Blog | This Way Out Group
Diversification is a sound financial planning strategy, but does it work for company building?
There are good reasons to diversify to achieve your objectives. There are also really good reasons not to diversify when you are growing a business to maximize value.
One Big Bet
How does Vitamix get away with charging $700 for a blender when reputable companies like Cuisinart and Breville make blenders for less than half the price?
It’s because Vitamix does just one thing, and they do it better than anyone else.
WhatsApp was just a messaging platform before Facebook acquired them for $19 billion US. Go Pro makes the best helmet mounted video cameras in the world.
These companies stand out because they poured all of their limited resources into one big bet.
The typical business school of thought is to diversify and cross sell your way to a “safe” business with a balanced portfolio of products – so when one product category tanks, another line of your business will hopefully boom. But the problem with selling too many things – especially for a young company – is that you water down everything you do to the point of mediocrity.
Here are six reasons to stop being a jack-of-all-trades and start specializing in doing one thing better than anyone else:
- It will increase the value of your business
When you sell one thing, you can differentiate yourself by pouring all of your marketing dollars into setting your one product apart, which will boost your company’s value. How do we know? In one study analyzing an assessment of more than 13,000 businesses, they found that companies which have a monopoly on what they sell get acquisition offers 42 % higher than the average business.
What one product/service you offer will set you apart creating a monopoly where you can command a higher offer?
- You can create a brand
Big multinationals can dump millions into each of their brands, which enable them to sell more than one thing. Kellogg can own the Corn Flakes brand and also peddle Pringles because they have enough cash to support both brands independently, but with every new product comes a dilution of your marketing dollars. It’s hard enough for smaller businesses to build one household name and virtually impossible to create two without gobs of equity-diluting outside money.
What will you focus your marketing dollars on to create brand recognition?
- You’ll be findable on Google
When you Google “helmet camera,” Go Pro is featured in just about every listing, despite the fact that there are hundreds of video camera manufacturers. It’s easy for Go Pro to optimize their website for the keywords that matter when they are focused on selling only one product.
What keyword(s) will make you, your product/service, or your business ‘findable’ on Google?
- Nobody cheered for Goliath
Small companies with the courage to make a single bet get a bump in popularity because we’re naturally inclined to want the underdog – willing to bet it all – to win. When Google launched its simple search engine with its endearing two search choices “I’m feeling lucky” vs. “Google search,” we all kicked Yahoo to the curb. Now that Google is all grown up and offering all sorts of stuff, we respect them as a company but do we love them quite as much?
Leverage what you do best to win. What do you do best, to bet the house and win?
- Every staff member will be able to deliver
When you do one thing and you do it well, you can train your staff to execute, unlike when you offer dozens or hundreds of products and services that go well beyond the competence level of your junior staff. Having employees who can deliver means you can let them focus and get the work done, freeing up your time to think more about the big picture.
How can you streamline your offering so your staff can execute without your day-to-day oversight?
- It will make you irresistible to an acquirer
The more you specialize in a single product, the more you will be attractive to an acquirer when the time comes to sell your business. Acquirers buy things they cannot easily replicate themselves.
Go Pro (NASDAQ: GPRO) is rumored to be a takeover target for a consumer electronics manufacturer or a content company that wants a beachhead in the action sports video market. Most consumer electronics companies could manufacturer their own helmet mounted cameras, but Go Pro is so far out in front of their competitors – they are the #1 brand channel on You Tube – that it would be easier to just buy the company rather than trying to claw market share away from a leader with such a dominant head start.
What will make your business irresistible to a potential acquirer?
Diversification is a great approach for your stock portfolio, but when it comes to your business, it may be a sure-fire road to mediocrity. Mediocrity does not maximize value or make your business attractive to potential buyers or acquirers.
Most business owners have not put a lot of thought into planning for their eventual exit from their business. Many many owners, of established as well as startup companies, don’t see any value in planning for an exit that is years if not decades into the future. If they can’t see immediate benefits and consequences for their actions and decisions, they leave it for ‘someday’.
