By: David Pohlman on March 14th, 2019
Buying and Selling: Savvy Buyers Evaluate These Factors As They Assess Business Valuation
Our industry is abuzz with acquisitions in every corner–from manufacturers to suppliers to dealers, it seems everyone is either looking to buy or planning for the day they will sell. And whether you have immediate plans to put your dealership on the market or hope to grow your business so that it can be passed on to the next generation, you should always be thinking about how you can grow the enterprise value of your business.
This past fall, I had an opportunity to co-present on the topic of Business Valuation Drivers at a BPCA meeting in California. The general methods for valuing a business in the office equipment space are largely known. Most often the valuation is a current market multiple applied to the adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of the business. However, what we discussed in this presentation were the additional elements that influence valuation – beyond just the standard formula approach. With acquisitions becoming a major trend, we set out to answer the question, “What are those that are acquiring really buying?”
Ultimately, our answer was, “the future revenue streams and attached profitability.”
When acquiring another company, you normally take ownership of the assets of the business including employees, inventory, the customer base and sometimes even the real estate. However, the most valuable piece of an acquisition lies in the potential a business has to generate future revenue streams. What you are really assessing in a potential acquisition is the certainty of the future revenue streams and affiliated profitability of those streams. The more profitable and certain the future revenue streams, the more a buyer should be willing to pay. Conversely, the more risk affiliated with the future revenue streams, the less a potential buyer should be willing to pay.
Whether you are looking to acquire a dealership or position yourself to be more attractive to potential buyers, here are three areas to think about in regards to valuation in our industry:
When it comes to determining the value of a business, one of the most important factors is how concentrated its customer base is. Put simply, how much business comes from a single customer or a group of very few customers?
Whether you are buying or selling, this is one factor that needs to be evaluated. If a material amount of a dealer’s revenue is coming from very few customers, the financial impact of one or two of those customers being lost post-acquisition is high. Therefore the value of the business should be reduced by at least some portion of the economic value those customers are contributing to the business.
Who really owns the customer? If your dealership or a dealership that you are looking to acquire has several customers that are heavily entangled with an OEM, then the risk is high that those customers could be lost through an acquisition by an entity that may not have a relationship with that particular OEM. This is even more challenging if the OEM has a direct contractual relationship with the customers. These scenarios would also logically reduce the value by some portion of what these customers represent economically to the dealership.
Contracted Recurring Revenue
In the case of acquisitions, the more contracted and secure the customers are, the better. This allows for a protected customer base. Contracts increase value by creating a more secure transaction, which ultimately translates into a more certain and secure set of future revenue streams. Without a contract, transactions are more vulnerable to competitor takeover. Bundling equipment, service, and supplies into a single contracted monthly payment approach can further prevent customer loss by giving the incumbent dealer and/or the acquiring company even more significant security and protection of the customer base. It makes it nearly impossible for customers to be lost during the agreement term because of the heavy cost of buying out all of the future service and supply – in addition to paying off the financing of the equipment. Bundled contracts also help protect profit margins by allowing for annual escalations to be executed consistently. Finally, this type of contract also creates additional benefits for the buyer because it makes future customer upgrades much more predictable.
If you are thinking about buying or selling, placing some focus on these elements will help you generate a better outcome. If you are looking to acquire, verifying the position of the target dealer around these three areas can help ensure you are ultimately happy with the outcome of your purchase. If you are hoping to sell your dealership, investing effort to improve your position in these key areas will strengthen your negotiations with potential buyers. Finally, if your plan is to continue running the business until you are ready to transition it to the next generation, awareness around strengthening the security of your dealership’s revenue will enhance the future success of the business.
Learn more about bundling and enterprise value:
David Pohlman is executive vice president and COO of GreatAmerica Financial Corp. and a member of the GreatAmerica Office of the President, which makes strategic, financial and operational decisions that set the direction of the company. In his role as COO, he is responsible for the sales, marketing, operations and strategic planning for all business units within GreatAmerica.