Building a business of value

Image Credit: City of Melbourne / That Startup Show / Photographer Wren Steiner

Image Credit: City of Melbourne / That Startup Show / Photographer Wren Steiner

Whether a business is just an idea in an entrepreneur’s mind or it is 20 years down the track, it’s always a good idea to think about the day when you will no longer run your business and to take practical steps to be ready for an exit.

In the technology sector, many savvy entrepreneurs are starting with the end in mind – spotting niche opportunities and building a presence in the market with a view to selling the business to a cashed up tech giant. Recent high profile examples of acquisitions have included:

  • Beats – the music headphones maker – founded in 2006 and acquired by Apple for $3bn in 2014
  • WhatsApp – instant messaging – launched November 2009 and acquired by Facebook for $19bn in February 2014
  • Instagram – the photo sharing service – raised $500k seed funding in March 2010 and acquired by Facebook in April 2012 for $1bn

Although acquisitions at this billion-dollar level are still rare, they do highlight a market trend and an opportunity for entrepreneurs and owners of more ‘everyday businesses’ to build businesses of value and to have greater control over how and when they exit.

Let’s get strategic

‘A strategic exit assigns value to the entity, not on the basis of what profit it could inherently generate, but on the basis of what future profit could be generated by the buyer exploiting the underlying assets or capabilities of the entity being acquired.’ 

Dr. Tom MacKaskill, Invest to Exit, April 2009 – Tom is a world expert on strategic exits, click here for more resources.

A strategic exit is a simple but critically important concept. Traditionally, business sales values have been based on what the seller has achieved with the business – for example multiplying Earnings Before Interest and Tax by 3, 4 or 5. This formula gives the buyer the chance of making a reasonable return in the short term.

However this approach does not take into account the future value and what the business could be worth to someone else – the strategic value. So for example, a software startup in the education space with three or four staff might be able to sign up half a dozen new clients a year, each worth $40k to $100k. If they sold or licensed the software to a global education business it could sell the product across its existing client base of several thousand clients, potentially generating $10m or much more per year – i.e. a lot more than a simple multiplier of 3-5 times EBIT.

Building a business of value

Developing a business so that the owners at least have the option of a strategic exit is a smart move for most businesses. The core idea is to build the business to a stage where the value and potential of its services can be communicated, proven and demonstrated to a potential buyer or strategic partner.

From the earliest stage, the business owners should operate on two levels. The first level is focused on the developing a valuable product and gaining customers who value the service. The second and higher level approach involves thinking about who might be the ultimate customer for the business – i.e. who might buy the business itself? – and develop the business to meet the needs of potential buyers.

Actions to implement this higher-level approach include identifying and building intelligence on potential strategic buyers. A long list of 20 list companies might result in a short list of 6 or 7 that you really get to know and identify how they could make returns from your product or business.

Think about what your business will need to look like at the time of sale and what you can do to help the buyer achieve revenues at the earliest opportunity. Essentially, the business needs to adopt a very focused and strategic approach that can include gaining reference customers in key market segments, developing a robust technical structure to support rapid scaling, excellent documentation, a clean IP position and solid contracts in place with talented staff. A pipeline of new product development can also demonstrate future value.

Multi billion dollar acquisitions of innovative startups by mega corporations will no doubt continue – driven by the need to acquire new ideas and revenue streams. Although only a handful of businesses are likely to achieve these massive exits, the principles behind them apply to many startups and small businesses with innovative products and services. Taking time to think ahead on how to build a sellable business – and who might buy it – is time well spent.

Colin Graham