05 Mar What Should My Company look like to Command a Premium Offer
EPISODE 210
This podcast discusses how tech-enabled services companies can secure premium offers during mergers and acquisitions. Key insights include:
- Deals are typically valued at 6-11x trailing 12-month EBITDA
- Growth rates of 15-25% are crucial
- EBITDA margins above 15% are ideal
- Recurring revenue above 60-70% is attractive to buyers
Critical Elements for Premium Offers:
1. Organic Growth
- Consistent year-over-year growth
- Demonstrated sales and marketing capabilities
- Strong leadership team
2. Profitability
- High EBITDA margins
- Efficient operational processes
- Rule of 45 (growth % + profit % ≈ 45)
3. Market Positioning
- Verticalized focus
- Broad geographic reach
- Specialized service offerings
4. Customer Relationships
- Multi-year contracts
- Low customer churn
- Repeat business
- Strong customer retention metrics
5. Deal Structure
- Flexibility in owner transition
- Balanced risk allocation
- Potential for earn-outs or seller notes
The podcast emphasizes working with M&A advisors like Revenue Rocket to optimize these factors and prepare a company for a premium acquisition offer.
RELATED EPISODES:
Episode 166: Understanding Revenue Models and How They Impact Valuations. Listen now >>
Episode 145: Why Sellers with Vertical Market Approaches Earn Premium Valuations. Listen now >>
Recurring Revenue
Episode 19: The Rule of 45. Listen now >>
Check out our podcast playlist on Organic Growth Strategy >>
EPISODE TRANSCRIPT:
Mike Harvath 00:06
Welcome to this week’s Shoot the Moon podcast, broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. If you tune in regularly, you know that revenue rocket is the world’s premier growth strategy and M&A advisor or tech enabled services companies. With me today are my partners, Matt Lockhart and Ryan Barnett, welcome guys.
Matt Lockhart 00:32
Good to be here. Mike, what do we go? Got going on this week? Ryan,
Ryan Barnett 00:37
Hey Matt. Hi, Mike, thanks for joining us to this week. You know, we’re always talking about things that are on our mind and things that we’re dealing with on a daily basis here at Riven rocket and in the M and A world in which we work on we’re talking with companies all the time who are really looking for premium offers for their tech enabled services business. So today, Mike, Matt, I’d love to hear your take on what does it mean to get a premium offer in this market. And if we look at a company, what kind of things can a company work on to help get to that premium offer? Now, Mike, why don’t you set us up in on the highest level, typically, how are deals valued in the tech services space? And just get us going on this, on this topic?
Mike Harvath 01:21
Yeah, sure thing. Ryan, so certainly deals are valued throughout the tech enabled services space on a multiple of EBITDA or profit, it’s important to optimize that profit as a percentage of revenue in order to command a premium. That’s not the only thing that’ll help you command a premium, but certainly that is one you know, you’re going to want to grow your business at a nice cadence every year, and hopefully within the top quartile your peers, from a growth rate perspective and from a profit perspective, will help command a premium, obviously, a mature business, you know, With systems as it relates to processes and staffing, will also help command a premium. And I think, depending on your your thoughts about how you want to proceed in the business, whether you’re selling in or selling out, and and how you present your role, both pre and post transaction, will help to you you know, there’s various nuances there that certainly will help you command a premium as you go to market.
Ryan Barnett 02:27
Okay, and Mike, if I said to back up a little bit, I mean, if you look at how valuations are done in this space, what’s the typical metric someone’s going to look at for, just to give a big range of ideas here,
Mike Harvath 02:40
yeah, Thanks, Ryan. You know, essentially the multiples range probably from six to as high as 11x trailing 12 month EBITDA, depending on the side of your firm, the focus at your firm, the amount of reoccurring revenue in your firm, and frankly, some of these other things we mentioned earlier in the podcast, as it relates to how you’re operating the business.
Ryan Barnett 03:02
And I think that’s the bulk of what I want to jump in here, Mike, so thanks for setting the stage. If I heard you correctly and parroted it back, typically, we’re going to see a offer is going to come in that’s based on your EBITDA, your adjusted EBITDA. And that offer can can be a big range from we’ve seen buyers that might lowball something in a very low range of three times EBITDA, and buyers on the other end that, if you’ve got a large, diversified platform, could be Well, well, well above market of where they’re at. So today, you really want to hack into some of these things and some of those questions that we’ve got around if you’re trying to sell your firm, what things should you focus on? So, Matt, why don’t you get us started on you really focus on a lot of sales, marketing related efforts? Can you get us started on what kind of growth is needed to receive a premium type offer?
