Though at times mistaken for an objective in its own right, in reality, value creation is an outcome of building a successful business. A business that is sustainably growing, profitable and cash generative has intrinsic value, whether as an independent private company, a public company or integrated into a larger group. Whilst there is benefit in pursuing early alignment between stakeholders on valuation ambition and exit timing, realising the value created is often difficult to manage to a specific timetable; aim to give yourself options wherever possible.
The scale-up phase is a great time to reassess this thinking. Debate around exit expectations and alignment between investors, founders and other executive management is something that scale-up investors will actively encourage. This leads to the first and most important lesson in realising value: most exits are well planned years before they happen.
What is most important for Exit Value Creation?
Mastering Due Diligence
The discipline of the scale-up methodology assists the business in growing from a start-up to a mature business; it is the same process that makes you fit for exit. The basics of executing on good customer acquisition and retention are still vital to providing visibility on future growth but building a forward-looking value proposition also requires actionable strategy, a growing pool of talent and a scalable organisational structure.
Many of the risks that a due diligence process would focus on become very easy to address if the company already holds these documents and adheres to good corporate governance procedures. The key to both scale-up and exit fitness is being ahead of the curve in investing in high level capacity to spread the load, reduce individual reliance and provide succession planning.
Investor or purchaser due diligence is often seen as a test to pass with the equivalent of last-minute cramming. This runs the risk of distracting key people from running the business and leaving gaps that can be exploited in the M&A game. Equally, significant time and resources are invested in creating important documentation and structure to the extent that it becomes a separate exercise from helping the trading of the business.
Start the process early by overlaying a dataroom request list and identifying what is available to build an in-house dataroom. Next, prioritise filling in the gaps in a methodical way based on the assessment of where the changes will have the most positive impact on trading, employee welfare and productivity or legal risk.
“When I was CFO for a contingent debt collection business, we differentiated ourselves by the integrity and quality of the process. But only by introducing Total Quality Management techniques did we succeed in creating a comprehensive documentation of what we did differently. This made it easier to ensure consistent adherence and provide a simple confirmation of the difference in due diligence. Preparation is vital because purchaser due diligence is an order of magnitude tougher than for fundraising. You will be very exposed if you haven’t developed sufficient capacity in your senior team and resilience in the business to continue high-level performance amidst distractions.” Steven Dunne, senior partner, Frog.
Forging the Right Relationships
For small businesses, it will be rare for large purchasers to make an inbound approach unless you make a strategic decision to build your profile and relationship with them. Corporate communications are important for raising profile but should be targeted at specific audiences (i.e. customers, potential acquirers or market influencers).
For many corporates, a commercial relationship will be required before a transaction can be justified but too heavy reliance on one potential purchaser may put others off acquiring. They might also see different characteristics in the business that they value, e.g. scale in a new merging market, new products, market share or proof of international expansion. Building multiple relationships keeps options open and gives the best rounded insight on routes to realising value.
Building Value Sustainably
Many growth businesses become focused on the valuation of the next funding round and treat each uplift as a success in its own right. Of course, it is important that investors see progress, but they must look forwards, not backwards, as high valuations put large expectations on a business.
An easy way to assess progress is to understand the minimum growth needed after a funding round to justify the post-money valuation excluding cash. Based on some heuristics on the relationship between growth and multiple, a £10m round on a 7 times revenue multiple for a £5m revenue business requires revenue to grow by 43% to justify the post-money valuation, whereas a £15m round would require 54%. This calculation provides the theoretical minimum required to have a next funding round at an increased valuation.
If you don’t yet have visibility on sustainable, profitable growth, then the journey from one funding round to the next becomes the whole focus. If growth isn’t sufficient to demonstrate a value uplift, there is a good chance that the previous value creation is impaired and, in an extreme (but unfortunately not that rare) scenario, lack of funding could see the company fold with zero value. Being in control of your own destiny is the only way to ensure that value creation is sustainable and not a bubble.
Being fully prepared for an exit is wholly aligned with the broader principles of the scale-up methodology, which help build resilient businesses where CEOs have control of their own destiny. The attached toolkit outlines the 11 steps to being successfully acquired, plus the CEO’s M&A Timetable.
About the author
Mike launched Frog in 2009, after seven years in industry and 12 years at 3i. He represents Frog on the boards of Clue, Evotix and Modulr.