How The M&A Market And Capital Raising Market Are Very Different And Why This Matters To You
Navidar | August 11, 2022
We are all familiar with markets, places where buyers and sellers come together—either physically or virtually—to facilitate transactions or the exchange of goods and services.
Markets serve a number of important functions, including matching buyers and sellers, promoting competition, and using prices as signals to allocate resources to their highest valued uses.
This note addresses two very important and separate, independent markets where Navidar and our clients spend a considerable amount of time. The first is the mergers and acquisitions (M&A) market where (most frequently) private companies seek to sell their businesses to prospective strategic and financial buyers and the second is the capital raising market where companies endeavor to raise money from prospective investors, including venture capitalists, private equity firms, and other sources of capital.
Two Key Messages For Our Readers
We develop two central points in this article. The first is that there are likely to be very broad differences in the values offered for your company in these markets. This point may not sound particularly informative, but it is not just the fact that there are differences in valuation depending on the acquirer or the investor, as the case may be, but the extent and degree of those differences that are very important. There will often be a single valuation that is significantly higher than all of the other valuations—what we refer to as the outlier valuation (Unlocking the Secrets to a Successful M&A Process: Outlier Valuations, Re-trades, and Other Key Considerations)—that a company selling its business or raising capital may be able to realize. The second major point is that hiring a banker is the best means for navigating these two markets and gives companies the best opportunity to obtain the outlier valuation on their sale or their capital raise.
Why These Markets Matter So Much For Technology and Technology-Enabled Businesses
Besides the commercial markets that technology and technology-enabled businesses are serving with their products and services, there are probably no two more important markets than the M&A market and the capital raising market. For many companies, it is highly likely that during the course of their corporate lives they will either want to, or need to, access the private capital markets by approaching professional and institutional investors in order to raise money to fund their company. Similarly, the M&A market figures prominently when a company decides to sell its business, as a great many companies do these days. Many academics and industry participants believe that the depth, sophistication, and level of development of these two markets help to explain why the United States is such a successful hotbed of innovation and new company formation.
Valuation Differences Can Be Surprisingly Large When Selling Your Business Or Raising Money
Our clients are frequently surprised when, at the end of the sale process or capital raising process that we have conducted for them, they receive offers from various buyers or investors that contain dramatically different valuations of their company. One CEO jokingly asked us whether the various buyers had in fact all been analyzing his company because he could not believe how far apart the valuations were among the various bids his company received. This phenomenon is hard for some people to understand. After all, it is in fact the same company that is being shown in the same way to these various prospective buyers or investors. How could their views on the value of the very same business be so different?
Part of the surprise at seeing these different valuations comes from the fact that most people are not used to seeing different values for the same item or asset. We see the price of milk or the price of gasoline—both largely determined by market forces—and we know exactly what we are supposed to pay if we want to buy that item. Similarly, if we want to purchase a share of a public company quoted, say, on New York Stock Exchange or the Nasdaq, we know (exactly) what it will cost. Could you ever imagine Microsoft Corporation’s stock being worth at the same moment $270 per share and $220 per share and also $320 per share? In other words, could you ever envision inputting the MSFT ticker and getting back a real-time price quote at the exact same moment in time of $220, and $270, and also $320? Of course not. This would never happen in a public market like the ones that exist for public companies in the United States because prices are known and obvious for all to see. But these types of valuation disparities are precisely what regularly happens in the private M&A and capital raising markets. One could in fact say that these valuation disparities are fundamental characteristics of each of these markets.
Make No Mistake: These Large Valuation Disparities Are Very Important For Your Company
There are two fundamental reasons why these frequent valuation disparities are extremely important to technology and technology-enabled businesses. The first one is perhaps obvious: large valuation differences may mean that companies are leaving money on the table—potentially a lot of it—when they sell their business or raise capital in these markets. The second reason is related to the first. The existence of outlier valuations presents opportunities to savvy companies who take the necessary steps to achieve and benefit from these outliers. (Unlocking the Secrets to a Successful M&A Process: Outlier Valuations, Re-trades, and Other Key Considerations) In other words, if wide valuation disparities exist in these two markets, then there is an opportunity for your company and its shareholders to receive that outlier valuation—the one valuation that is well above all the others—which in many cases can mean millions of extra dollars to the company’s management, owners and investors.
