As we continue our series on Business Valuation, we go to Transworld of the Gulf Coast M&A Specialist, Bill Whiston, for his perspective on industry conditions and how they impact the value of your business. Bill has many years of experience as a business owner and business advisor and is our go-to resource for our M&A transactions.
What Industry Conditions Drive Business Valuation?
Understanding industry conditions is not an easy feat. To generalize is difficult as every industry has its own specific value drivers and industry conditions. In previous articles, we've talked about economic conditions, but industry conditions are largely based on the following factors:
- Is the industry overall growing or shrinking?
- If the industry is growing historically, at what rate? And why?
- Is the growth projected to continue, accelerate or slow?
- What is the total market size potential (in terms of $ spend)?
- Does the industry have high barriers to entry?
- What is the competitive environment in that industry look like today, and in the future?
- How much risk does technology change influence (or perhaps make obsolete) the industry?
- Is the industry fragmented (made up of a bunch of small players)?
- Is it consolidated already or experiencing consolidation?
- Is the M&A activity robust, full of strategic buyers or not?
Industry Potential for Growth
Growth potential in an industry is a significant value driver when it comes to determining the value of your business. When you look at different industries, like the restaurant industry, for example, trends impact value. During the pandemic, when restaurants were forced to close, clearly the industry conditions had a negative impact on valuation. This year, the National Restaurant Association predicts growth in the industry as higher menu prices drive revenue. But there are also challenges, including higher food prices and increased competition.
In other industries, let’s say, ones like magazine publishing or coal mining, there is a dim outlook as these industries have been shrinking over time and are forecast to continue that pattern. These industries are clearly at a disadvantage in terms of business valuation as it is difficult to attract buyers to a dying sector.
Leader.com ranks healthcare, personal care and services, travel leisure and hospitality, and commercial and residential construction among the fastest-growing industries this year. While this is important information, you should also consider the historical growth over time and long-term trends for the future.
Technology is another factor that can determine the potential value of a business and its future growth potential. How much risk does technology have in the industry to change, influence or perhaps make it obsolete?
Note on Industry - Valuation Multiples
While the focus in this article surrounds Industry Conditions, there is no question that different industries drive very different valuation multiples. For example, the tech sector drives incredible (illogical) multiples. Telecommunications and fiber optics almost always require customers to pay for a subscription and often have multi-year contracts. Since the revenue is locked, a buyer knows that revenue is going to continue without having to heavily adjust their risk factor of achieving such future cash flows
Take the opposite end of the scale. Think project-based industries (such as homebuilding or business brokerage). Most of the time these businesses’ value is derived off the pipeline of the business. Therefore, the multiples in these industries are much lower.
That said, if a business in a particular industry can think outside the box and find ways to take a predominantly project-based business and transform it to a recurring revenue model, then your business value can outperform others in the general industry. We had one client who was a wedding photographer and decided to pivot to team sports and school pictures. That change created a much more valuable business model for someone else to purchase and scale, and it sold for a much higher multiple than its industry peers.
What is the total market size potential (in terms of $ spend)?
Sometimes, for instance, we run across companies that are so niched their entire U.S. market demand might only be $25 million a year. On the other hand, the industry could be a $100 million or multi-billion industry. When you identify the market potential, you have an idea of know how much of the pie there is out there to go out and win.
Does the Industry Have High Barriers to Entry?
In looking at a business from a buyer’s perspective, it is important to understand what you need to know to enter the industry. Things to consider:
- What industry knowledge is required?
- What equipment is required?
- What technology is required?
These factors can create barriers to entry, so you need to understand how difficult or possible it is to overcome them.
What is the competitive environment in that industry look like today, and in the future?
If the industry is fragmented (made up of a bunch of small players), it can be appealing to larger companies or private equity firms that would like to expand their market in a region. It often makes more sense for them to acquire smaller companies that already have a significant market share in a particular region rather than expanding into that market as a competitor. If the industry is consolidated already or experiencing consolidation, it can make it less opportune for someone to come in and acquire. It.
