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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. Here are some deal-structuring strategies that put the ball in the owner's court:
🔑 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.
🔑 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.
🔑 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 realize a higher valuation if the business hits or exceeds predefined goals.
🔑 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.
🔑 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.
🔑 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.
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.
Our firm Hybrid Capital is a FINRA registered boutique investment bank / broker-dealer. We work closely with Private Equity, Family Offices, and investment firms to help capitalize or exit promising businesses. If you'd like to discuss capital raising, exit planning, or M&A, please send me an email: logan@hybridcapital.net