You may not need an exit strategy if you intend to die at your desk and leave a mess for your family and team to clean up.
So let’s suppose. Do the following points describe you?
You Don’t Need an Exit Strategy IF You:
- Want to liquidate your business upon closing even if it means getting only pennies on the dollar
- Want to maximize your tax bill to the state and Uncle Sam, minimizing the return to your family
- Do get to sell in the end (maybe a firesale) and you enjoy paying your technical/transaction advisors at their highest premium fees
- Are willing to walk away from 30-50% of the value of your business
- Are willing to let the business lose clients when you depart
- Don’t feel responsible for your employees after you’re gone. Will they still have a job, will they move, will they have to take a pay cut?
- You and your business are not a community partner, in donations, sponsorships or time, and your closing will not hurt the community
You Don’t Need an Exit Strategy IF Your Family, Your Spouse, or Your Children:
- Can and will jump in and run the business your way, without any need for some development and succession planning in advance
- Can salvage or sell the business on their own while you are indisposed
- Do not need or expect the business to be liquidated in some way to secure their future
- Do not expect or deserve a return for all the sacrifices they made for you to build that business
These statements are a bit exaggerated. ‘Yes, But my situation is different…’ is not enough. Without a Framework for your exit; you, the business, your team, your family, your finances and your future will all be shortchanged. Is that your intention? Is that your plan?
- Everyone needs a Master Plan – for their business and their life
- Every owner needs contingency planning – ideally before you opened the doors to your business – sooner rather than too late
- Every owner needs to start exit planning early – years earlier than any transaction advisor every required of you
- Exit planning and execution take time and a team to maximize your return and optimize your exit transition
If not now, when?
Call us for your free consultation.
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“Attracting a buyer is like preparing for a beauty contest” – Gary Miller
Dog owners and breeders know that it takes years of discipline, training and preparation for their pure bred champion dog to stand out from the crowd and win the blue ribbon at the Westminster Kennel Club dog show. They know that the dog that ‘shows best’ will win ‘first’. They know the decision is in the judge’s hands.
To show best and win first in selling your business, it’s up to you to make your business both buyer ready and buyer attractive.
To Prepare Your Business, Think Like a Buyer
Before you enter the market place of potential buyers, preparation is essential not optional. Plan on at least 1-2 years of preparation efforts before you begin the 6-9 month transaction process. Yes, years. This preparation means all the difference in the value of your business and the price it will command in the market place.
Preparation is a choice far too few owners take seriously. Preparation makes your business stronger, more attractive and more valuable. Without preparation, you give (gift) all the leverage in a negotiation to the buyer and the buyer’s intermediary.
To think like a buyer, there are a few key steps that will make your business more attractive and appealing to potential buyers. They include:
- Getting a base-line valuation performed by an independent valuation firm to quantify the current market value of the business.
- Documenting all assets and inventory accurately. Dispose of any obsolete materials or expired inventory to get to a true accounting of what you have.
- Cleaning up all financial records to show current market value of assets and inventory now to avoid any issue for your buyer. If you wait until you have an interested buyer and they discover that your financial records show a higher value than market value at that late date, it will weaken your negotiating position or worse, put the deal itself at risk.
- Investing in an audit of your financials now, done by an independent accounting firm. This will give you time to clean up/correct any errors or concerns identified. It also establishes a pattern of good business management.
- Bringing all legal requirements and records up to date. Revisit all vendor and client contracts before you pursue any buyer opportunity.
- Implementing and document all systems and processes for operating your business. If you’ve never documented anything, you have no leverage to say what it’s worth. If the entire business is in your head, a buyer will not pay the full potential value of your business if they have to depend on you to achieve it. This step in itself adds value to the bottom line and drastically reduces business continuity risk.
