and how that is determined. In this blog we provide a few insights that can help with that. 

Structure; how is 'the market' organized then?

Tech, or in a broader sense, the IT sector has a rather skewed distribution when it comes to company size. This leaves 96% of the IT entrepreneurs under 8 employees and under 1 m.Euro. This is also called the start-up phase, but we also see quite a lot of IT companies that spend quite a long time in this phase persist. More than 50% of the so-called start-ups will not make it. Within the remaining 4%, only 0.0001% of the IT companies have a turnover of more than 5 m.Euro and more than 50 employees (the so-called 'delegate' and 'standardization' phase). Guiding your company through the 'organization' and 'management' phase (from 1 m.Euro to 5 m.Euro) is therefore not trivial.  

Within container IT, there is a big difference in company type and revenue model in addition to company size. This ranges from purely hourly services to concepts to software and platform services (or combinations thereof). 

Summarizing; the company size, degree of organisation, revenue model, turnover/profit, complexity and risk profile in the It group of companies are very different. 

What type of buyers are there actually? 

If you think about it selling your company then there are (roughly) four main categories of buyers:

  • Strategic Buyers; companies that sell similar or additional products/services to which your company is a nice addition. Here we also see more and more non-tech buyers.  
  • MBO/MBI: Management Buy Out (current management buys into the company) or Management Buy-In (people from outside the company buy in)
  • venture capital & Private Equity; Private Equity buys 100% (or almost 100%) from the company and takes full control. Venture Capital buys in for a smaller share (50% or less).
  • informal investors; these are high net worth individuals or smaller VCs who generally focus on smaller investments and often also in the early phases of a company (start-up)

So there is also a stratification in the market of buyers and there are also different characteristics. For example, you see Informal Investors and VCs more often in the so-called smaller 'tickets' (smaller investments), but these are often also riskier. These are also called venture investors. 

At the same time, you would rather see larger parties focus on larger and more proven companies with a lower risk profile. An advantage of larger acquisitions is that it makes a greater contribution to the growth strategy of the acquiring party and that the relationship to the transaction and integration costs is better than multiple small acquisitions.  

Other interesting differences are the bandwidth for prices paid internationally compared to the Netherlands. It should be noted that with an average multiplier of 6.1 x EBITDA this is a lot lower compared to, for example, the US. 

Nice statistics but what does this mean for me?

As indicated, the multiplier indicated above is an average. What will the bandwidth look like if you sell your company? This is determined by several factors, but mainly by:

  • Profitability
  • Revenue model

Decisive for the level of the multiplier are, in particular, the origin and future-proofness of the profit (sustainable profits). More specifically; does the profit come from hours (only linearly scalable) and/or is there also recurring profit (recurring revenue) from software and/or platform services. The latter of course has a much greater leverage and an increasingly favorable cost/benefit ratio. 

For companies that only work on the basis of hours, a lower multiplier is therefore paid, which also takes into account whether or not the service is generic (added value). For companies with a large share of revenue and profit from software, this multiplier quickly rises to double digits, which partly determines whether software is supplied for a vertical and whether one has a dominant position within it.  

The formula? 

In addition to the profit and the revenue model, there are price-determining factors such as; 

  • Potential 
  • Risk
  • Discounts 

A dominant position in a vertical is of course nice, but a buying party is also looking for growth potential. The question is therefore how scalable your products and services are across 1 or more growth dimensions (autonomous, geographical, other verticals, functional footprint at the customer, etc.). Interestingly, strategic buyers pay on average 15% more than non-strategic buyers. This is prompted, among other things, by a better view of benefits, but also by not always being able to afford that the deal goes to a competitor. 

As indicated earlier, there are parties who prefer to wait until a company is more stable in terms of customers, organization and income. They are also prepared to pay a higher price here for more certainty that the investment can be earned back. Risk is therefore also an important factor.

Finally, one will after studying it Information Memorandum and a proposed purchase, of course, also carry out a so-called Due Diligence. In addition to a due diligence, the company's business operations will also be broadly examined. Here it is important that no major restrictions or under-investments are found as these are converted into discounts on the price.   

As you can already see from the article, there is no general formula, but there are a number of recurring factors in determining the value of a company.  

What is wisdom in selling a business? 

In a sale of your company, the buying party is generally larger and also dominant in the process. What you do not want is that the bandwidth and the process are determined by the purchasing party at a very early stage and that you lag behind the facts. 

Also find we at No Monkey Business that in the process the emphasis is too much on all derivatives such as turnover, profit, balance sheet, contracts, etc. and too little on the company and the entrepreneur. 

The value of the company for us is not:

Value = profit x average multiplier – discount – risk premium

Of course this forms an important basis, but it is too focused on the past. We would like to put more emphasis on the potential of the company and the strategic dialogue with the buyer on how to capitalize on this potential. This is of course also included in the price of the company. 

So make sure you are prepared and that you know what you are selling instead of playing 'defence'. Take a look at us 4 step exit program and give yourself the time and opportunity to arrive at a better formula and outcome:

Value = improved profit x higher multiplier – no discounts – hardly any risk premium

Curious how we do this together with our customers? Make here an appointment for that strategic cup of coffee or order us Card game to take another look at the 16 success factors for IT entrepreneurs under the Christmas tree.