I attended a mid-market summit hosted by a leading investment bank in New York City some time ago. An executive of the firm recounted some of her most memorable experiences on two high-profile initial public offerings: United Parcel Service (UPS) and Martha Stewart Living Omnimedia Inc. (MSO). It was fascinating to hear the strategies her team used to create valuation premiums during the underwriting of the stock before going public. It also dawned on me that these strategies can be relevant in the exit of mid-market businesses.
Private Business Exit vs. IPOIn an IPO, essentially all or part of a company is being sold to the general public. At the date of the IPO, a team of investment bankers must price or underwrite the stock. Of course, the investment bankers will put the best spin on that stock to obtain a premium, but, ultimately, the market dictates that stock's true valuation. This is not all that different from the sale of a mid-market business to a third party.
Value Creation Strategies from United Parcel Service's IPOUPS went public on November 10, 1999 and was a leader in the package delivery industry. In any valuation, the normal protocol is to establish market comparables to gauge a range of potential valuation. The obvious comparable for UPS was, of course, FedEx, but the management was dead set against using them in the "comp set." UPS felt that it deserved a higher valuation than its industry peers.
So, the investment bank in charge of taking UPS public used a different strategy. Rather than comparing UPS to its own peers, it compared the valuation premium of "best of breed" companies from other industries. That meant looking at the share price premiums between Coca Cola and Pepsi, Home Depot and Lowes, and Walmart and Target. The investment bank also highlighted UPS' superior financial and operation performance directly against FedEx.
How This Applies to the Sale of a Mid-Market BusinessIn essence, the lesson is this: If you think you've built a great mid-market business, don't settle for the industry market comparable to predetermine your valuation. Consider using the "best of breed" strategy to compare to market leaders in other industries. To do this you will need to:
- Determine if you are Best of Breed.
Perform a financial analysis of public companies in your industry, including a review of their profit margins, return on equity and return on invested capital. Are these metrics in your company superior to your industry peers? If so, a best of breed premium might be justified.
- Calculate a potential range of valuation multiples in your industry.
Obtain the market caps for public companies' comparable in your industry and calculate the TTM EV/EBITDA. This will provide you with current valuation ranges for your peers.
- Select a few adjacent industries that may be relevant to your own.
Are there companies with dominant positions in their own industry that command best of breed stock price premiums over their competitors? If so, calculate the quantum of these premiums and apply it to valuation multiples typical in your industry.
This is undoubtedly a very aggressive strategy for most mid-market businesses. That said, performing this exercise can still drive valuation premiums for those companies that deliver superior financial results compared to other industry participants.
Value Creation Strategies from Martha Stewart Living Omnimedia's IPOOn October 19, 1999, Martha Stewart Living Omnimedia Inc. (MSO) went public on the NYSE. According to our hosts at the mid-market summit, one of the greatest challenge with this IPO was the fact that the company's value was closely tied to Martha Stewart herself. Investors were fearful that if Stewart was ever hit by the proverbial bus, the company's stock would plummet. Although this was a real risk, the lead investment banking firm set out to prove that the company had an extremely deep management team. The investment memorandum highlighted the importance of each director and executive officer as well as the key creative personnel. MSO's advisors also performed masterful work in presenting Martha Stewart as a brand rather than a person. The strategic use of the word, "omnimedia," served to illustrate that the company was a media company with many different platforms, including print and television.
How This Applies to the Sale of a Mid-Market Business
The MSO IPO showed that personal goodwill can be an issue even for the largest multinational company. Investors and corporate buyers discount the value of companies when owners are intimately involved in the business because of the risk this poses.
So, what can a mid-market business owner do to prove that the success of a business is not solely tied to its founder or CEO? Take some of the lessons learned from the MSO IPO:
- Build a deep bench of talented executives.
If you have a team of top level talent, take some time to document their expertise and qualifications. Better yet, have your employees do it themselves.
- Establish a brand that goes beyond the owner.
Make sure that customer relationships are owned by the company rather than individuals. Plus, although many great companies are named after their founders, such as McDonald's, Gillette and Disney, it's important to find opportunities to associate a company name with quality of service or great products rather than any specific person.