When it comes time for a business owner to contemplate an exit from their business, it is important to consider the differences between a ‘good business’ and a ‘good investment’. The next owner of your company will likely be looking for a ‘good investment’, not just a good business. Therefore, if you want to attract a qualified buyer for your business and get the highest value, then you’ll need to focus on a number of things to make this happen. This is written to assist you in identifying the distinctions between the two and what you can do to improve the attractiveness of your business as an investment.
Hallmarks of a Good Business
Most privately-held businesses are lifestyle businesses. In other words, the business generates enough revenue and profitability for an owner to live comfortably. Often times owners focus on the personal benefits of business ownership over the potential for the future of the business. For example, business owners may choose to live with low or no growth in the business as a trade-off to a more flexible schedule, not having to borrow money or bring on additional shareholders and avoiding additional complexity in their business.
When a business owner has a ‘good business’, such as the lifestyle business describe above, there will often-times be a limited set of professional buyers for that business. In fact, the largest pool of potential buyers for that business may be individuals who want to enjoy the same lifestyle as the owner.
Professional, outside/ unrelated buyers who oftentimes are able to pay higher prices for a particular business holding are looking for more.
Hallmarks of a Good Investment
Arguably the hallmarks that make a business a ‘good investment’ are ones that every investor but also every lifestyle business owner is likely to favor. The list below is by no means a complete accounting of all attributes of a desirable company, but it will provide an overview of some areas that professional investors consider important when purchasing a privately-held business.
A Business That Can Run Without the Owner
Owner dependency is a major issue with professional buyers. If your company is highly dependent upon you in order to run (and grow) into the future, then buyers may not consider your company a good investment or its value truly transferable. If you think about your investments in public securities or mutual funds, those companies run without you. In fact, it’s likely that you do not know who runs those businesses because you are merely an investor. There is a separation of ownership and management. In most small businesses the owner is intricately involved with many facets of the business. While some management may be in place, this at times may not be enough to reduce the high levels of owner dependency that are present in many closely held businesses. Therefore, in order to make your company a better investment and more transferable, you will want to reduce the company’s dependency upon you.
A Business that Has Management in Place and is Successfully Pursuing a Strategy for Growth
The next attribute that will help define your business as a good investment is how empowered and successful your management team is in pursuing growth through a defined strategy. If you have managers who take initiative, make good decisions, measure and report their own performance and can be entrusted to direct themselves towards achieving strategic goals, then your company begins to look more like an investment. (this also helps to illustrate lower owner dependency)
A Business that Is In an Industry that Has Attracted Capital and Has Growth Potential
If your business is in a slow / no growth industry but provides for a good income for you and your family, then it may not be sought after as an investment for a professional buyer. However, if you are in an area of growth and outside investment is finding its way into your industry naturally, chances improve that outside investors will more readily recognize upside potential in your business.
A Business that is Outperforming its Peers in Terms of Profitability
It is not enough for a company to be independent of the owner, to have empowered management and to be in the right industry. For your company to be considered a good investment, it is also important that your company’s performance be stronger than your peer group. A good investment is not just one that makes money, but one that is ‘best in class’ – a company that outdoes the competition. To the extent you can articulate and illustrate the key areas where your company outperforms the competition, your business will look like a better investment.
It is important to present a good investment to a future owner, not just a good business. There are a number of things that you can do today to determine the difference between the two and to improve your business using this knowledge. One of the first things that you may want to do is determine how dependent your company is on your individual efforts. Ask us about how to get started thinking more completely about this critical issue!
Published: October 14, 2015
Phone: (812) 602-6306
The information in this material is only as current as the date indicted, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. While all information prepared in this document is believed to be accurate, any statements of opinion constitute only current opinions of Payne Wealth Partners, Inc., which are subject to change and which Payne Wealth Partners, Inc. does not undertake to update. Accordingly, you should not put undue reliance on these statements.