Wednesday, January 29, 2014

How to Drive Value in Your Healthcare Information Technology Company Sale


One of the most demanding aspects of selling a Healthcare Software Company  is coming up with a business valuation. Sometimes the valuations provided by the marketplace defy the valuation judgment that commonly dictates a selling price for a bricks and mortar company, for example. This article covers how an investment banker can correctly position your Healthcare Information Technology Company  to the right buyer in order to accomplish a attractive transaction price.

One of the most demanding factors of selling a Healthcare Software Company  is coming up with a business valuation. Sometimes the valuations provided by the market (translation - a concluded transaction) defy all logic. In other business segments there are some pretty helpful rules of thumb for valuation metrics. In one line of business it may be 1 X Revenue, in another it could be 5 X EBITDA or cash flow.

Since it is essential to our business to aid our Healthcare Information Technology Company clients raise their business selling value, I have given this considerable thought. Why are some of these Healthcare Software Company valuations so elevated?

It is because of the profitability leverage a Healthcare Software Company  can generate. A clear-cut case in point is; what is Microsoft's incremental expense to supply the next copy of Office Professional? It is most likely $1.20 for three CD's and 80 cents for packaging. Let's say the license cost is $400. The gross margin is north of 99%. That does not materialize in manufacturing or services or retail or most other industries.

One drawback in selling a small Healthcare Information Technology Company  is that they do not have any of the brand recognition, distribution, or standards leverage that the big companies own. So, on their own, they cannot produce this profitability leverage. The buying company, however, does not aim to compensate the small seller for the post acquisition results that are directly attributable to the buyer's market presence. This is what we refer to as the valuation gap.

What we attempt to do is to help the buyer rationalize paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, we want to get strategic value for our seller. Below are the factors that we use in positioning our Healthcare Information Technology Company  for maximum selling price:

Cost for the buyer to develop the product internally - Many years ago, Barry Boehm, in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite comprehensive and complex, but I have boiled it down and simplified it for our purposes. We have the advantage of estimating the "projects" retrospectively because we already know the number of lines of code comprising our client's products. This information is designed to help us understand what it might cost the buyer to build it internally so that he starts his own build versus buy analysis.

Most acquirers could write the code themselves, but we put forward they analyze the cost of their time to market delay. Believe me, with first mover advantage from a competitor or, worse, customer defections, there is a very real cost of not getting your product today. We were able to convince one buyer that they would be able to defend our seller's entire purchase price predicated on the amount of client defections their acquisition would avert.

Another arrow in our valuation driving quiver for our sellers is we restate historical financials using the pricing premium of the brand name acquirer. We had one client that was a small IT company that had developed a superior piece of software that compared favorably with a sizable, publicly traded company's solution. Our product had the same functionality, ease of use, and open systems platform, but there was one very significant difference. The buyer's perception of risk was far greater with the little IT company that could be "out of business tomorrow."

We were literally able to increase twofold the financial performance of our client on paper and put forward a compelling line of reasoning to the big company buyer that those results would be immediately obtainable to him post acquisition. It certainly was not GAP Accounting, but it was helpful as a tool to direct transaction value.

Financials are of great consequence so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value factors) of 2 X contractually recurring revenue during the current year. So, for example, if the company has monthly maintenance contracts of $100,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.

We try to assign values for miscellaneous assets that the seller is providing to the buyer. Don't overlook the strategic value of Blue Chip accounts. Those accounts become a platform for the buyer's complete product suite being offered post acquisition into an "installed account." It is a lot easier to market add-on applications and products into an loyal account than it is to close that new account. These strategic accounts can possess huge importance to a purchaser.

Lastly, we use a customer acquisition cost model to propel value in the eyes of a prospective buyer. Let's say that your sales professional at 100% of Quota earns total salary and commissions of $125,000 and sells 5 net new accounts. That would mean that your base customer acquisition cost per account was $25,000. Add a 20% company overhead for the 85 accounts, for example, and the company value, using this calculation would be $2,550,000.

After reading this you may be saying to yourself, come on, this is a little far-fetched. These factors do have real value, but that value is open to a varied interpretation by the marketplace. We are trying to assign metrics to a very subjective set of components. The buyers are intelligent, and practiced in the Merger and Acquisition process and quite frankly, they try to repel these inventive approaches to driving up their economic outlay. The greatest leverage point we have is that those buyers recognize that we are presenting the same analysis to their competitors and they don't know which component or components of value that we have presented will resonate with their competition. In the final analysis, we are just trying to provide the buyers some reasonable explanation for their board of directors to justify paying far more than a financial multiple for our client's
 


Dave Kauppi is a Merger and Acquisition Advisor and Managing Director of MidMarket Capital, providing business broker and investment banking services to owners in the sale of information technology companies. To view our lists of buyers and sellers click to visit our Web Site MidMarket Capital

No comments:

Post a Comment