- Deciding now who on your management team will be essential to the successful transition of the business to new ownership. Tell them your plans now and what you’ll do for them because they help you through the transaction process. Without them, your business is much less attractive to your buyer. You need them on board to champion the business when your potential buyer arrives to do their due diligence.
- Executing your own internal due diligence now to identify what is ready, what is not ready, where you are strong and where there are holes in what a buyer would expect to find in the due diligence process. With a timeline of years, you give yourself the luxury to methodically clean up, resolve and eliminate any potential red flag. The more complete, transparent and prepared you are, the less likely the buyer’s team are to dig for hidden problems.
Your All-Star Team of Advisors
To prepare you, your business, and your team to take your business to market, you need an all-star team of advisors, not just one or two. The most successful transactions close when you surround yourself with a cooperating, collaborating coordinated team of advisors to ensure your business is buyer ready and buyer attractive to achieve the outcome you want on your terms. In addition to your current business attorney and accountant, your core team must include at least:
- An exit strategist to manage the preparation of your business for you and orchestrate your transaction team; so you can stay focused on what you do best – accelerating growth and maximizing the value of your business.
- An attorney with significant transaction experience in the type of transaction you want to close. A divorce attorney or real estate attorney or a litigation attorney may not have the experience to give you the leverage to negotiate the best deal.
- Your Chief Financial Officer – even if you’ve never had a CFO on your team in the past. Even a part-time CFO will help position your business in the best light for a buyer.
- An investment banker with substantial transaction experience in your industry can be invaluable in negotiating the deal and moving the process to closure.
- A tax accountant experienced in major transactions who can evaluate and guide you to minimize the tax impact of the deal by preparing years in advance.
- A specialist wealth advisor to help establish your wealth preservation plan beyond the business, long before that plan will be funded by a successful sale to your buyer.
You need the entire team, not full-time, but all on board early and engaged to advise you through the preparation stage and right through the transaction to your ideal buyer.
Select the best advisors you can find, not the cheapest. The best, who deliver the most value, will pay for themselves many times over in the returns you receive.
Think like a buyer. When you and your team analyze your business through the eye of your ideal buyer, over time, you will add value and increase the leverage you can command in the deal. That’s how you attract the best buyers, “show best” and “win first”.
If you’re wondering when is the right time to sell your business, you may want to wait until your company is generating $1 million in earnings before interest, taxes, depreciation, and amortization (EBITDA).
What’s so special about the million dollar mark?
Hitting the million dollar mark is a tipping point at which the number of buyers interested in acquiring your business goes up dramatically. The more interested buyers you have, the better multiple of earnings you will command.
Since businesses are often valued on a multiple of earnings, getting to a million in profits means you’re not only getting a higher multiple but also applying your multiple to a higher number.
For example, according to research at www.SellabilityScore.com, a company with $200,000 in EBITDA might be lucky to fetch three times EBITDA, or $600,000. A company with a million dollars in EBITDA would likely command at least five times that figure, or $5 million. So the company with $1 million in EBITDA is five times bigger than the $200,000 company, but almost 10 times more valuable.
There are a number of reasons that offer multiples go up with company size, including:
- Frictional Costs
It costs about the same in legal and banking fees to buy a company for $600,000 as it does to buy a company for $5 million. In large deals, these “frictional costs” become a rounding error. In contrast, they amount to a punitive tax on smaller deals.
- The 5-20 Rule
I first learned about the 5-20 rule from Todd Taskey, M&A Advisor at Potomac Business Capital in the Washington, D.C. area. He discovered that, in many of the deals he does, the acquiring company is between 5 and 20 times the size of the target company. I’ve since noticed the 5-20 rule in many situations and I believe that your natural acquirer will more than likely indeed be between 5 and 20 times the size of your business.
If an acquiring business is less than 5 times your size, it is a ‘bet-the-company’ decision for that acquirer: If the acquisition fails, it will likely kill the acquiring company.
