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That’s not a downward trend! Let’s normalize revenues

By / August 23, 2018

revenue

One of the worst red flags for an acquirer is when they see your revenues drop in the year you sell your company compared to the previous year. Even worse is the following scenario: You show a good solid symmetrical increase in revenues over a number of years, only to have revenues go soft just before a sale.

For example, assume that you want to sell your company this year. Looking back over three years financials, let’s say that your company booked $20 million three years ago, then $22 million two years ago, and then—a banner year!—$27 million last year.

That’s a nice growth path. You added $2 million and then $5 million to your revenue. What’s not to like?

But let’s also say that in the year of sale your revenues declined to $26 million. Even though your company has experienced solid gains in revenue growth—moving from $20 to $26 million over three years—it appears as though your revenues are falling from $27 million to $26 million year-over-year at the time of sale.

Since we obviously don’t have data about next year’s sales, a $1 million drop in sales year-over-year will be perceived as the beginning of a downward trend by an acquirer who is looking for any reason to lower the purchase price of your company.

How do you argue for maximum valuation, when your company seems to be losing market share? The answer: Normalizing your revenues.

In a situation like this, your investment banker should dig deeply into the reasons why your $27 million year was so strong…and an anomaly. Maybe a huge housing development got platted out and permitted, and you scored all the window, door, lumber, and truss business. That one-time occurrence was a fantastic boost in your revenues. Let’s say it was $3 million in unexpected revenue. You know it was a “sugar high” that may not repeat, but why should you be punished in the valuation of your business just because of this one-time event?

The best approach to take here is to have your investment banker write an explanation of this in the informational memorandum (the document that describes all your operations and financials). The investment banker should make a bar chart or infographic that shows that what’s really happening to your company is the following: You are growing at the rate of $2 million a year. You booked $20 million three years ago, $22 million two years ago, $24 million (normalized) last year, and $26 million this year.

Inevitably the acquirer will say, “Wait, you didn’t book $24 million last year. Says right here in the financials that you booked $27 million!” You and your investment banker should respond: “We actually booked $24 million in a normalized revenue projection and, as you can see with this evidence we have presented, a huge one-time project gave us an anomalous boost of $3 million in revenue.”

Since you are not going to have your valuation pegged to last year’s revenue (or only partially so), it actually behooves you to show symmetrical $2 million increases rather than to reveal a phantom “downward trend” in revenues represented by the “drop” from $27 million to $26 million.

Why wouldn’t you want to take credit for that sugar high of an unusual incremental $3 million boost in revenue? Isn’t it better to just own that as evidence that, well, it might happen again?

As nice as it is to show such strong recent revenues, acquirers want revenues and growth that are sustainable. The sustainability allows them to plan and predict. If they know that a company will increase sales by $2 million a year, that’s marginally more attractive from a planning point of than revenues that are asymmetrical, up one year, down the next.

All of that said, can you get credit for a $3 million flush of orders from another new development in your service area? You certainly can. In the informational memorandum, a good investment banker will have surveyed forthcoming new projects/planned projects, and baked in the possibility of you obtaining that work in the future. Although those future jobs are not nearly as valuable as actual booked revenue, they show promise for your markets, and that should help infuse a sense of optimism in the mind of the acquirer, which will probably affect the valuation in positive way.

John D. Wagner

John Wagner is a managing director at 1st West Mergers and Acquisitions, which offers a specialty practice in the LBM sector. To learn more, contact John at: [email protected], or visit www.1stwestma.com.