A Banker’s View: 5 Driver's of a Deal

By Sam Thompson

Sam is a Partner & Senior Managing Director at Progress Partners, with extensive experience in media, marketing, and retail technology.

Introduction

As a venture capitalist and M&A advisor, I am often asked the question of how companies are valued in an acquisition. Of course, there are various answers to this question, and no two deals are exactly the same. While analysts love tying an exit multiple to one particular statistic, the fact of the matter is that the equation is often more complex. That being said, there are a number of constant factors that come into play time after time. Financial and strategic acquirers alike will judge and calculate the market value of a business based on these five factors: Growth, Profitability, Predictability, Technology, and Team. Whether it’s a venture deal like our seed-stage investment in IAS or an M&A advisory engagement like our work with AdSwizz on their sale to Pandora, these are the five drivers of multiple that I look for when predicting future value with Progress Ventures, or determining current value with Progress Partners

Over the next few weeks, I hope to share and discuss deals that I believe emulate the importance of these 5 deal drivers. I will talk about how these drivers lead to high multiples when it comes to deals and how each driver serves an important role in the acquisition, even if it is not the main driver of said deal. While there are 5 drivers to every successful deal, there is always one driver that stands out more than the others on each particular acquisition. For example, some deals might have Growth as the dominant driver with the other 4 drivers playing a smaller role.  An example of this is the recent acquisition of Tableau by Salesforce. This deal allows further growth for the billion-dollar public company, Tableau. In the next article, I will talk about an example where growth acted as a dominant driver in the acquisition. By breaking this deal down we will see how not just growth but also profitability, predictability, technology, and the team also had a hand in driving this deal. 

You can also view this article on LinkedIn with public commentary & likes here.

Growth

When looking into the acquisitions of technology platforms, the growth potential of the company and the broader market around it has a distinct presence in the decision to pursue the said company. Perhaps familiar to some and controversial to others, ultimately, the growth rate has higher-consequence on a valuation multiple than cash flow. As a founder or early-stage investor, this can be a difficult concept to grasp. If you’re well organized enough and have the team to execute, profitability can be achieved. That said, those profits that you’re generating? You should be putting them back into the business. That’s because if you’re not growing at a minimum rate of 50-60% YoY you may run the risk of being perceived as a slow-growth business, or even worse, stagnant. Acquirers may also view a private company paying off dividends, or a founder taking profits out of the business, as a red flag. If the current business owners don’t believe 100% in the long-term trajectory of the business, why should the prospective owners invest in the long term value?

A recent example of an acquisition-driven by growth is the impending sale of Tableau to Salesforce. This $15.7 billion deal was driven by the opportunity of growth for both companies. As mentioned previously by my fellow Partner, Chris Legg, this deal allows Salesforce to grow their software into the Data analytics market. Salesforce is working to become the dominant business technology company and through their ability to infiltrate the data analytics market with the technology of Tableau, they are coming steps closer to dominance. 

For Tableau, this deal allows their company to grow and help more customers with their technology. Through their merger with Salesforce, their technology can reach to more consumers under the market-dominant company that Salesforce is. 

Another example of a recent sale led by growth is the sale of Data Plus Math to LiveRamp. This sale was led by growth in because the technology that Data Plus Math has will aid LiveRamp in enhancing their skill set. Their extensive client list includes major U.S. media companies and national cable clients will also allow LiveRamp to grow their client base. This 30x multiple deal proves the point of how growth, as one of the 5 drivers, leads to higher multiples. This deal came at a time that is considered to be the potential turning point of television advertising. Through co-branding, the companies will be growing their skill sets to provide attribution and lift reporting on addressable television advertising campaigns. This acquisition positioned LiveRamp to be prepared for the changes coming to television advertising. 

You can also view this article on LinkedIn with public commentary & likes here.