Likewise, if the acquirer is more than 20 times the size of your business, the acquirer will not enjoy a meaningful lift to its revenue by buying you. Most big, mature companies aspire for minimum top-line revenue growth of 10 to 20 percent. If they can get 5 percent in organic growth, they will try to achieve another 5 percent through acquisition, which means they need to look for a company with enough clout to move the needle.
- Private Equity
Private Equity Groups (PEGs) make up a large chunk of the acquirers in the mid market. The value of your company will move up considerably if you’re able to get a few PEGs interested in buying your business. But most PEGs are looking for companies with at least $1 million in EBITDA. The million-dollar cut-off is somewhat arbitrary, but very common. As with homebuyers who narrow their house search to houses that fit within a price range, or colleges that look for a minimum SAT score, if you don’t fit the minimum criteria, you may not be considered.
So When Is The Right Time To Sell Your Business?
If you’re close to a million dollars in EBITDA and getting antsy to sell, you may want to hold off until your profits eclipse the million-dollar threshold, because the universe of buyers—and the multiple those buyers are willing to offer—jumps nicely once you reach seven figures.
You’ve heard the phrase: ‘Variety is the spice of life’. But in business, variety will quickly drain the life out of your business strategy. Don’t dabble with your strategy. Merely dabbling with a strategic plan is like setting sail on a boat with no rudder to steer it. You may catch a good wind, but the wind controls your direction and speed not you, the skipper. A clear consistent strategic plan that holds a company on course, builds a foundation of strength from year to year to pursue bigger goals.
Companies of all sizes struggle with identifying the best options to accelerate growth and drive value. These firms will dabble with different approaches to see which will work best. Too often they stretch current resources—money, time, and people—too thin when they ‘tryout’ these initiatives. The actual investment in any new approach is diluted, and the new initiatives get abandoned quickly before they can return results or add value. Taking on too many new initiatives or tackling too many goals wastes resources, reduces any potential results, and divides the team.
Before taking action or setting sail; define your critical 3-5 objectives for the year, your destination for the year. Then develop a set of goals, initiatives, activities and projects that lead to or take you closer to achieving those objectives this year.
When you consistently lead with a defined set of constrained consistent, integrated goals you give your company and your executing team a single voice, a single unified focus instead of dabbling in areas where you have no expertise.
Planning your strategy is always about optimizing the given resources to achieve elevated (stretch) goals. To leverage your most valuable assets (usually your rarest resource)
- Make each goal clear and explicit
- Focus on the smallest number of goals that will produce the highest returns.
- Identify and specify your criteria for each of these goals (why they must be a goal, how it will be measured). These will drive operational implementation.
- Identify and acknowledge what opportunities and goals will be missed by your selected strategy. Build consensus to focus on what you do best and not dabble in distractions.
- Assess that this is indeed the best path (but not the only possible path) to take to meet your goals and criteria.
Businesses most committed to achieving the goals of their strategic plan for growth and value also commit to an internal due diligence to determine the critical factors they’ll need (or that they lack) to fulfill that strategic plan. This investment in a deeper analysis of the opportunities they plan to target separates assumptions from reality. It’s also a confirmation of commitment to apply the necessary resources (or invest in them) to achieve the goals of your strategic plan, both short-term and long-term.
Dabbling Is Poison
In 2015, there is no room to dabble with your strategy. The market window to maximize the value of your business is limited. You can’t afford to have dabblers on your team in any area. ‘Only experts need apply’. Strategic dabbling not only puts this year’s goals at risk, but also your goals for the next five years (aka your exit plan).
Don’t be cornered by team members or advisors who want to dabble in a new area, or wear another hat for you, on your dime. To learn more about releasing dabblers and building an all-star team around you, check out my eBook, How to Manage a Gaggle of Advisors to Build an All-Star Exit Team.
