How Synergies Impact the Sale of Your Business

Financial Synergy Increases Business Valuations

The combination of two businesses from a merger or acquisition often results in financial synergies or the collective benefit from revenue enhancements and cost savings. A merger or acquisition is more likely to result in financial synergies when the two companies have complementary strengths and areas of operations which may be run more efficiently when combined. Acquirers are frequently competitors seeking to expand as well as private equity groups seeking to roll up similar businesses as part of their growth strategy. When the profits of the combined entity are greater than its individual parts, the acquirer’s Return of Investment (ROI) is in reality higher than it often appears. This in turn should lead to a higher purchase price so long as the business broker justifies the premium valuation based on the power of synergies. In general, synergies increase business valuations by enabling strategic buyers to realize cost savings, revenue growth, or increased market power.

Revenue Synergies

Revenue synergy is the additional revenue from the combination of two businesses compared to the revenue generated by each business as a stand alone entity. Cross-selling, market expansion, and the innovation of new products or services are all revenue synergies. Sellers of businesses often do not realize that their business gives potential acquirers the opportunity for revenue synergies. Businesses with entrenched customer relationships often allow an acquirer to benefit from revenue synergies.  For example, a deal involving the acquisition of a plumbing business by a mold remediation or roofing company is likely to result in revenue synergies. The entrenched, captive, and longstanding plumbing customers are likely to use the acquirer’s mold or roofing services. As an added bonus, the acquirer’s pre-existing customers may also use the combined company’s plumbing services after the acquisition.

Cost Synergies

Cost synergy is the reduction in the cost structure from the combination of two businesses compared to the cost structure of each business as a stand alone entity. Cost synergies can take many forms including reducing occupancy, sales, administrative, accounting, and bookkeeping costs. It also allows for a more cost effective means of procuring materials and inventory. A larger corporate entity often has economies of scale by virtue of having more purchasing power, bargaining leverage with suppliers, and the means to produce goods or services in a more efficient manner than smaller competitors. Cost synergies often result when a business acquires multiple locations within the same industry, and can thus spread out their operational costs while exerting leverage with suppliers and vendors due to increasing purchasing power.

Experienced Business Brokers Emphasize Synergies

Many large and well established businesses have entrenched customer relationships or cost centers that may be made more efficient and rationalized from the power of synergies. For such businesses, the acquirer – after realizing synergistic benefits –  will have a higher adjusted owner benefit (or true economic profit) compared to the seller. When the profit or adjusted owner benefit of an acquired business will clearly increase after the closing due to the power of synergies, the higher potential profit for the acquirer must factor in to the valuation of the business. Acquirers are willing to pay a premium price for a business if they are assured that their profits and resulting ROI will increase due to synergies.  Experienced business brokers know that a higher ROI (or profits divided by total investment) for an acquirer leads to a higher selling price, and will emphasize this to strategic buyers during the listing process.

Example of How Synergies Impact Business Valuations

  • Let us suppose that Wayne is selling ‘Wayne’s Wholesale World,’ which distributes non-perishable items and assorted goods to a recurring customer base of convenience stores, restaurants, and retail stores in South Florida.
  • Last year, Wayne’s business produced $5M in gross sales, $1.5M of gross profit, and $600K of adjusted owner benefit.
  • The average valuation for a wholesale and distribution business in Florida is 2.5 x the annual Seller’s Discretionary Earnings (SDE) or adjusted owner benefit.
  • Thus, applying the average valuation multiple would result in a valuation of $1.5M ($600K x 2.5) for Wayne’s business.
  • Putting aside any other unique attributes of Wayne’s business which may warrant an increase or decrease to its valuation multiple, it should be clear that there are potential synergistic benefits for a competitor or acquirer with an existing wholesale and distribution business.
  • First, Wayne’s business has deeply entrenched customer relationships with very strong cross-selling opportunities.
  • An acquirer in the restaurant or hospitality industry, for example, may sell its products or services to Wayne’s customers, and may also sell Wayne’s products to its own customers.
  • Second, the potential for significant cost synergies exist for an acquirer who already distributes products to some of Wayne’s customers, thus saving delivery and labor expenses.
  • Moreover, a competitor or acquirer in the restaurant supplies or related industry may realize significant savings in cost of goods sold from better purchasing and bargaining power.
  • This will raise the acquired company’s gross profit percentage (currently 30% or $1.5M/$5M) and ultimately its net profits.
  • Indeed, assuming that the acquired company will realize a 34% gross profit percentage results in adjusted owner benefit increasing from $600K to $800K.
  • This adds an additional $500K of value to the business when applying the median valuation multiple of 2.5x.
  • The overall potential for serious revenue and cost synergies implies a premium valuation for Wayne’s business, and all else being equal should result in an asking price of $2m, well above the original $1.5M median valuation.

The premium valuation given to businesses which allows for synergistic benefits to an acquirer should always be explained and presented clearly by the business broker. The more details and pathways for which the acquirer’s profits will increase after an acquisition due to revenue or cost synergies means it is more likely that the acquirer will agree to pay a premium price for the business.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.