Key Drivers of an Attractive Business
“Quality is the best business plan” John Lasseter of Pixar
There are a lot of businesses operating, but few quality businesses. A lot of businesses are started to provide an income to the owner and after that, there is little cash retained to grow and support the business – generally in a case like that, the business is worth more to that owner than to anyone else.
Receiving a premium business valuation is dependent on the business itself.. A quality business that will attract more interest from buyers if it has the following characteristics:
- History of consistent, if not growing earnings. This is a bit subjective and margins vary widely industry to industry, but the business should generate sufficient cash flow to adequately cover all of its obligations and maintenance or growth capital requirements for the upcoming year. Now every industry is unique and industry wide shocks will occur, but generally an earnings chart that is “up and to the right” is preferable.
- Recurring revenues from a diverse customer base. When evaluating whether to buy a business, buyers are really making an educated guess as to the sustainability of a businesses earnings and one that has a strong, diverse customer base will attract higher interest than a business with high customer concentration (and thus higher risk of an earnings drop if something where to change with that customer). Diversity in geography, size, services offered, and industry are all attractive factors as they reduce the risk that an external shock will significantly disrupt revenues. This can be a challenging hurdle to some small to medium sized businesses that often start based on the support of a few key customers, but sellers can overcome this by articulating the rationale for any existing concentration as well as their (realistic) plan for diversification.
- A capable supporting team. Most owner/operators pride themselves on being jack of all trades within their business and all decisions flow through them. The challenge is that an owners time is not scalable under this model and as such, it not only constraints growth, but significantly adds risk to the business if something were to cause that owner to have to step away from running day-to-day operations (like a lotto win or more often, a health scare). Having a strong supporting cast both on the operations and administration side should be something that all owners seek to achieve. Not only does it demonstrate to buyers that the business can support a change in leadership, but most entrepreneurs who have successfully grown their business see this support as a crucial reason why they were able to focus on growth efforts that wouldn’t otherwise be possible.
- Hard assets – well, it depends. This is a bit industry dependent as some buyers only want hard assets businesses (think trucking or heavy equipment) because of a preference for having something tangible within a business as well as using these assets as a way to secure financing (lending against assets is a common way for buyers to finance part of an acquisition). In contrast, other buyers don’t want to concern themselves with worrying about equipment utilization and ongoing maintenance commitments, so they shy away from these types of businesses and gravitate to service or distribution related businesses. Either way, buyers will pay a premium for newer and well maintained equipment and will heavily scrutinize and discount any equipment that appears like it is in ill-repair. Another way buyers gauge this is how clean do owners keep their shops. This sounds superficial, but a well-organized, clean shop reflects a well-organized business. We have toured many shops that a dirty, unorganized and borderline unsafe. Buyers see this – clean your shop!
- A definable competitive advantage. What is your advantage in the market – why do clients choose you over the business down the street. Maybe it’s a patented process, some intellectual property, a key client contract, or a unique piece of high demand/high margin equipment. In many cases its just above average execution and unrelentless customer service. Whatever it is, an owner should be able to clearly articulate what their advantage is and more importantly, why its defensible. Buyers will pay a premium for a strong competitive advantage, especially one that they can scale and grow.
There are many other attributes that a buyer will consider, but we raise these as they are common across any business that we evaluate and we challenge every owner to critically critique their business with an eye to improving their business in these areas.
We would love to hear your story – please feel free to contact us anytime (we are good with evenings and weekend chats).