Growth: Turn Down for What?

We spend a lot of time talking (and talking, and talking) about revenue trends and earnings trends and successfully selling or exiting from a small business.  A lot of people are going to successfully exit their business.  They’ll do it on their own terms and get a reasonable return for their efforts.  But how do you really knock it out of the park?

I’ll tell you:  you think like these modern kids.  The whippersnappers.  That’s how.  Turn down for what?

The absolute best way to exit a business like a boss is to sell while demonstrating fantastic growth.   The vast majority of companies are sold based on past performance. Consider Company X below.  It’s generated $2 million in EBITDA for the last umpteen years.  So the buyer values it at some multiple (say 5x) of that number, and we all go on our merry way.

Year 1 $2,000,000
Year 2 $2,000,000
Year 3 $2,000,000
Year 4 $2,000,000
Year 5 (Present Day) $2,000,000

But executives and entrepreneurs often want to get compensated for all the sweat and tears that go into getting to that $2 million in EBITDA.  A premium, if you will.  Unfortunately, a buyer can’t afford to pay a premium on this company – it’s a known commodity, earnings are consistent, and there is only so much room for ROI in the valuation.

Now let’s look at company Y:

Rev_growth_Y1

Here we have a company growing steadily.   In this case the seller has more leverage in convincing the buyer that there is further upside.  The company grows every year! Of COURSE I’m not selling it for 5x last year’s earnings.   We’re going to sell it for at least 5x of next year’s earnings.

But the rate of growth is slowing ($500k is a smaller % growth each year).  So while this is a great profile, it’s not quite Rock Star level.  Check out the chart below:

slowing_growth

Now let’s do this one more time.  We want to really crush this exit.  Growing 5ook per year didn’t quite get us there.  The earnings growth on a absolute basis looks pretty, but as the chart below shows us, Company Y’s growth is actually slowing.

{chart= % growth}

Enter Company Z.  Company Z is growing at 30% per year.  So Year of Year, every year in our observable period, the company grows 30%.  What does that do to absolute earnings?  BOOM.  That’s what.

In a company like this, we are much more comfortable basing value on earnings further into the future.  Sticking with a simple multple of earnings, we’re also potentially increasing the earnings multiple.  Why?  Think of this like running a DCF.  Company Z is throwing off a lot more future earnings… which are worth more in todays dollars.

So there you have it. Developing a Company Z is all in the execution, but if you want to exit like a rockstar you have to think like the whippersnapper.  Growth: Turn Down for What??

Final Thoughts

Dan is the Founder of Quantive and Value Scout. He has two decades of experience in leading M&A transactions. Additionally oversees Quantive's valuation practice and has performed thousands of business valuations.

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