The goal of any startup business owner or venture capital investor is to turn a profit on the investment of their time and money. However, a harder question to answer is how exactly they will go about making that profit. According to Deloitte’s 2020 Startup Benchmarking Survey, 82% of startups have some form of exit strategy. Of those, 29% plan to IPO, 32% plan for a merger, and 39% plan to be acquired by a larger company. Furthermore, PWC’s 2021 Mid-year update on Global M&A trends reports that capital in the private markets has never been higher. Approximately 400 special purpose acquisition companies (SPACs) still don’t have a target, and they contribute up to a half trillion dollars in combined cash and leverage to the M&A market.
So, how does a company stand out in this competitive environment in which 81% of startups planning to exit are going the M&A route all competing for the same half a trillion dollars? Business leaders are realizing that cost-cutting is no longer enough to create value; revenue strategies that promote long-term growth are at a premium, and M&A buyers are willing to pay top dollar for it. Two simple, but effective, strategies for increasing a company’s valuation and becoming more attractive to buyers are creating a consistent cash flow and automating business operations.
Consistent Cash Flow
Buyers want businesses that have consistent cash flows; they don’t want to buy a business and then wonder where their next check is coming from. A recurring revenue business model is the key to achieving a steady stream of revenue. There are several different types of recurring revenue business models, including hard contract (an apartment lease where you have an up front contract and pay a pre-determined amount each month), auto-renewal (a digital content subscription that continues until you cancel it), sunk money consumable models (a coffee machine where you use the same machine and buy single serving cups), and more. The wide variety of different types of recurring revenue models means there is one for almost any type of business.
Business owners might be reticent to change to a recurring revenue business model because the per unit revenue is lower, and sometimes the overall revenue is also lower. However, it is important to keep in mind the big picture question: What does an M&A buyer want? In this case, a buyer would rather see recurring revenue and consistent cash flows at a lower revenue than inconsistent cash flows with slightly higher revenue. If a company’s operations can sustain the decline in cash flow when converting to a recurring revenue model, the resulting valuation multiple can jump up to 300% – from 2-4x earnings to 6-12x earnings. This drastic increase in valuation is because the buyer is confident in a steady stream of continued earnings.
Buyers don’t want to buy a business only to work 80 hours a week to enjoy the cash flow – that is buying a job, not a business, and nobody wants to pay millions for a job. A buyer wants to come in and have everything running smoothly with as little input and busy work as possible. In this area, automation is key. For almost every aspect of business, there is an app or software that can automate tasks and make things run more smoothly and effectively. Moreover, the ubiquity of offerings for these automated processes has resulted in inexpensive subscriptions to each; it is no longer expensive to automate business operations. Not all business processes can be fully automated, but many can. And many processes that can’t be fully automated can be partially automated, making employees’ jobs easier with fewer errors. As the saying goes, “Work smarter, not harder.” Automation will allow you and your employees to focus on providing a great customer experience and improving product and sales, thus driving revenue and growth.
The key to increasing a company’s valuation and standing out in an extremely competitive crowd is all about making life easier for the buyers. Business owners need to show the potential for consistent revenues and long-term growth in order to attract M&A buyers. An attractive business is like a tree that gives an investor both fruit and shade – a steady revenue stream provides sustenance, and automation offers a place to rest. A recurring revenue business model provides the consistent cash flow that a buyer is looking for, and automated operations minimize the busy work and allow buyers to focus on improving and growing the business. In the M&A market, valuation is all about the business model, and these aspects will drive a company’s valuation sky high.