How To Maximise A Buyers Finance Model To Your Advantage

What do ROI and IRR mean and how can understanding them help sell my Company?

All astute Business people, and in particular financially driven Buyers (Venture Capitalists, Private Equity Firms etc), will know the cost of equity and will only make investments that provide a return in excess of that cost within a reasonable timeframe.  In general terms, financial Buyers of SME Companies are looking for a Return on Investment (ROI) or Internal Rate of Return (IRR) in the range of 20-35%, depending on the sector of operation and the risks associated with that particular industry.  Providing proof to this type of Buyer that purchasing your business at your valuation expectation will allow them to achieve the IRR thresholds they are looking for is vital.  

How can I calculate this?

Here's a step-by-step summary of how you perform the analysis:

For example, if I want to sell my Company which has a £2 million value expectation, for simple terms let's say that an appropriate debt-to-equity ratio in the current M&A environment is 50 percent debt and 50 percent equity.  In this case, an acquisition of my business could be financed as £1 million in debt and £1 million in Buyer's equity.

What happens next?

1.  The first stage is to understand how the acquisition of your businesses will be financed, as this is pivotal in positioning your Company at an attractive IRR.  Talking to a finance firm, Bank or broker who specialise in M&A deals in your sector will allow you to confirm the current level of debt to equity which deals are being based on.  Once you have this information you can use this ratio and apply it to your value expectations to see whether they are realistic in the current market.  

2.  The next stage is to determine the forecasted sales, overheads and free cash flows of the business over the next five years, including the cost to service the debt amount used in the acquisition.

3.  Calculate the equity remaining for the Buyer assuming that the Company will be sold after five years at a conservative multiple of EBITDA (usually the same as the entry multiple).

4.  Use the initial equity investment determined in No.1 above, the free cash flows after debt servicing in No.2 and the equity remaining for a Buyer upon a subsequent sale in No.3 to calculate the potential IRR on their investment.

Hopefully, this analysis proves that the valuation of your business will earn your Buyers a return on investment in line with industry standards, or ideally a much more higher and attractive uplift. If not, you might have to reassess the reasonability of your valuation expectations. Effectively in this analysis, you have taken the Buyer's IRR and used it to your advantage, creating a ‘win-win’ scenario when negotiating a deal.

Valuing a Company is more common sense and financial calculations than science or magic, and of course every Buyer will value you differently, the key is to find the Buyer who will pay the highest price and effectively has the greatest need for the acquisition to occur.  If you are prepared to instruct advisors who know the market and how to tailor information for each individual Buyer, you can work toward getting the valuation you want.

Adam Croft, Senior Business Broker

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