Matt Lockhart 03:57
Yeah, sure. Ryan, you know, obviously there’s, there’s not, there’s not one answer here. There’s a bit of a dependency upon what type of business it is, the recurring revenue levels, etc, etc. But needless to say, demonstrating organic growth, right? So that’s non acquisitive growth is absolutely critical in receiving a premium offer, you know, and that, and the growth rate, again, can can range a little bit between sort of sub industry within tech services, but at a at sort of a bare minimum, I Think, to be thought of in the premium category would be 15% growth rate, and that’s in the case of sort of recurring revenue businesses. If you’re looking at a mix of business or revenue types recurring, non recurring, etc, etc, then. And, you know, I think that it, it’s a good baseline number to have in place would be 20% year over year growth rate. And if you want to really get people’s attention that you’ve built a premium sales and marketing go to market, you’ve, you’ve got the wheel nailed and and you’re you’re been able to demonstrate that you can do that on a year over year basis, and you’re somewhere in between 20 and 25% growth rates are above 25% growth rates on a consistent basis, then you’re certainly going to be getting people’s attention because investing in businesses like that and expanding upon the great work that has been done in that in that growth business, I think, you know, is super appealing.
Ryan Barnett 05:57
I think thanks Matt. The higher the growth rate, I think the better the multiple is that the general consensus, reasonable growth with the that is proven. I think that’s a big part. If you look at, for example, a forecast that has a hockey stick growth that’s going to be questioned by buyers. So understanding there’s a proven history of growth, this is certainly one way to help increase the multiple. Mike, we talk a lot about the rule of 45 and how growth and profit come together. If you’ve got essentially the rule 45 is your your revenue, your growth percentage plus your EBITDA percentage, could be around 45 Mike, how? How does profit and profit percentage, either in a gross margin or an even a percentage? How does that impact getting a premium offer,
Mike Harvath 06:12
you know your profit as a percentage is important in your in your business, certainly you’ll want to be in the top quartile of your peers and in order to command a premium. And I think in our industry, you know, all the best performers are performing north at 15% EBITDA. Certainly we see, you know, firms perform north of 20% EBITDA, 2022 23 tends to be, you know, a top, I don’t know, I would say 5% of the firms in the market perform at that level or above, unless you’ve implemented sort of what I would call new technologies around AI, that disintermediate labor. It’s very, very difficult to get above, you know, 22 23% EBITDA, so certainly more is more. When it comes to looking at a multiple on EBITDA, very profitable firms that are growing will command the highest valuation.
Ryan Barnett 07:55
And if you think about that margin profile, more profitable is better. Matt, is there a kind of absolute size? How does just a pure relative size of a firm in revenue and EBITDA? How does that start to look at that, the offer structure, or the the the the range of perhaps an EBITDA analysis here?
Matt Lockhart 08:17
Yeah, again, and I hate to do it Ryan, but a bit of qualifiers based upon the sub market, right? So, you know, for example, in the the MSP marketplace, for example, I mean, there has been so much activity, there’s been so much consolidation that, you know, the levels are becoming pretty well understood, right and and premium, and maybe characterizing premium as being a double digit multiplier opportunity you know really are going to exist when you’re probably north of $4 million of EBITDA. And now that’s not too far off of the general tech services marketplace, you know, but you know, some specialty offering firms, be it cloud based firms, you know, etc, etc, could be a little less than that in EBIT, If they are, if they’re truly specialized, the more generalized and the more you know, sort of project related revenue, non recurring revenue, you know, then you’re, you’re, you’re going to need to get into those higher, higher signal digit EBITDA numbers, right? 6-7-8, $9, million of EBITDA. Until you’re going to get into that, you know, super premium category, I think
Ryan Barnett 09:53
So, having that growth, that organic growth, paired with the profitability and paired with an absolute. Size is just some of the foundational metrics that we’re we’re talking about. Mike, how does a company’s target market play into this? And when I think about target market, I think about the geographies they serve, or the niche industries that they might go into. Our firms that are specializing or have a centralized focus. Are they getting premium offers?
Mike Harvath 10:27
Absolutely, you know, firms that are verticalized and tend to be more broad from a geographic perspective, tend to get a premium offer versus more of a, you know, what I’ll call a geographic generalist. We’ve seen that over the years. It certainly continues to be more important, particularly if someone’s building on a thesis around that vertical market, or an adjacency to that vertical market, it can command as much as a one to 2x even a multiple premium, with everything else being equal, based on what we’ve seen. And so, you know, we’ve long talked about the value of verticalization. Certainly there’s, there’s a, you know, reduction in competition for verticalized firms, typically, and typically, they tend to operate at faster growth rates and higher EBITDA margins. Couple that with EBITDA premium being paid for those with the right buyer, you know, certainly all that adds up to getting an optimal offer. So
Ryan Barnett 11:31
if we’ve got growth here, and we’ve got EBITDA percentages in size, Matt, and you’ve got focus again on the market, how does the team structure need to look for when? And I’m focusing here on really sales and marketing, perhaps team the the team structure and the processes in place to help create that growth engine. How much? How much does a firm need to really invest in that those growth functions to help facilitate that premium type offer.
