A company purchases another business for one of two reasons. Either they believe they can increase that business’s value or they believe acquiring it will make their own company worth more. Business owners can maximize their value by proving they can help the buyer accomplish both goals. Highlighting strategic value is an important part of any owner’s exit strategy.
Drive Strategic Value by Reducing Competition
As a business strategy, getting rid of the competition makes sense, even if that means buying it. Companies have been buying their competition for more than a hundred years. If supply and demand determine the price of a good or service, decreasing competition allows entrepreneurs to drive up the cost and make more money.
During the Industrial Revolution, powerful industrialists monopolized railroads, steel, tobacco, oil, and banking. After the Civil War, they monopolized most major industries and used their power to control both supply and price.
Their greed and unethical practices earned them the name “robber barons.” They consolidated their business organizations into trusts and were ruthless in their acquisition of the competition. They paid employees as little as possible and demanded long hours, making it impossible for small competitors to keep up.
While the robber barons lived in luxury, their workers had an extremely low standard of living that led to riots, strikes, and other forms of civil unrest. Charles Schwab was an American steel magnate. James Fisk was an unscrupulous stock broker. George Pullman was a railroad magnate whose actions led to the Pullman strike. Public reaction to their monopolies caused the U.S. government to create antitrust laws, which kept businesses from becoming monopolizes.
Antitrust legislation banned price discrimination between buyers, kept competing companies from merging and insisted rates had to be reasonable and just. Today, when one company takes over another, their intentions aren’t as predatory as those of the robber barons, but reducing competition still provides strong motivation behind the purchase.
Microsoft, for example, exhibits many qualities of a monopoly. In 2002, a federal judge stated the company holds a monopoly in PC operating systems. Bill Gates has made acquisitions through the company that consistently reduced competition. Legislators expressed concern that Microsoft could substantially increase the price it charges for Windows, and users would have no choice but to pay it.
When businesses sell to a competitor, they may have to submit a premerger notification to the Federal Trade Commission and the Department of Justice and complete a Hart-Scott filing to prove the merger will not cause reduced competition.
That doesn’t mean businesses can’t buy their competitors, as we see with Microsoft. Exclusive-dealing agreements can be both positive for competition and legal under antitrust legislation, so acquisitions that reduce competition happen almost every day. In fact, one of the best ways to sell a business is to sell to a rival. They understand the value of your product or service because what they provide is similar. Protective strategies and seller savvy are necessary to make this part of a business’s exit strategy, which is possible with proper planning.
When Companies Offer Corresponding Products
One good example of strategic value that improves business valuation involves companies that offer products or services that complement each other. Apple combined the product iPod with the service iTunes. Xerox bundles copiers, printers, and supplies with customer support services.
Determine strategic value by analyzing how customers will use products and services once they are combined. An iPod was worthless without music, so combining it with iTunes adds value to the device. Customers cannot use XM Satellite radio unless they have an active subscription, so the product is worthless without the service.
Another example is when one company has a customer base in need of the target company’s products or services. When eBay acquired PayPal, it improved shopping convenience for users and facilitated use of both solutions.
Use strategic value to increase business valuation when it provides greater flexibility. Oracle on Demand provides database software products, which is combined with a consulting and management service to help companies maximize Oracle investments.
Unlock strategic value by highlighting the peace of mind that comes from buying a strong brand. Otis is a reputable elevator manufacturer that merged with a service firm to differentiate itself from the competition. Most companies buy elevators from one firm and pay for maintenance from a separate entity. Otis saw a dramatic increase in revenue when it added its service component.
Point out strategic value that comes from one-stop bundling. If your product combined with those of the prospective buyer allows customers to access everything from one location, it increases business valuation. Regis Corporation runs over 13,000 salons worldwide. The company has acquired hair care and beauty products that it sells at each location to improve profits and enhance customer convenience.
Sometimes, large companies seek to purchase smaller ones when they offer a product or service the large company would like to offer, but it would take extensive development for them to create something similar. For large businesses, getting the edge on competition makes a proposition extremely attractive. Uncover strategic value when your product or service reduces time to market.
Helping Buyers Appreciate Strategic Value
Just because you can see how much strategic value improves your business valuation doesn’t mean buyers will want to pay for it. The whole reason they are interested in your company may be because they see the value it will add to their company in a few years, but that doesn’t mean they will be willing to pay for something you can’t show on paper.
The ability to communicate strategic value to buyers is invaluable in turning that benefit into actual dollars. A selling team might have to work on a buyer for weeks or sometimes months before they recognize strategic value. Here’s why there’s such a discrepancy between what the seller sees and what the buyer is willing to pay for:
- Buyers are often large industries with separate divisions that don’t interact. The Mergers and Acquisitions department is focused on concrete numbers like cash flow calculations and customer concentration. Their job is to acquire your business at the lowest price and minimize the company’s investment risk while boosting profits. They may not understand future trends or industry dynamics.
- Knowledge must be transmitted through multiple levels. Once the Mergers and Acquisitions department is convinced of how strategic value impacts a fair business valuation, the Central Financial Officer, top executive, board members, and Vice Presidents might take similar convincing before everyone is in agreement.