Every business owner intuitively has a sense for their metrics. When you identify those metrics and quantify them, magic happens. Your magic ‘operational dashboard’ that will transform your business is simply a listing of your business’ key metrics (your key performance metrics (KPI)). They are effective for many reasons.
GoDaddy CEO Bob Parsons, summed it up when he said,
“Measure everything of significance.
Anything that is measured and watched, improves.”
It’s simpler than you think. Make a list of your company’s key metrics. These become your personal ‘magic’ dashboard.
Simply by measuring something, it can improve. Draft your own operational dashboard to track performance and exactly how your business is performing overall. Start measuring performance against key metrics you need to hit or industry standards, financial standards, etc.
Everything that you track and measure will:
- Improve productivity
- Increase in value
- Demonstrate what was intangible value
- Provide the data to spot and fix problems faster
- Strengthen the core of your business
- Validate forecasts
- Increase the value of your business
Prove it to yourself. Pick 3 things significant to your bottom-line. Measure, watch and track them for 30 days. See what improves.
The fourth quarter is a perfect time to review, refine and revise the metrics you want to track and measure for the coming year to hit your numbers and achieve your goals. Don’t wait until January to start thinking about what you want to improve. Instead, make your plan, share it with your team and be ready to execute starting on January 2.
To ensure your company will survive and thrive and meet the demands of your market, customers and vendors, you must work on the business systematically and analytically to build value in every area. If you don’t know where to start or if you don’t know what metrics to track to improve your business, call 508.820.3322 or email us. You can also check out our 12 month program, Build Your Business Value.
You already know that your company’s revenue and profits play a big role in how much your business is worth. Did you also know the role that cash flow plays in your valuation and therefore the size of the check you can receive at closing?
Cash vs. Profits
Cash flow is different from profits in that it measures the cash coming in and out of your business rather than an accounting interpretation of your profit and loss. For example, if you charge $10,000 upfront for a service that takes you three months to deliver, you recognize $3,333 of revenue per month on your profit and loss statement for each of the three months it takes you to deliver the work.
But since you charged upfront, you get all $10,000 of cash on the day your customer decided to buy. This positive cash flow cycle improves your company’s valuation because when it comes time to sell your business, the buyer will have to write two checks: one to you, the owner, and a second to your company to fund its working capital – the cash your company needs to fund all immediate obligations like payroll, rent, etc.
The trick is that both checks are drawn from the buyer’s same bank account. Therefore, the less cash the acquirer has to inject into your business to fund its working capital, the more money it has to pay you for your company.
However, the inverse is also true.
If your company spends all its cash as it comes in (like living paycheck to paycheck), an acquirer will calculate that she needs to inject a lot of working capital into your business on closing day, which will deplete her resources and reduce the check she can write to you. Everything she has to put into working capital to continue the business, reduces the available cash that she could pay you and reduces your leverage to command a higher selling price.
How To Improve Your Cash Flow
There are many ways to improve your cash flow – and therefore, the value of your business. Here are just three simple ways you can try now.
- Find a way to reduce the cash you spend on equipment, however you can every time. Can you buy used gear on sites like eBay? Can you share a very expensive piece of machinery with another non-competitive business? Can you rent it instead of buying?
- Reassess your pricing. If you can’t accumulate cash reserves, check to see if you are underpricing your services or if your cost to price equation needs to be reviewed.
- Streamline processes and productivity to keep payroll and services within budget allocations.
Profits are an important factor in your company’s value but so too is the cash your company generates. We call this phenomenon The Valuation Teeter Totter and it is one of the key drivers of the value of your company. Curious to see how you’re performing on a whole set of value drivers? Get your private Sellability Score here.
When you look ahead to next year, where will your growth come from? Will it be from selling more to your existing customers or finding new customers for your existing products and services? The answer to the growth vs. value question may have a profound impact on the value of your business itself.