But—and unfortunately there is often a “but”—these outlier valuations are not easy to achieve. Buyers or investors do not advertise the fact that they are willing to pay the highest prices or offer to pay outlier valuations, unless they are pushed to do so. And many, if not most, companies who seek these valuations may not end up getting them. If selling your company and raising capital are ultimately processes of price discovery in which companies seek to determine what their value is in private M&A and capital raising markets, then unfortunately many companies sub-optimize in this price discovery process and do not achieve the outlier valuation.
We established earlier that there are clear and significant difference between the public markets where prices and valuations are known and transparent and the M&A and capital raising markets where terms and valuations are not readily known, are subject to negotiation, and are affected by the level of competition for that particular asset.
How CEOs Can Navigate—And Perhaps Even Benefit From—These Market Dynamics
The best way to get the highest valuation and the best terms for your company—whether you are pursuing a sale transaction in the M&A market or seeking to raise capital in the capital raising market—is to hire a skilled and experienced investment banker whom you have gotten to know and trust. (The Value Of Forming A Relationship With A Banker Long Before You Hire Them To Sell Your Company Or Raise Growth Capital). We believe that this is truly the best means of maximizing your opportunity to achieve the most desirable outcomes both in terms of valuation and other important deal terms (like escrow, indemnification, and other representations and warranties).
Hiring the right banker can do many things to dramatically increase the odds of finding the outlier valuation, if an outlier exists and can be achieved in that market at that time. An experienced banker helps in numerous ways. First, they will position your company in the most appealing way for acquirers or investors (which is often very different from a company’s default positioning which is geared to its customers in its target markets). Second, they will access a wide network that will provide your company access to the broadest group of potential acquirers or investors, which many companies do not have access to or lack the time and management bandwidth to access. Finally, as professionals who run these types of processes regularly, your bankers will run a well-coordinated and professional process that synchronizes the outreach, messaging, and bid timing with the various groups that they contact in order to create the highest degree of competition among the various buyers which forces buyers to reveal their true valuation thinking about the company.
We hope that this last point resonates. The price discovery from a well-run process is essential to bringing out a buyer’s or investor’s true valuation thinking and incents them to reveal the best terms that they are prepared to offer. No smart negotiator—that is, any experienced strategic acquirer or professional venture capital or private equity investor—would in the absence of a process immediately offer their highest valuation and best deal terms for any asset that interests them. This would not be rational behavior on their part and should not be expected. Only by utilizing the competitive dynamic created by a well-run process orchestrated by an experienced banker, in which buyers or investors know (or believe) that they are competing with others, can a company determine the true—and highest—valuation that these professionals are willing to pay for their company. This is yet another reason why we believe that the odds are highly stacked against companies achieving an outlier valuation if they undertake the sale process or capital raising process on their own and without professional assistance.
The M&A and capital raising processes are essentially ways to do price discovery in a market where information—particularly information about valuations—is not easily accessed or readily available. By embarking on a sale transaction or a capital raise with an experienced banker as your navigator, you will be able you to thoroughly discover and analyze various opportunities that may not otherwise be readily apparent or easily discoverable. If you have selected an experienced banker who thoughtfully positions your company and runs a professional process that taps a global network of buyers (M&A) or investors (capital raise), then you can be confident that you have gotten access to the best prices and terms in the market at that time, which may make a very big difference to you and your shareholders.
If you are interested in speaking to us about ways to start preparing your company now for a future M&A, or if you are currently seeking advice on a potential transaction, please contact Stephen Day at [email protected] or (512)765-6973.