One of the biggest challenges between business owners and investors – whether raising capital, seeking an exit, or exploring M&A – is the valuation gap. Owners typically aim for a high valuation (obviously), while investors propose lower figures. Everyone is trying to make money. Which is fair, but this gap can kill a deal.
What happens if investors are under-valuing your business? How do we bridge that gap?
If the business owner truly believes in their business, then my favorite strategy is to say “PROVE IT”. If done correctly, this approach can give owners leverage in negotiations and lead to a better payout. We’ve compiled a list of helpful techniques that put the ball in the owner’s court.
Key Deal-Structuring Strategies
1. Earn-out Clauses
Part of the sale price or investment is tied to future performance. The seller gets some payment upfront, and the rest is contingent on hitting agreed targets. This shifts risk onto the owner, giving them the chance to prove their business can achieve the growth they claim.
2. Seller Financing
The business owner agrees to finance part of the sale by receiving a note from the buyer. The owner finances part of the deal by accepting payments over time, reducing the buyer’s initial outlay.
3. Revenue-based Models and Performance Milestones
Rather than using an EBITDA multiple or speculative projections, valuation can be tied to actual financial results or key performance metrics. The seller realizes a higher valuation if the business hits or exceeds predefined goals.
4. Equity Rollover
In M&A deals, the owner retains a minority stake post-sale, staying invested in the company’s success. This aligns incentives and reassures investors that the owner will remain engaged to ensure continued growth.
5. Contingent Consideration
Similar to earn-outs, part of the valuation is contingent on future milestones, like a product launch or securing a major client. This protects the buyer, while allowing the seller to achieve their desired valuation if key targets are met.
6. Ratchet Mechanisms
This adjusts ownership stakes based on performance. If the company underperforms, the investor’s stake increases. If targets are hit, the owner’s share is protected and/or rewarded.
Bridging the Valuation Gap
Successful negotiations depend on strategic positioning, diligence, and recognizing that “everything comes down to a negotiation of risk and reward.” Performance-based structures benefit both parties by rewarding achievement while mitigating risk.
If you successfully reduce the valuation gap on a “prove it” basis, then you should be able to strategically bake in better compensation for yourself! At the end of the day when it comes to investors, everything comes down to a negotiation of risk and reward. So be diligent, strategically position yourself, and be prepared to be flexible during negotiations. Both sides benefit from a deal that rewards performance, mitigates risk, and fosters long-term success.