Matt Lockhart 12:06
Well, I think that our listeners probably have have heard the term, you know, platform, right, in the view of a business as a whole, right? So, but there’s, I think there’s multiple sort of sub platforms right that create the foundation that enable a buyer to see a firm, as you know, as a high growth business, right and and as we talked about, you know, having that, having that demonstrated capability and demonstrated history of growth is is critical, but a buyer needs to see that that foundation is in place that allows, you know, continued investment and to be able to maintain and or accelerate that growth rate. Right? So certainly, having key leaders in, in, you know, sales and marketing, be it a Chief Revenue Officer or simply, simply Senior Vice President, Vice President of Sales and Marketing, but again, demonstrated leadership and thought leadership in in the role as well as, you know the the the appropriate, you know, subject matter expertise as it pertains to the market. You know the offerings and the positioning, what customers are interested in. And then from a sales perspective, again, having the demonstrated experience in, you know, driving the wheel and and when I say the wheel, the fly wheel right, the execution wheel, so that there is a new client acquisition, there’s existing client growth, and Again, a sustainable and accelerated growth rate in the business.
Ryan Barnett 14:03
So if a firm is really able to generate that growth and be able to bring on customers, Mike, how does the role of recurring revenue and customer retention start to play in the valuation process, and, and, and getting a premium offer.
Mike Harvath 14:26
Yeah, great question. Ryan, you know the quality of the revenue is critical. And when you think about someone looking at the business from the outside and being able to come in and play a role, they want to know that you have a history of taking care of your clients and continuing to grow the business. They also want to mitigate risk. And they mitigate risk by seeing that there’s not significant customer churn, that if you have recurring revenue and long term contracts, that creates an additional barrier to. Exit, and ultimately, looking at, in general, how satisfied the customers are with the business, but also, you know, the trajectory of that those trends over time, that gives them a lot of comfort and can absolutely contribute to a premium offer, I think if you have, and it doesn’t matter, really, you know, certainly it’s easier, I would say, to create a recurring revenue model within what we traditionally call managed services companies, but for application companies, custom development shops, you Know, AI development folks that implement applications, business applications, certainly, there’s an opportunity to, you know, build your revenue model around recurring revenue, and the more you can do that, particularly get those numbers, 5060, 70% of overall revenue. That creates a lot of comfort in buyers minds, that you know that’s a higher quality, sort of higher value contract, and that there’s less risk in assuming that business, that that business is going to go away. And so there’s several moving parts here. One is the reoccurring contracts, recurring contracts, but also the repeat revenue and customer turn, you want customer turn to be low. You want repeat revenue to be high. And if you’ve continued to grow the business up into the right and and sprinkle in, you know, a high recurring revenue percentage, and certainly, all those things add up to premium value.
Ryan Barnett 16:40
It’s great advice. I I think the number we oftentimes see is above 60 to 70% recurring revenue is where premium offers come in, and customer retention and churn also plays a big part in that analysis. Matt, you’ve done, done a lot of work here when it comes to the actual contracts and revenue contracts themselves, especially when it comes to managed service providers. Can you just touch on how those contracts may impact an offer, and maybe even the case where a customer, where there isn’t there’s a lot of handshakes in our industry, and I think that we’ve seen great businesses built on some handshake relationships. But how does the contractual relationship of customers impact the offers that people may be getting?