Profitability

Profitability is the key to many deals in the M&A space. While a lack of accelerated growth through re-investment may inhibit a company’s valuation, a lack of control on cash flow is even more detrimental. It is far easier to accept a controlled and deliberate burn than to have no concept the drivers of margin. Some of the largest companies in the world prioritize revenue over profitability and the key is to a deliberate financial strategy. Projecting future cash flows is considerably more credible when a business has demonstrated control of their financial condition. A break-even business by choice that has demonstrated growth shows significant potential. At the same time, you’d be hard-pressed to find interest in a break-even business that has low to no growth.

An example of a deal driven by controlled profitability would be the acquisition of AdsWizz by Pandora (Progress Partners advised AdsWizz on the transaction). Prior to Acquisition, AdsWizz built one of the leading ad serving technology for streaming music companies like Pandora to better serve advertisers and publishers. This, in turn, improved publishers’ revenues and advertisers’ access to the streaming world of music and spoken word. This technology is core to generating revenue on the free version of the music streaming services. AdsWizz was in a favorable market position, gaining attention from all the top publishers and pushed all available capital into the company’s growth. At the same time, as the business scaled, they grew closer and closer to a breakeven cash flow. Without that achievement, neither Pandora, nor other platforms would have taken the same interest in AdsWizz as a strategic acquisition. 

Deals such as the Pandora Adwizz deal show how controlled profitability/losses can be the most significant driver of a deal, while also relying on 4 other drivers; growth, predictability, technology, and team. Though the deal was done with the intention to increase revenue, it also allowed Pandora to increase access to global advertisers. The technology behind Adwizz was crucial to its own control of profitability. In the acquisition, Pandora also gained some key talent--an example of another deal driver, Team--which we will talk about in future posts.  

You can also view this article on LinkedIn with public commentary & likes here.

Predictability

When it comes to predictability, long term contracts and monthly recurring revenue (MRR) are paramount. For this reason, a business’ revenue model can be an extremely relevant factor in its valuation. This is why SaaS businesses often sell for more than 8x revenue. At the same time, this is why our industry has seen businesses such as Criteo and Marin Systems struggle as they rely on inconsistent insertion order-driven revenue. Ultimately, predictable revenues create more defensible long-term values and higher valuation multiples. 

While no single driver defines a deal, the more predictable a company’s revenue the greater comfort is gained by an acquirer to recoup the cost of acquisition. In fact, the more aggressive a buyer will be. Not every business is able to pursue a true SaaS model, in fact most cases are businesses that have some hybrid between “licensing” and “services” revenue. 

Truth of the matter is that more often than not customers are not completely self-service, require some hand-holding, and a ready and willing to pay for that help. For those fully SaaS businesses, you can expect to see the best multiples on exit. A great example of that is the recent exit of Qualtrics to SAP. We have seen insights technology become increasingly popular over the past few years which has sparked a series of M&A activity in the market. Not only does Qualtrics provide a sticky product for customer satisfaction surveys, but they also strike at the heart of SAP’s core value proposition and how it can be improved. A great read to better understand the dynamics of that deal and some sound justification of the value is written up by Josh Bersin. Thanks for your great write up, Josh!

So for those of you who have a great platform or service that can’t be a pure SaaS play, there needs to be other factors in play to drive predictability, commonly fulfilled as synergistic elements. We see this happen often in emerging markets when there is a complimentary service or solution that brings an untapped revenue source for a buyer to increase earnings from the acquisition. 

For example, the podcast space is becoming increasingly popular and we estimate an increase of about 14.5 million hours of podcast content created since 2004. More specifically, Spotify’s acquisition of Gimlet Media (a publisher behind some of the most popular shows in the podcast space right now) was estimated to be around $230 million dollars. With the increased popularity of the podcast medium, this purchase allows Spotify to take significant market share. The price can be justified by Spotify’s ability to predict future revenue from their own capacity to monetize content. 

Ultimately, predictability can come in many forms. As businesses scale and look to achieve a premium multiple, they must understand where they can provide a strong case for the predictability of future revenue. At the same time, each of the drivers we review have impact. Still to come: Team and Technology.

