No self-respecting buyer or major investor will take your word that your financial health (and your perceived valuation) is what you say it is. Acquiring companies spend a lot of money to prove that your EBITDA multiple is either wrong or at least doesn’t exactly correspond to the market comparables. During my years at EY, the financial diligence for an acquisition would often uncover concerns proving the price of the target company was not aligned with its financial history. It was so commonplace that a robust ‘red flag’ report was hardly the exception.
What’s Your Story?
The symptom that we observed is that the company’s financials told a very different story than the executive team told, understood, or believed. Unfortunately for the acquiree – numbers don’t lie. Eventually the exceptional revenue, the temporary favorable cost structures, and the like, will be aired for all to see when a potential acquirers hired detective unearths the ‘truth’. So how do you tell a story with your financials to create a great valuation story? Here are three lessons I have seen companies learn the hard way:
- Building your story, rather than just telling your story. When the time arrives for a financial event, you shouldn’t be telling your story for the first time. Your story begins with the very first dollar earned and spent. If you’re building a software business, there are clear and established successful financial models to follow. The same goes for manufacturing, computer hardware, services, etc. You can’t twist your generic “Revenue” category at the 11th hour to tell a new story. Build your story from the first dollar.
- Get as granular as possible in your revenue and cost accounting. The generic “Revenue” example above is a good starting place for this point. How many different types or streams of revenue do you have? One time? Subscription? Product sales? An asset sale that no one will give you credit for? It’s easy to make it appear as if you had a banner year when all you did was sell off a manufacturing plant. Rest assured, the diligence team will uncover that, and you’ll have to tell that story, which can and usually will, take away steam from your value story.
- Align operations planning with revenue planning. Are you projecting hockey stick revenue growth? Revenue requires support. Fast growing revenue requires fast growing headcount, facilities, equipment, manufacturing capacity, etc. If your operational planning doesn’t align with your revenue projections, your story will not hold up.
It’s Not Too Late
In the end, you have to exert control over your business. When you’re at a liquidity event (IPO, acquisition, fundraising, etc.), the story you tell on the road show or in your pitch must match the story your financials will tell. Are you too late in the game or too close to a financial event to adopt the above? You might want to hire a sell-side diligence team to do some self-reflection so you know where the skeletons are hiding.