Matt Lockhart 17:29
Yeah, in a recurring revenue business, obviously, multi year contracts with a an auto renewal clause is is sort of the premium that’s the best. And you know, most, I think MSP providers typically work on a one year with an auto renewal. That’s sort of a baseline for a best practice, and many are attempting to move their customers. But that’s, I think that’s where that sort of premium comes in, is it’s not always easy to move customers into that multi year scenario. They need to have a lot of trust, etc, etc. And then is it? Is it truly locked down? Or are there, you know, is it a multi year contract? But it’s easy to get out of in in recurring and non recurring businesses, if you can demonstrate the year over year, repeat client sales. So this isn’t necessarily true, recurring revenue, sort of SaaS revenue based contractual models, however, you are demonstrating that customers keep coming back, right? And they come back for years and years and years, 10 years right, etc, etc. I still think there’s an argument to be able to if, if all the other conditions right, because it’s like a jigsaw puzzle that we gotta put together here to put to get the premium offer in place. If, if, if the other pieces within the puzzle are fitting. You know, there’s an argument that that, you know, we can still obtain that premium offer, even if it’s not the best of the best contractual, you know, recurring revenue. And then again, you know, there’s tons of of tech services, businesses that just aren’t aligned to a recurring revenue model, right? I mean, it’s just, it is the way it is. They as a matter of fact, the vast majority of the market is in a non recurring revenue model. And so there the contracts, there’s best practices in in contracting. But again, we will more point to the historical data that demonstrates real quality of service, because you’ve got customers coming back year after year after year,
Ryan Barnett 19:57
Yeah, they absolutely nailed it that having that. That those repeat and recurring customers are absolutely getting to lead to premium valuations, having the right paperwork behind it matters, and it especially if you’re working, I think, with financial buyers. And when I bring that term, financial buyers into the mix, Mike, when you think about the buyer types that are out there, you know, we oftentimes think of financial buyers or strategic buyers that seems to have a mix on the multiple you may be getting. But also this, I think, brings up the topic of deal structure. So if you’re thinking about, you know, almost anyone could get a huge, even a multiple type offer, if deal structure is a big factor in here. So Mike, can you just tell me the high levels of how deal structure can start to impact the enterprise value that a firm might be looking for?
Mike Harvath 20:52
Yeah, sure thing. Ryan, so if you think about, you know, walking them out in the shoes of a buyer, a buyer is trying to evaluate risk and the risk of till those cash flows moving forward, versus how they structure an offer in a deal. And if you think of the lowest risk opportunity for a buyer, that would be an all cash deal to you as a seller, but they’re taking the full risk weight and risk of that business on and and the fact that, you know, they’re trying to architect a return rate would mean, typically, that there’s going to be some level of discount or lower offer applied to that because, you know, granted all M and A comes with risk, but they want to try to mitigate any potential downside. Should there be some unforeseen issue, or skeleton the closet or a big customer gives them notice post deal as an example that’s not going to allow them to get to their return rates as quickly as maybe modeled or forecasted. On the other hand, if you have a completely at risk model for a seller, or one that’s completely optimized to mitigate the buyers risk. Think 100% earn out type transaction which they are extremely rare, but do do exist. We just got an offer on a client. We’re bringing the market in that manner which, by the way, wasn’t accepted by our client, but, but they do occur, and occasionally do happen and get accepted that allows the buyer to, you know, obfuscate almost all of their risk pursuant to the return rate or the payout because it’s tied to specific milestone thresholds of business performance. And in the end, you know, they can pay a lot more provided the business performs to that level of expectation, because they just, you know, don’t have any risk or very low risk. The reality of the matter is that most offers are somewhere in the middle, right? They include a portion that’s cash, a portion that is sort of a risk mitigation play for the buyer. Think of what we’ll call earn out or contingent payment on future performance of the business. And sometimes there’s other financing vehicles, like seller notes, which essentially the seller will provide financing for a portion of the purchase price, but, but that note is is guaranteed. It’s just paid out over time, not at the time of close. And so you know, when you think about all these different components, all of them impact, what, where the valuation should, should land. These would be the risk profile associated with the revenue moving forward. You hear a common theme there. It’s the same as you know, same impacts as it relates to the offer pursuant to you know, what’s historically as business, business performance look like. How much you know, customer turnovers have been what percentage do you have in recurring contracts? All those things get back to this fundamental question of you know, how much risk is being transferred from the seller to the buyer. As you can imagine, as a seller operating the business, you have 100% of the risk associated with that business. Your goal when you sell is to either sell 100% of that risk or on the lion’s share of that risk, and then you work through getting paid over time to obfuscate all of the risk once the business is completely sold. And so, you know, all those things that sort of the mix and match optimization of the value are will impact valuation, and will certainly impact premium valuation. You know, I’ll put a plug in for having a Quality Advisor, M&A advisor in your camp, like Revenue Rocket, we know what level leverage to pull to get to an optimal value based on cash to variable to, you know, gain share or risk based payment to notes and being able to having had the fortunate being a fortunate position that we’ve negotiated a lot of those, we can bring that, those key learnings to a bear for you.