You can also view this article on LinkedIn with public commentary & likes here.

Technology

When the majority of the deals you look at are in the tech world, you start to realize the difference that a good product can make. Great sales and marketing can get a foot in the door and generate revenues in the short term, but ultimately it is the quality of the product itself that will determine whether or not clients continue to use it. Many professionals in our world refer to this as “product stickiness,” and in a saturated market, it is the most important factor in deterring customer attrition (churn). 

Not only does the quality of the tech matter in a business’ valuation, but the role of the tech in the revenue model plays a major role as well. Many businesses present themselves as “tech companies”, while the majority of their revenues come from managed services. While every business needs people, the reality is that buyers and investors will pay a premium for businesses that can generate revenues with as little overhead as possible. Ultimately selling services requires personnel, and personnel is going to be one of the top operating expenses at any company. Selling a pure technology product will improve a business’ exit multiple because the business model has a higher operating margin. 

A recent transaction that emulates a deal driven by technology is the acquisition of Celect by Nike. Celect is a leading predictive analytics platform for the retail industry. The core platform allows customers to predict consumer purchase intent, including location, timing, and even style preferences. This strategic acquisition allows Celect’s technology to drive the entire Nike consumer experience. This deal was driven by Nike’s strategy to scale back its wholesale business and expand its direct to consumer (DTC) retail presence. In the acquisition, Nike brought in a substantial data-science team. I will discuss this deal further in an upcoming article release about the breakdown of the Nike Celect acquisition. Be sure to keep an eye out for this post. This decision related to another one of the deal drivers that will be discussed in this series: Team. We will talk more about deals driven by a company’s team in the next and final installment of this series. 

You can also view this article on LinkedIn with public commentary & likes here.

Team

While technology plays a major role when it comes to a business’ product, there is no replacement for quality team when it comes to long term stability and growth potential. Buyers and investors place a premium on leadership, and key management when determining the value of a business. Talented and well-suited hires can be difficult to find, and for that reason, higher multiples are often applied to businesses with well-rounded teams with few or no gaps to fill. 

We don't always stop to think about the people behind a company that makes it so successful, but that is a key to success. In order to have a product or service that is returning high revenue, you must have a talented team and leadership to help push the company to those high standards of success. While we often see deals driven by the four other factors we have previously discussed in this series, it is important to recognize the importance employees have on the evaluation of a company when going into a merger or acquisition. The extreme end of the team spectrum is an acquihire, where there is little more than a proof of concept from a technology and market traction perspective. But it’s this validation of the “team” ability that drives acquisition interest. 

We see deals like this when we look at Facebook’s acquisition of FriendFeed in 2009. Facebook acquired the start-up company FriendFeed for $47 million. This deal worked out to being equal to about $4 million per engineer at Friendfeed. This aqui-hire showed how important Facebook found the skilled team to help drive engineering initiatives pre-IPO. Facebook continued its series of aqui-hires into 2010 when they acquired drop.io primarily for the companies founder, Sam Lessin. These aqui-hires were all done pre-IPO for facebook which was a key move for the success of the company’s Public Offering.  

People will often tell you that valuations are more of an art form than a science or an equation, but at the end of the day even the most inexplicable deals can usually be explained by one or more of these five factors. With all five in place (Growth, Profitability, Predictability, Technology, and Team), you’ll usually see the higher multiple. With even one missing, the multiples will quickly drop. So, as a founder, investor, executive, employee, or other stakeholders, if you consider your business to be on the path to acquisition, be sure to keep this factors in mind. It is all too easy to lose track when a business is scaling up, so stay focused and you’ll be better prepared to achieve your exit goals.

You can also view this article on LinkedIn with public commentary & likes here.

To learn more or if you have questions, send an email to the author sthompson@progresspartners.com or our marketing team marketing@progresspartners.com.