Blog-Layout
How strategy decisions will influence your net profit
Dieter Weisshaar • April 24, 2020
Photo by JESHOOTS.COM on Unsplash
Boardroom discussions from the software industry - strategy determines your net profits more than you may think
When you set your strategy for the next years as a board member, it is always in the company's best interest and your stakeholders need to understand the consequences.
Company evaluations
in the software industry may vary from 12-22 times EBITDA
or even a revenue multiple of 2 -7 times
in case of software technology transaction (Source: EY - Software M&A Recap, Third quarter 2019, Canada and US Market Insights, December 2019) . I would consider this high site from a European perspective and see M&A transactions of SME Software companies at 7- 12 times EBITDA.
EBITDA to sales ratios (EBITDA margins) are trending up by revenue of a software company as EBITDA nicely scales in the software industry. Hence EBITDA margins may vary as well from 10 % to 35 % across the industry, highly depending on company size and sector. The average EBITDA margin is about 25,9 %
in 2019 on a trailing-12-months, falling to 22,6 % in Q1 2020
according to CSI Market. That actually positions the evaluations in multiples of revenue and EBITDA into the same ballpark.
How does this now impact your strategy discussion
in the boardroom? You want to grow 50% in revenue by M&A. The outcome is that you actually spend 2-7 times on acquired revenues (Europe on the lower end). 50% growth times 3 is a 150% investment of your current revenue. If most of the assets you acquire are software IP and intangible assets, you may need to amortize more than 50-70 % of the M&A transaction value over the course of 3-8 years in your P&L. That leads to an amortization of 150 % of current revenue equal M&A transaction value * 60 % amortization ratio / 5 years amortization period = 18% amortization of current revenue per year.
This number may vary a lot by the M&A transaction and it is down to international accounting standards.
Let's make an assumption your revenue is growing by 50 % by M&A and your EBITDA will grow 50 % + as well as you are spending some money for organic growth on integration and further growth initiatives into SG&A. Your EBITDA margin was 20 % before and stay at this level on a higher revenue, you will be hit by your M&A amortization at 12 % of your higher revenue level.
Actually you can easily more than half your contribution from your EBITDA
(from 20% to 8 % in this case) to net profits by the M&A amortization being on a buy and build strategy. If you have once acquired the companies, it will not change soon as you need to run out of your amortization periods for a couple of years to get back to higher net profits. There is no fast strategy change on the net profit side.
This is not an issue
as your company valuation
in the software industry is determined by revenue and EBITDA multiples and outgrowing the market may get you a premium. But you take a conscious decision for a few years on net profits. It really depends if you are looking for creating company value through a growth strategy and gaining market share (you may look at Salesforce (c)) or an optimization case on net earnings. On the long run from my point of view the software industry is rewarding the top players of its market segments most. This is a conceptual debate on strategy to have.
Published on linkedin
Growing the business is on the agenda of almost very board room. Expectations are high, a business plan can be created quickly but achieving growth isn't as easy. To gain market share your company needs to beat market growth but how can this be done.
On our famous online book store you find far over 60.000 books on strategy but only a good 4.000 on strategy execution or implementation. There are far more universities that offer marketing and only a few on sales as a major. Creating the ambition, the project goals, the strategy is a cool thing and requires great thinkers. Taking the things to daily execution requires an additional skill which is rare, may be perceived as boring but is the key success factor for every company.
You receive a new project and on the first view it looks complex and you need to get your arms around it. How can you structure a complex situation to discover various perspectives and approaches. At C-Level you may not even have all the information or expertise to resolve it on your own. Some ideas that worked for me.
You may have seen the rise of tech companies at the end of 90th of last century. Web Content, eCommerce and startups were the exciting topics, til the point when the dotcom bubble burst. It was the time when salaries went crazy in this sector, the company evaluations and stock markets were on all time high and venture capital market was overheated.
Marketing budgets are always a discussion topic. What can a CEO expect if a percentage of revenue is spent for corporate marketing? Have the goals been defined and expectations aligned. Marketing can not meet expectations if the ecosystem is not supportive. Let's have a deeper look in the B2B sector and the dependencies.
Investors and shareholders ask their board members to scale up the business - grow faster than market and create value. That is a fair expectation. Let's have a look on some key success factors and considerations.
This is probably one of the hardest questions to answer. How much do I need to spend to win a customer and close a deal. This varies highly by market, product, target group, persona - let's have a look at the IT B2B market.
Cloud businesses achieve far higher company evaluations than traditional software companies. Rightly so, as their growth capability will out perform traditional software licenses and support business models.
Warum scheitert die Energiewende? Die Politik kann oder will nicht nachrechnen. Es liegt an einer kleinen Zahl um es vereinfacht darzustellen: Der Wirkfaktor (Wirkungsgrad etc.) der Wärmepumpe. Unser Strom ist viel zu teuer.
Every single day, when you open Social Media, you got told that there is a New Work and new leadership skills. It is indisputable that leadership has changed from decades ago and that is rightly so. In the light of the new resignation and war for talent, great leadership skills are fundamental for every company. But we should not miss out Expertise as a skill.