Take a look at the research from a recent analysis of owners who completed their Sellability Score questionnaire. The analysis looked at 5,364 businesses and found that the average company that received an overture from an acquirer was offered 3.5 times their pre-tax profit. When we isolated just the businesses that had a historical growth rate of 20 percent or greater, the multiple offered improved to 4.3 times pre-tax profit, or about 20 percent more than their slower growth counterparts.
However, the real bump in multiple appeared when we isolated just those companies that claim to have a unique product or service for which they have a virtual monopoly. Niche companies enjoyed average offers of 5.4 times pre-tax profit, or roughly 50 percent more than the average companies, and fully 20 percent more than the fastest growth companies.
Nurture Your Niche
Chasing “bad” revenue by offering a wide array of products and services is common among growth companies. The easiest way to grow is to sell more things to your existing customers, so you just keep adding adjacent product and service lines. But when a strategic acquirer buys your business, you are asking them to buy something they cannot easily replicate on their own.
A large company acquirer will place less value on the revenue derived from products and services that you have in common. They will argue that their economies of scale position them better to sell the things that you both offer today.
Likewise, they will pay the largest premium to get access to a new product or service they can sell to their customers. Big, mature companies have customers and systems, but they sometimes lack innovation; and many choose a strategy of acquisition as a way to buy their innovation.
Focusing on your niche is one of many areas where the long-term value of your business is at odds with short-term profit. For example, if you wanted to maximize your short-term profit, you might avoid investing in new technology or hiring a head of sales, arguing that both investments would hinder short-term profit. The truly valuable company finds a way to deliver profit in the short term while simultaneously focusing their strategy on what drives up the value of the business.
You can get your own Sellability Score, and see how you compare on the eight key drivers of sellability, by taking our 13-minute survey here.
Lower middle market business owners risk the future success and likely demise of their business (90% walk away with nothing*). All because no one told them early exit planning is a better way to control the outcome and maintain more leverage in any transaction negotiation. The mistakes owners make when they delay exit planning are often very costly and sometimes irrecoverable.
Baker’s Dozen Mistakes
Here are 13 mistakes owners of private and family run businesses frequently make. They:
- Never align personal, financial, business, family, reinvention and exit objectives. When your objectives pull you in opposite or competing directions, indecision keeps you paralyzed.
- Misjudge their company’s true, transferrable value in the market place. Almost every business owner undervalues or overvalues their business to a potential buyer (financial or strategic).
- Avoid establishing an “Owner’s” Estate Plan. Putting an estate plan in place does not mean you will expire in the next 60 days. Rather it ensures your plans and intentions for the business survival, your team and your family are secure; regardless of what may happen to you someday.
- Neglect claiming and protecting all the intellectual property they have built up in their business. As a result, they leave the business and themselves vulnerable to unnecessary risks and lawsuit losses.
- Start and run their business long-term without any contingency plans in place to protect them and the business from partner disputes or ownership challenges.
- Use the business coffers as their own ATM, so there is no residual value in the business to attract new owners.
- Enjoy a lifestyle funded by the business which cannot be maintained when they sell the business. Their exit options and returns are limited by their personal or family wealth mismanagement.
- Resist marketplace changes and become rigid in their business model missing a market shift or new opportunities.
- Give up on finding or grooming a capable successor. Developing successors takes time, training, delegating and finally relinquishing control.
- Never prepare the company to be ready to transfer ownership.
- Claim excessive tax costs preclude planning for an exit, when the opposite is true. With early exit planning, owners can drastically minimize the tax impact of any transaction down to single digits.
- Postpone considering all exit options until it’s too late to execute most of those options and their choice is being dictated by time, health or other critical game-changing issue.
- Pursue the wrong exit option in the last 6-9 months. As a result, they run out of time, cashflow and opportunities to close an ideal deal to meet their exit criteria.
Now you know so you can avoid each one.
If you need help assessing your business or fixing these mistakes to put your business on a stronger path with early exit planning, call us at 508.820.3322 or email us.