How Your Revenue Quality Can Impact Your Future Exit Options

By Eric Bosveld, B&A Corporate Advisors

June 4, 2020

We all know that the actions you take today will influence business performance in the future, and therefore its marketability and value, should you decide to sell. Many of those actions can directly influence the “quality” of the business’s future revenue.

High-quality revenue is generally considered to be sales that are sustainable and predictable, are profitable, and come from a diversity of products, customers, markets, etc. High-quality revenue reduces the risk for any new owner or management team and therefore can increase business value.

For a sale or recapitalization with a financial buyer, such as a Private Equity firm, family office, or private investor, the quality of the revenue is a critical determinant of value, and indeed an important pre-qualifier for many. Many will have their own criteria on how they assess revenue quality. Suffice it to say, that acquisition candidates with narrow product lines, and/or in singular markets with high customer concentration are often a “pass”, even if the business is very profitable. Other financial buyers that are less risk averse or use less leverage to finance their transactions, may be interested, but only when growth prospects are very strong and/or when they can buy “cheap.”

For insider or family transfers, high-quality revenue improves the probability that next-generation management will have the cash flow to pay off a seller note, pay down any outside loans used to purchase the business, or redeem legacy owners preferred shares.

It may be a different story if you are looking for an eventual sale to another industry participant, or a “strategic” buyer, including those that are Private Equity sponsored (i.e. those looking for “add-ons” for a portfolio company they own). Revenue that comes from a wide diversity of customers, markets or products may or may not be an important criterion, and therefore may or may not be reflected in the value of an offer.

Strategic buyers may be interested in your business only because it adds something specific (E.g. a product line, management talent, your facility) to their business that will take too long or would be too difficult or expensive to build/develop organically. If that valued attribute, such as a product line, makes up only a portion of your overall business, the rest of it may be discounted.

Consolidation strategies can create cost-saving and revenue synergies for a buyer, but it is difficult for them to justify paying for redundant products/product lines that could be discontinued post-acquisition. Forward, backward, and horizontal integration strategies all impact the perspective a strategic buyer will have on the value of your business and the importance of your revenue quality.

On the other hand, if the strategic buyer is looking to buy your business and run it as a separate business unit, then your revenue quality is very important.

It therefore pays to know what the key strategic acquirers in your industry are looking for. You can discover a lot by watching and learning from the actions they take in the marketplace. Are they buying companies for their technology, access to new markets, to diversify their product lines, for their customer base, etc.? It may be best to begin to build a relationship with them to better understand their acquisition strategies, but they may be reluctant to share much if you are a competitor or not immediately open to a sale.

You can also build relationships with investment bankers/M&A Professionals focused on your industry. i.e. those that have regular discussions with senior leadership at strategics and understand the types of acquisitions they are pursuing.

It is a mistake to assume that a strategic will always value your business higher than a financial buyer unless you build your business and its revenue base around what would make it the perfect strategic fit.
A lot of entrepreneurs with no immediate plans to sell, simply hope that one day a big industry executive will just drop off a huge cheque. They are usually disappointed. Others hope to transfer to insiders like family or management but don’t decisively work towards building high-quality revenue streams to ensure the business can be paid for. If a sale to Private Equity is an option you are considering, the actions you take today to improve your revenue quality should pay off by generating interest from a larger pool of financial buyers willing to compete for the opportunity to invest in your business.

The key is to know the exit path you want to take well in advance of your planned exit and to think strategically about the quality of revenue. The sooner you decide your optimal path, the better you will be able to shape the business’s revenue quality to ensure that path is viable.