Another factor to consider is M&A activity. Is it robust and full of strategic buyers or not? As we like to say, “One buyer is no buyer,” so the more activity you have, the more competition there is and the higher that competition drives the value of businesses in that industry.
How Transworld Helps You Get the Best Deal as a Seller
Our advisors help you understand the conditions that exist around your industry. Most of these are not within your control, so navigating the conditions as they exist to help you get the best prices for your business is where we come in. We understand the different industries, how they play in your local market and who your ideal strategic buyers will be. We help you target them, create a competitive buyer field and get you the best deal possible.
Within those industry conditions, we help you strategize your specific business conditions to compete in the market. Often, we talk to sellers who do not understand that they have some strong value drivers. They may have a great position within their industry, and they don't realize exactly how to take advantage of each of their intellectual properties. For example, you can have a company that has branded and named some of its own products. It has a strong reputation in the market. But if they have not taken that name or that brand and had it secured legally as intellectual property, they may not maximize the value of their company.
As business advisors, we help guide them to understand their greatest assets and ensure they protect their business value. That intellectual property can become a line item in the sale that increases value. We also look for and target strategic buyers and private equity investors who understand the industry and recognize that it’s going to be sustainable or that a business’s secret sauce is going to make work despite industry conditions.
When you're in an attractive industry, it drives competition. Part of our process is to make sure that we're driving as much competition from buyers to a seller's business as possible.
Evaluating Industry Conditions
It is important from both a buyer and seller perspective to understand the conditions specific to your industry when making decisions on buying or selling. With a seller, we research the industry conditions specific to their business. And when we talk to buyers, generally, if they're looking at a certain industry segment, they are already very tuned into what the industry conditions are. If they're not, then we'll help them with the research and tell them what they can expect when they jump into an industry.
We also help clients understand the risk in future cash flows and how different industries often trade at higher multiples. And to dig a little deeper, you have to peel the onion back and understand that certain businesses may actually be applied in several industries. When that happens, we look at what component of that business may be a higher multiple from a market perspective, like subscription-based businesses with recurring revenue. Others, like construction-related businesses, could be seen as a lesser value because it's driven based on projects and one-time earnings.
A Real-World Example from Our M&A Specialist
After 20+ years of running his business, Bill Whiston, our M&A specialist here at Transworld of the Gulf Coast, sold his industrial distribution company. When he started looking at exiting the business, it had a great reputation on the market, had fantastic employees and had strong processes. They also had a strong customer base. While not a large company in the market, they were able to compete with a large national distributor and regularly beat them.
He was approached by buyers over time and was never offered the right price. So, they did a competitive process to sell the business and approached a lot of buyers. Some of them were serious, others were not. But through the process, they were able to find those that were most interested, most capable and had an appealing culture that would work well with his employees. Bill was able to make a great deal with a great company.
In Bill’s case, industry conditions were good. The industry was fragmented, and Bill was a regional distributor. No one could compete with his company in his market. So, a larger company really had no choice but to acquire companies like Bill’s if they wanted that market share. There were a lot of acquisitions happening by the national players, and that's where he saw the value increase significantly. Bill waited until the time was right and the buyers were interested. Creating a competitive situation and recognizing who his ideal buyers were positively impacted his valuation and final sale price. Bill’s personal experience in working through the sale of his business is one reason he is an ideal advisor in the M&A space.
About Transworld Business Advisors of the Gulf Coast
Transworld Business Advisors of the Gulf Coast covers the northern Gulf Coast along the I-10 & I-65 corridors with special emphasis in Mobile, AL to New Orleans, LA. We strive to be the top business brokerage firm in the area and leverage our extensive experiences and our international Transworld platform to run confidential and competitive business sales processes. We help entrepreneurs to buy a business or sell a business, with a focus on helping family-owned and closely held businesses with their strategic plans for the future. Transworld offers a wide range of advisory services to the northern Gulf Coast Region, including Alabama, Mississippi, Louisiana and the Florida panhandle, that are tailored to fit your business needs, whether you’re buying, selling, preparing to sell, or franchising.
If you are ready to sell, or you would like assistance getting your business ready to sell, reach out today at [email protected].
