In the course of our discussions of deal dynamics and valuations with both buyer and sellers, it has become apparent that there will be even more scrutiny on historical key performance indicators (“KPIs”) and assumptions used to project future financial performance. These are always highly diligenced areas in any transaction, but even more so now as buyers and investors are trying to understand the impact of the pandemic on a business and what its future may hold under various scenarios.
Nobody knows a business better than the owner/operator who has lived the business for years. The tricky part, however, can be for them to articulate what drives their success in quantitative terms during a sales process. A buyer or investor must be confident that the business model is sustainable, and there is an executable plan that will grow the business with a high probability of success.
Often business owners can be so busy working in the business that they don’t have time to work on the business. They know their sales team is performing well because the business is growing, but they don’t have good visibility as to how their sales pipeline has trended, or whether they are getting better/worse at converting opportunities, or from what channel their most profitable new clients are coming into their sales funnel, to name just a few examples.
An M&A process is incredibly educational for all parties involved. Buyers come to the transaction with their perspective of the industry and business and compare the target based on the metrics the buyer feels are most important. Meanwhile, the seller knows what they have used successfully in the past to measure and guide the business, and it can be uncomfortable to be pushed to view their business through a new lens.
Often the seller recognizes during the transaction that there is merit to having a better quantitative history of the business in the form of KPIs. Unfortunately, sometimes this comes too late in the process, and the data is either unavailable, or it is too onerous of a process to reverse engineer the historical data while simultaneously running a business and a sale process.
This lack of clarity can result in a discount in value as the buyer’s perceived investment risk is higher than it would otherwise have been had the data been collected and presented.
We highlight four key metrics categories business owners should focus on. Owners and operators should use this list as a starting point to examine their business, understand what data they have captured, what data they can capture, and put the requisite systems in place to help better run their business. In doing so, they will obtain valuable information that will help them when they consider a recapitalization or an ultimate exit down the road.
The foundation of any business is its customers. Understanding the historical unit economics at the customer level will create confidence in the ongoing operations and provide the foundation for modeling future growth. Some KPIs to consider include:
- Revenue and margin by customer
- Business mix by customer
- Recurring/reoccurring revenue
- Cost of customer acquisition
- Long term value of customer
- Customer tenure / retention
- Customer churn / net new customers
Sales and Marketing Data
Once an owner understands who their ideal customers are, it is crucial to systematize and optimize the process of selling into that type of client. Some KPIs and concepts to consider include:
- Detailed description of the sales process and typical sales cycle
- Historical pipeline over time, including derivative KPIs…
- Average time through each stage of the sales funnel
- Average conversion at each stage of the sales funnel
Budget and Projections Data
The data captured in the recommendations above create a foundation for projecting future performance. Ideally, the company can use actual historic KPIs and financial data to more accurately project near- and mid-term performance at a very granular level. The business owner should be able to provide:
- Detailed description of budgeting process (should be rooted in historical KPIs for credibility; assumptions need to be defensible)
- Anticipated customer level data of recurring, new and follow-on opportunities (bottoms-up build of the projected financial model)
- Employee related costs built off actual company census and anticipated hires/terms over foreseeable future
The last significant area of consideration will be the anomalous events, both positive and negative, that have impacted the business in the last few years. These events could include one-time insurance proceeds, litigation costs, or other non-recurring items that create “noise” in the historical financials.
These could also include “Pro-forma” type of adjustments like investments in infrastructure that make the business more efficient and profitable, the benefit of which would have accrued to the seller had they only done it sooner. There is a lot of grey area in these adjustments, and this is where a quality of earnings report (“QoE”) can be very helpful in getting a third party to independently validate the proposed adjustments to show the business on a normalized, stand-alone basis. Sellers must be able to:
- Provide a detailed description of any non-recurring adjustments to a normalized rate with quantitative backup
- Note, “non-recurring” and “normalized” will require discussion and should be defendable
- Demonstrate intellectual integrity
- Positive and negative adjustments, at both the revenue and expense categories, should be considered – not all adjustments will necessarily be in the seller’s favor
KPIs can be specific to industries and even businesses; the KPIs tracked by an e-commerce business will vary greatly from a SaaS platform or a manufacturing company. These KPIs are just a few of the main concepts that can support a company’s value during the process of a sale or refinancing. Moreover, even within each of these concepts, there may be a variety of ways to calculate the underlying KPIs based on the data available.
Today’s M&A and capital markets are rapidly changing, and the near-term future is uncertain. Each business faces its own unique set of circumstances and dynamics, which is why it is vital to work with an experienced advisor that can guide you through the process of preparing for a transaction or capital raise, even if it is potentially months or years away.
Livingstone is an international mid-market M&A and debt advisory firm with offices in Beijing, Chicago, Düsseldorf, London, Los Angeles, Madrid, and Stockholm. We have deep industry expertise, and extensive global coverage, with dedicated teams across our offices serving the Business & Technology Services, Healthcare, and Industrial segments and close an average 50+ transactions annually.