Value Drivers in Middle Market M&A Transactions

The value of a company is determined by more than just the financial numbers. Two companies in the same industry can have the same EBITDA (Earnings Before Interest Taxes Depreciation and Amortization), but one is worth 8x while the other is worth only 6x. There are numerous factors that drive value, the most common are as follows.

Serving a large, addressable market drives value because it offers significant growth potential in terms of growing market share. An addressable market is one that is fragmented, meaning no one company is large enough to move the market in a particular direction. Consolidated markets offer far less avenues of growth as the biggest players often dominate the industry.

Scale, or the size of the company, can create a defensible market position and pricing power. Scale also yields operational efficiencies that create a competitive advantage and higher margins.  A company with scale can be a platform for acquisitions. Platforms typically trade for a higher multiple.

Being a leader in one’s respective market is essential as it leads to pricing power and is a threat to competitors, especially new entrants. Investors look for industry leaders with client diversification and long-standing relationships with their customers.

Client diversification, which is characterized as no one client representing more than 20% of a company’s revenues and no two clients making up more than 30% of revenues, is essential for buyers. Overreliance on one or a couple of clients will drive down valuations as it heightens the risk of future cash flows should one of the big clients go out of business or choose a different partner. 

Proprietary technology, processes, and know-how all increase a company’s value. This can be a key differentiator to competitors and can yield higher sales and higher margins.

The go-to-market strategy, or the method of distribution for products and services, drives value. A company that does not control its distribution channel to the end customer has a higher level of sales risk than a company that owns the marketing relationship. Differentiation in the marketing approach can increase brand awareness and, therefore, value.

Financial performance is a significant driver of value. Companies that demonstrate several years of continued growth with improving margins will typically be valued more than a company with deteriorating performance and margins.

An experienced management team that is innovative and nimble is valuable. If the team has experience successfully acquiring and integrating a target, is atypical in middle-market M&A, and can position the company as a platform acquisition. A complete management team (CEO/President, COO, CFO, CRO, CTO) is valued.

Growth opportunities, both organic and inorganic, drive value as investors/buyers will look for 10%-15% growth annually. Organic growth opportunities through future new business lines, new clients, geographic expansion, etc. should be highlighted along with a high-level strategy to implement the initiatives. Inorganic growth through acquisitions should be addressed with specific companies identified, when possible.