Analyzing Revenues in M&A | What is important?

A quick prompt to any large language models will give you 20 tips on analyzing revenues. This article is not about quick tips and tricks on how to perform technical analyses. This article outlines the five key areas that matter most during M&A in helping you understand the revenues. Understanding these five key aspects of the revenues will help you become more confident about the business you are buying.

In M&A transactions, buyers are often racing against the clock to secure funding and close the deal while competing with other buyers. Exclusivity windows are short, and the pressure to make informed decisions is high. Focusing on these five areas will help you get the understanding and assurance you need to move forward.

1. What does the business sale?

Differentiating between whether the company sells a product or a service will help you think more deeply about the numbers reported in the income statement. This will also help in understanding what questions to ask the seller. Product companies focus on inventory, supply chain, and production capabilities, whereas service companies are people-intensive: hiring, training, and customer experience are more important.

2. Who Is Buying This—Really?

A sale document prepared by the seller's banker may highlight a vague market size such as a “$4B industry growing 5% year on year." The key is understanding the company’s actual, reachable market.  For instance, while a local restaurant may technically be part of the $100B food service market, its true opportunity might be confined to $2M due to geographic and operational limitations. To accurately understand the customer profile, one must ask:

• Who are the real customers in the specific geography the business serves?
• Are these customers individuals, small and medium-sized businesses, or large enterprises?
• What are their buying behaviors?
• Is the company’s revenue highly concentrated among just a few key clients?

3. Is the Revenue Recurring or Episodic?

The type of questions that a buyer needs to ask themselves and of the seller varies greatly depending on whether the business regularly interacts with the customers versus having scattered interactions.

• A recurring revenue model requires understanding how long customers have been with the business and visibility into the future by understanding the contract structure.
• Whereas episodic revenue would require an understanding of how robust the sales processes are.

A red flag to watch out for in both cases is if there is no established go-to-market strategy and the sales are mainly driven by the seller.

4. How Has Revenue Evolved Over the Last 5 Years?

Understanding how revenue has evolved over the last five years requires more than just reviewing the numbers. We need to understand the context and why the revenue increased or decreased; the story is important.

• It’s important to determine whether growth was due to an increase in demand for the products or services or non-recurring factors. In some cases, growth may simply be due to an overall increase in input prices, which does not improve the margins.
• For example, an overall increase in prices in the beef industry has led to an increase in revenue across the value chain. However, this revenue growth was not driven by any improvements in the operations or access to new customers or geographies.

This deeper level of understanding is crucial for understanding the true reasons for movement in revenue.

5. What Will Revenue Look Like—And Why?

In some instances, sellers try to sell their companies when the company is doing well due to factors such as an overall boom in the market. Assigning a TTM EBITDA multiple in these cases would lead to paying more to buy the company. For these reasons, the buyer should understand the seller's projection for the year and the growth plans.

• Often a blanket percentage—say 5%—is assumed to arrive at the revenue for the next year without much consideration for which segment or geography would contribute to that growth.
• The projections should be backed by long-term contracts in the case of recurring revenues or an order book in the case of product companies.

 Final Thoughts: 

While these areas are thoroughly investigated during the due diligence phase, having a high-level understanding of these areas will help you guide your QoE provider's focus in identifying the red flags. Answering these five questions will help you form a strong deal thesis and not only ask the right questions but also get the required answers.

Contact us today to learn how we can support your next deal.