How the Type of Buyer Affects Your Business Value
How the Type of Buyer Affects Your Business Value.
There are two types of buyers for your business:
- Investment Buyers, and
- Strategic Buyers.
An Investment buyer purchases a business for the income and expects to grow and improve it to increase that income.
Therefore, value of your business to an investment buyer is a function of the income (cash flow) it produces and the risk of that the income might decrease in the future. And, more often than not, the investment buyer’s perceived risk of income reduction is high.
A Strategic buyer, on the other hand, currently owns a business and will purchase your business based on something more than just the income. This “something more” includes:
- To get access to one or more of your business’ component parts that can improve the buyer’s existing business, such as:
- Employees (whether for skills or their personal goodwill), or
- Special technology, services or products, or
- Where they can achieve economies of scale by, for example:
- Cutting expenses in your business using resources of the buyer’s existing business, or
- Negotiating better pricing based on increased volume.
The cash flow the business produces is a secondary, rather than primary purpose.
The key for you as a business owner is that a strategic buyer will likely pay more for your business than an investment buyer.
Consider a service company (we’ll call it Out of Town Co.) that wants to sell its product into a new geographic area. It could hire a salesperson and perhaps open a sales office and begin prospecting that market.
But its sales would be limited by the experience and credibility of its sales team in the market, and by the current service providers in the market. Sales would be slowed by the costs incurred by customers to change service providers and, where contracts are in place, by the term of those contracts. Plus, if customers are satisfied by current service providers, getting them to make a change and risk a bad experience will often render the initial sales unprofitable.
If, on the other hand, Out of Town Co. bought another services company (we’ll call this one Local Provider Co.) that already served the new market, Out of Town Co. would acquire Local Provider Co.’s customer base, experienced sales and service delivery staff, and, most importantly, its reputation in the new market (also called “goodwill”).
Local Provider Co. is worth a premium to Out of Town Co. because, in addition to income from existing operations, Out of Town Co. can grow the Local Provider Co. business by selling more of Out of Town Co. services to Local Provider Co. customer. Out of Town Co. will likely improve Local Provider Co.’s profits as well by consolidating back office operations (financial, human resources, payroll, etc.).
Out of Town Co. can make a business case that Local Provider Co. is worth more to it because the benefits are greater than the current income from operations. Out of Town Co. can, therefore, pay a premium over an investment buyer based on the increase income after the acquisition.
Most small and medium sized businesses are purchased by investment buyers because the owner hasn’t considered in advance what companies could be strategic buyers, nor tailored his business to be attractive to those strategic buyers.
Creating a strategic buyer market for your business requires forethought and planning, and engaging a broker who understands the process of marketing your business to a strategic buyer.
First, it is important to consider what companies would likely be strategic buyers for your business.
- Does your business a particular niche (market, geographic or other) that a buyer from another industry could exploit with its complimentary services or products?
- Does your business offer a niche product or service that a buyer could offer to its current customers to increase the lifetime value of those customers?
- Is there a competitor who has tried to sell into your business’ niche with little or no success?
Then, once you’ve identified possible strategic buyers, you must put in place the structures that will maximize the value of your business to those buyers.
- Building a good quality customer base in a well-defined niche with repeat customers who understand and appreciate the value your business provides.
- Competing only on service or (deep) expertise. NEVER compete on price (these customers are the least loyal and most costly to acquire).
- Developing a team that understands your value proposition and executes on it through documented systems designed to ensure repeatability and high gross margin.
- Hire slow and fire fast (the fire fast being the most important of the two).
- Pay employees slightly above the market rate.
- Give key employees an upside to growing the business.
- Get out of the way – get the key employees to run the business (Don’t be a hero. If you’re an essential component of the business operations, the business is worth less than it would otherwise be).
- Building a sales force (that doesn’t include you) and consistent repeatable sales and marketing systems.
- Having excellent financial record keeping and reporting systems.
- Managing finances monthly (including profitability) and basing decisions on profitability and the long-term goal of selling the business.
- Show growth in revenues and profitability each and every year. Growing businesses are worth much, much more than sporadic or declining businesses.
- Investing in the business when it will result in increases to profitability and business value.
When considering what to implement, remember the 80/20 rule: 80% of the benefits come from 20% of the inputs. Taking even just a few of these steps will put you far above most other businesses owners.
Some areas to focus on for maximum impact include:
- Increasing gross revenue (while maintaining gross profit),
- Increasing sales for current customers, and
- Building sales and marketing systems that can be implemented by a sales team (rather than the owner).
Finally, working with an experience broker who will be honest with you about the value of your business, and will implement a marketing plan to create an auction among strategic buyers will likely increase the wealth you realize from your business.
If you are considering the sale of your business, please call me at 407-649-7777. We can help you find and select a qualified broker, and get ready for the business sale process so it doesn’t impact business profitability or value in the near term.