Ryan Barnett 25:22
And I think Mike, we this is a topic we could certainly discuss all day, but if we take a look at the lens of just addressing some of the things now, I think what goes hand in hand with what you just mentioned in deal structure, oftentimes is really predicated to the owner’s involvement in the business or a management team transition plan. Matt, can you tell me a little bit more about how the that we call it a selling in or selling out, how that could impact deal terms and and getting a premium offer? Yeah, sure,
Matt Lockhart 26:00
you know. I mean, as Mike talked about, the the more flexibility that a seller has, it had, the the greater the opportunity to get an optimal, you know, and or premium offer in in most, if not, yeah, I think most cases, if a seller is looking to exit the business completely and and decrease their transition time, and, and, and that’s the term that, or the term that we use for that is selling out, they’re selling and getting out. Then, you know what typically comes along with that is an ask for the highest level of cash at close. And you know, to build upon Mike’s comments, if you know, the higher the level of the cash at close, the more the less risk that there is for the seller. In that case, you know the assurance of the cash that is going to be delivered. And so what goes along with that is, is, typically, you’re not going to be in the premium, premium category from an offer perspective. You know, correspondingly, you know, if you’re selling in you’re rolling equity, you’re able to give the buyer some flexibility in terms of management of cash flow in a deal, maybe even agree upon a gain share or an earn out scenario. Well, then you’re giving yourself the the opportunity to simply through that structure, increase the offer, and if you’re betting on yourself, which most founder led businesses have done from the get go, if you’re betting on yourself and you’ve got confidence in your business and you’ve got confidence in your team, then certainly a wise move to look at having that flexibility.
Ryan Barnett 28:03
Yeah, absolutely. So first, I summarize what I heard today, Mike and Matt. I heard that growth has gotta be a feature of the business, and you’ve gotta be growing at a more than 10% ideally higher 10, 20, 30% and that’s gotta be paired with healthy EBITDA margins that are above 10, 15% ideally, and then 20 plus percent. I heard that you had to have growth functions and staff in order to hit those growth goals. So it can’t just be a year of owner based sales. It probably needs to have a growth function attached to it to help us grow. I heard that having a target market is going to help increase that, that that offer like get to a premium offer. And I heard that having kind of wider geographies, the ability to serve a wide geography, geographical market can help bring, bring a premium offer. Talked a bit about recurring revenue getting above 60 70% and I heard that repeat revenues really can be looked at as something that can be almost as powerful as recurring revenue if you got the right buyer in mind. And then I heard that if you the deal terms are a big part to this, and if you’re willing to stay in and work on those deal terms that can also command a premium offer. Matt, I’ll turn over for you any last thoughts, but I guess the one question I have here is, how does working with an M&A advisor help you get to that premium offer? What is the role of company like revenue rocket play to help establish all the things we talked about.
Matt Lockhart 29:43
Yeah, well, in our case, I think there’s a few different ways, and we’ve been there. We we got into this business of helping other businesses, like the ones that we used to run, and so, you know, we’ve been in. Seats, and we’ve seen it, and I think that that’s super important. You know, the first way that we can help is is we can help a firm for literally years before it is their time, to help them optimize, to help them increase their growth rates, to help them ready their business for that, that optimal exit, and that’s not a two week, two month process really. I mean it to provide optimization. It, it takes time to, you know, improve some of these levers. And another example is, is you can, you can quickly create sort of leading offerings that have value in and of themselves, right? And so, for example, today, creating a leading AI offering is certainly something, but then applying that in the right way to the target market that you are serving today and you are best known in, again, that’s not a two week or two month process. So there’s a variety of different ways in which we help firms, you know, get ready. And I can’t advocate enough. As a matter of fact, I was a conversation just last week with a former CEO who was, you know, sort of, he was like, Man, I wish I would have taken a little bit more time. And I wish I would have gotten more help from the outside. And so, you know, really can’t stress that enough. And then, you know, obviously, in in bringing your company to market and identifying the very best matches those firms that are going to see the premium value that you bring. In addition to that, running a process that there’s the appropriate level of competition, because that matters in in in helping to ensure you know that optimal price point, so certainly, a variety of ways over time, and as we’ve talked about before, find that advisor that really has that expertise in your space.
Ryan Barnett 32:13
No, great, great thanks, Matt. Really appreciate the insight here, Mike, I’ll turn it over to you for any last thoughts.
Mike Harvath 32:20
Thanks, Ryan, yeah, I think this is an important topic. I think, you know, for many of you, this has been your life’s work. You really do want to take the time to optimize it and get the business in alignment for for a premium offer. I think it only makes sense, and certainly we’re here to help with that. You know, we’ve done lots of what we call M&A readiness type of engagements for our clients and and certainly that leads into bringing you to market to get a above market offer. So that will tie ribbon on it for this week’s Shoot the Moon podcast. Make it a great week. Thanks so much.