How to Improve Your Company Value
Business owners can focus on several key areas to improve their business valuation. A diverse customer base, sustainable recurring revenue, improving cash flow, and scalability all make a business worth more to prospective buyers. Here are several areas most businesses can improve to substantially increase selling price.
Reduce risk with contractually recurring revenue. Stable revenue from contracts counts for more than one-time purchases. Buyers wonder how new ownership will impact your business’s customer base, but customers will move to a competitor when they can no longer count on relationships with you as the owner. Revenue from licensing, warranties, and annual maintenance results in reduced risk and allows you to ask a higher price.
Eliminate high entry barriers for the purchasing entity. If there are permits, licenses, or patents that apply to your industry, obtain them even if they’re not strictly necessary. It’s easier for established local businesses to comply with regulations, and satisfying legal requirements reduces time-to-market to make your company more attractive.
Diversify your customer base. Buyers prefer a situation in which no single client makes up more than ten percent of revenue. That way, if one major customer moves to a competitor, it doesn’t take as many new clients to make up for the funds that customer is no longer providing. Risk-averse buyers will pay more for companies with a varied customer base.
Analyze deductions and expenses. If you’re maximizing deductions by allowing your company to pay for your high salary, bonuses, travel, and benefits, you’re paying less in taxes but you’re also making your company appear less profitable. Business owners should normalize expenses at least a year before they plan to sell, to provide an accurate reflection of company worth.
Build your online reputation. One of the biggest ways to build strategic value is to build your image or brand. Financial data shows annual profit and projects growth, but your company website and online interactions also reflect the value of your business. Gather e-commerce metrics to show how your online presence results in profits. Here are a few examples:
- Average acquisition costs measure what it costs to acquire new customers.
- Customer lifetime value measures how long each customer spends shopping at your business online and is tied to retention.
- Average order value measures the amount of revenue per transaction.
- Retention rate indicates how many clients come back to buy more.
Customer satisfaction used to be an intangible that’s hard to measure. Online surveys and positive customer feedback provide numbers to support how the public views your product or service and can be used to improve business valuation.
Strengthen your management staff. McDonalds was successful nationwide because it developed systems and processes that created consistency at each location. When buyers are interested in your company, they wonder what will happen when you are no longer involved. Higher uncertainty results in a decreased purchase price. Develop processes that can be repeated to reduce that uncertainty.
Create strategic value by training and empowering management. Include high-level employees in both decision-making and the aspects of operations you would normally do yourself. Work to improve employee satisfaction and reduce turnover rates. Show prospective buyers your business has a team of professionals who will continue to thrive even in your absence.
Establish your expertise. Proving strategic value is much like marketing. Businesses that are able to showcase their best features stand out from the competition. Use online channels and the media to establish your services and products as the most prominent in your region. Make yourself available to local reporters to provide insight on topics related to your industry. Offer content both online and in print so others can use it as a resource.
Strive for innovation. Examine products or services and find ways you can create processes or technologies your competitors don’t have. Increase your Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) multiple by investing in process improvements and equipment that make your company the future of your industry.
Resist commoditization. When a number of businesses offer the same products or services and basically the only difference is price, it’s called commoditization. In technology, memory chips and keyboards are all basically the same. With services like dry cleaning and taxi service, the main difference is what it costs. Construction materials like wood and paint have minor differences, but there’s not much variation between suppliers. Find any way you can to keep your business from getting lost in the crowd, then emphasize that distinction to prospective buyers.
Develop scalability. Scalable businesses experience profit margin increases in proportion to the revenue increase. For a business to experience scalability, costs must rise at a lower rate than revenue. Software companies demonstrate scalability because once the product is created, production costs are very low. Here are ways business owners can position their business for scalable growth.
- Automate recurring tasks. A robust CRM or e-commerce software frees owners from time-consuming activities and doesn’t ask for a paycheck.
- Resist the quick fix. Always think toward the future and resist temporary solutions.
- Be willing to outsource. That way, you only pay for services when you need them.
Diversify products. Just like buyers prefer companies with a diverse customer base, they also are attracted to businesses that offer a wide range of products. Catherine Hettinger invented fidget spinners, a toy that experienced a rapid increase in popularity between April and July of 2017. However, the crazy fad faded quickly. Now, fidget spinners sit on every gas station and toy store shelf in the country, but no one is buying and Hettinger is trying to come up with something new.
Businesses can diversify by modifying existing goods or services to appeal to a different group. For example, if you make software for design professionals, consider creating a version that is accessible to amateurs. Adapt high-end products to offer a more affordable version.
Other companies diversify by adding related products. If you supply fitness equipment, for example, offer related training material.
Seek advice. Selling a business is a major transaction that, for most people, happens once in a lifetime. Complex legal issues and intense emotions can complicate the sale. An experienced advisor can help navigate one of the most important financial decisions you make.
You know all the intangibles that increase your business’s worth, even more than your financials might show. Outside consultants can be helpful in explaining this issue in terms that help larger businesses see how your company aligns with their goals. By purchasing your company, even at a higher price, they can make it worth more and improve the value of their own business at the same time.
Choose a firm with experience working with sellers in your industry. They are the most capable of recognizing your company’s strategic value and communicating it to interested parties. Working with them ahead of time arms you with a well-designed exit strategy so you receive the best price for the business you worked so hard to build.