What’s drives the value of your business?
It’s a question I always ask my prospective clients, and about 99 percent of the time, they answer in the form of a question: “Um, revenue?”
Most business owners don’t know where the value of their business is locked up. They’re too busy focusing on growth, profitability, and revenue. But if you’re zeroed in on revenue and earnings growth only, it’s going to be difficult to successfully position your business in a high-multiple market.
To be fair, revenue and earnings are indeed part of the value equation, but, frequently, there are much more determinant factors creating the true value of the business. And without a solid understanding of your value drivers, you’ll be blind to the true value of your company from the perspective of potential buyers who may be after nonrevenue assets such as your brand or customer base.
Missing the Forest for the Trees
To ensure a strong exit, it’s essential to think beyond revenue and earnings growth to understand and leverage what’s actually driving your company’s value.
Take Amazon’s billion-dollar purchase of Zappos. The online shoe and clothing retailer didn’t sell anything that Amazon couldn’t sell, and it didn’t have customers that Amazon couldn’t get or didn’t already have. So what did it want? In large part, Zappos’ culture. Amazon was in the midst of an organizational shift and found an ideal cultural model in Zappos. Culture doesn’t show up on any P&L statements, but to Amazon, it was worth big bucks.
Many business owners make the colossal mistake of focusing solely on the top line, blind to potential value drivers as well as constraints. While it’s fun to watch revenue grow, if that’s all you focus on, you’ll never see how much money you’re losing through your cash-flow model.
To a potential buyer, that signals risk. And risk leads to a lower price. That’s all there is to it. It’s pretty hard to convince a buyer that losing money is not a risky proposition.
Don’t Just Think Outside the Box — Flip It Upside Down
When you look at potential value drivers, the first step is to take a good look at how your company is positioned in the market.
I recently worked with a California-based regional trucking company. It was family-run, had a bunch of trucks on the road, and was worth about $27 million. The problem it faced was that there was no way to ramp up revenue and earnings steeply enough to get the price its leaders wanted for the business. It would take too long.
Through our assessment, we discovered that about 90 percent of its payload was energy-related equipment — including pumps, storage tanks, and generators. The company also had a competitive edge in the regional market because it had developed software to increase the efficiency and effectiveness of its logistics.
A simple rebranding of the business as an energy logistics company didn’t change a thing about its operations, but it resulted in a sale at a price nearly 150 percent higher than previously valued just seven months later. That’s a dramatic increase in value without adding sales or customers.
To maximize your company’s value, you must understand and leverage the nonrevenue assets that are key value drivers available to you. Here’s how:
1. Analyze Possible Constraints to Valuation
There are many factors that can constrain value. When working with a new client, my team and I start by looking at about 55 of these factors to see where we can release value that’s being inadvertently constrained. One client, for example, had a poorly structured cap table, and by simply resetting the company’s capitalization, we reclaimed nearly $4 million in value.
The solution can be as simple as getting your paperwork in order. I’ve seen companies that have never produced standard operating procedures and are lacking sales and marketing documentation as well as competitive analyses. I’ve even seen companies operating without an operating agreement or a single document on the company’s structure. How can a buyer assess the value of your business without the necessary corporate documentation? Going back and filling in those gaps can add a lot of value.
2. Understand Your Potential Buyers
Every prospective buyer is going to value your company differently. For instance, if a company wants access to your customers, it will base your value on how much your customers will add to the value of its business. Another company may instead be after your brand or intellectual property, and it’s going to value you based on how much value those assets will bring to their table.
You need to understand the network of companies or organizations that might be interested in buying your business for a variety of reasons.
3. Identify Actions for Capturing Value
By knowing what your potential buyer is after, you’ll know exactly how to adjust your strategy for capturing the available value and adding and maximizing the returns at that transaction.
For example, a buyer is willing to pay six times your earnings because he wants your customers. To maximize the value of your business in the eyes of that buyer, you’ll focus on and invest in attracting and retaining more customers. However, if another buyer is willing to pay eight times your earnings to gain access to your IP, trade secrets, or brand, you’ll instead focus fewer resources on customer acquisition and more resources on increasing the value and availability of those assets.
To make sure your company is best positioned for the end game, your exit plan must run parallel with your revenue growth plan. Plan for an exit now, whether you’re ready to sell or not, and you’ll dramatically boost your ROI when it really counts.
Steve Little is the CEO and managing partner of Zero Limits Ventures. Little has led six successful startups to private acquisitions averaging $100 million each. He has raised more than $1 billion in startup and growth funding for 11 different businesses in multiple industries, led the buy-side M&A team for a major technology innovator, and acquired and successfully integrated nine companies in less than 12 months.