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Want higher value? Small and smart can get you more

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Small can be worth a lot more for growing value, especially if you can hone that strategic asset that your business brings to market. By TOM McKASKILL

By Tom McKaskill

Sell a business Small can be better

Small can be worth a lot more for growing value, especially if you can hone that strategic asset that your business brings to market.

How often have you been told that you need to grow your revenue and profit to make your company more valuable? Increasing size and a higher stream of future profits drives conventional valuation models, and yet sometimes higher valuations can be derived from being smarter rather than being larger.

Conventional valuation makes an assumption that the existing business will continue to do business the same way and with the same product/market interface and will continue to be managed in the same manner as it been in the past. With such an assumption, it can only result in one approach to valuation – whatever is there now will continue to be there in the future and nothing has changed.

Thus historical performance is probably as good as you will get in terms of predicting the future performance of the business. Whatever risk profile the business had before, all other things being equal, will exist in the future. But what if you could change the future?

With a conventional business, that is one that derives its value purely from its own generated profits, you can set out to change the future by changing the capability and capacity of the owner.

Thus a new owner who can exploit untapped potential in the business will generate a much higher level of future profits. If, at the same time, you can create an environment where the future risk of the business is decreased, you can also increase the current valuation. Thus a business which puts its efforts into reducing risk and creating greater future potential for a more capable buyer can readily be worth more than the same business that solely concentrates on getting bigger and generating more current profits.

The case for “small is beautiful” applies even more with businesses which have underlying strategic assets or capabilities that can be exploited on a large scale by a national or global buyer.

The essence of value in such a business lies not its own revenue and profit generation but in the extent to which the buyer can generate rapid profits through exploiting the strategic value. Thus a biotechnology firm that develops new drugs may never have any revenue, but is still worth a considerable amount if it makes a breakthrough discovery. The revenue is generated by, say, a large pharmaceutical acquirer that takes the approved drug to market through its extensive distribution channels.

In the case of strategic value-based businesses, value is not increased by getting bigger and generating more revenue and profit, but by further developing the asset or capability which is the basis of the strategic value.

If structured correctly and sold to the right buyer, the small development firm can be worth a lot of money. Valuations in the multiples of 10s are readily achieved in such situations.

The key to higher valuation is to understand what creates value for the buyer. Conventional valuation models are not creative nor proactive when it comes to strategically matching the untapped potential in a business with the right buyer. Small can be worth a lot more if the selling process is done right.

 

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.

 

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