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Hey everybody. Welcome to the Nerd Marketing podcast. This is Drew Sanocki. We’re talking about investments in private companies. We’re talking about maximizing your valuation in this episode. I think it’s a really important episode for that reason.
Everybody wants to maximize your valuation, whether you’re raising money … If you raise money, if you’re going to raise a couple million bucks, you want to do it at a higher valuation so you give away less of your company. Obviously, if you’re going to sell your company, you want to maximize that valuation so you can get more money in your pocket.
This isn’t the typical maximize your valuation list that you’ll see on a number of brokerage sites. Just Google it. You’ll find plenty. This is my take, based on ten or so years in the game, on the things that I see, in particular around direct to consumer brands, and SaaS brands. Really, I’ve tried to distill it down to six tips, six things you want to do to maximize your valuation.
Drum roll please. Number one. I would say decide on your story. What I mean by that is are you going to raise money or sell off of a growth story, or a profitability story? I’ll give you an example. Karmaloop. When we acquired the assets of that business, it was probably … They couldn’t tell a growth story because the company was in bankruptcy. It was a declining asset. They’re in bankruptcy. You can’t tell a growth story. They couldn’t also tell a profitability story, because they were in bankruptcy.
You put those two things together, and the business fetches a much smaller valuation. So assuming you could do one or the other, try to decide now if you are going to be selling a growth story in a couple years, or selling that profitability story, because it’s going to dictate what you do, and decisions around your business.
If you are going to sell the growth story, you want to put as much of your profits back in the business, step on the gas, run Facebook ad campaigns at a lower return on ad spend. Whatever it is, you want to sell that growth story, so you want to lower your profitability, and always favor growth at the expense of profits.
On the flip side, you’re going to sell a profitability story, you want to do what you can to maximize the profitability of the business, like your target return on ad spend goes from two to ten, or something, to just generate as many profits as you can.
The growth story and the profitability story determine very different kinds of buyers, and very different multiples, as we discussed multiples in the last episode. If you are growing, and you choose that growth story to tell, you sell that in your deal book. Then, you could also argue that you get valued off of multiple of revenue.
Conversely, if you’re on board with the profitability story, you want to maximize that owner’s discretionary cash flow, because that’s the thing that’s going to drive the multiple of the business, and the ultimate valuation. So, I’d say, number one, decide on what story you want to tell.
Number two, you want to reduce risk in the business. We talked about how valuations go from nothing for the smallest, riskiest businesses, all the way up to the public equity markets, where they are whatever the average PE is right now, 25. So a lot of that has to do with size, and size reduces risk in the business.
There are other things aside from size that will reduce the risk in the business. The number of products you carry, for example. I’ve looked at businesses selling one or two products. That’s a riskier business, because there’s a life cycle to products. If those products go out of favor, there’s no business. Compare that to AutoAnything, for example, which has millions of SKUs, so a hit to any one SKU is not going to hurt the business.
The number of vendors that you source from. That’s another thing we look at when we make an investment in a company. If you’re sourcing from one vendor, that vendor has a tremendous amount of power over you. It’s a much riskier business than if you were sourcing from multiple vendors, or if there’re multiple options there.
The number of customers in your business. I’ve seen businesses, maybe on the agency side, where there’s really only one or two big clients, and nothing else. That’s a much riskier business than a business that has 100 clients. So the number of customers also reduces risk.
I think not only the number of customers, is probably how much of your revenue is repeat revenue. Certain businesses have high repeat revenue. Think of Starbucks. If the average customers comes back five times a week, that is a lot less risky, a lot easier to project for the buyer, versus if you’re selling, I don’t know, something that you sell one of a year, a washing machine, or something like that. It’s a much riskier business, because there’s very low customer retention.
This is why strategically, you would want to push, if you can, push some of your customers into subscription products. It takes some of the risk out of the business, and ideally, increases your multiple. This is why SaaS companies are valued higher than eCommerce companies of the same size, because SaaS revenue is recurring. A buyer can very easily project future revenue and earnings of that company. The SaaS multiple might be eight times, versus the three times the cash flow multiple we’ve talked about in eCommerce. That’s all about making the business less risky.
Number three, I would say standardize. Standardize where you can. Go get Michael Gerber’s book, The E-Myth. Build that operating manual for your business. You want to make that business turnkey, and filled with automation, and standard operating procedures in every position. Everybody who does something in your business has a job description so someone else can slot in and run that.
The reason that reduces risk is because buyers don’t like surprises. They don’t want to lose the one employee that has everything up in his or her head. They want to know that they can step in and operate that business. As a side benefit, the more turnkey your business is, you can argue for a lower earn out, or a smaller earn out. You don’t want to be locked up, running your business for three years after you sell it. The more turnkey you can make your business, the more likely you are to be able to leave that business when you sell it, and the less risk is in the business.
I like to compare here, look at Flippa. The businesses there, in my opinion, are not open books. Half of them probably don’t even exist. You get a random screenshot of a Google Analytics account. This is, of course, where people are buying and sell businesses that are $1,000 up to, I don’t know, 50k, 100k, something like that. Businesses are not an open book there. You really got to dig to figure out what’s going on. So there’s a lot of risk there. Those businesses are going to fetch lower valuations.
On the other end of the spectrum, I like to point at this company I did diligence on a while back called Kidcraft. They create children’s products. This was probably the most buttoned up business I had ever seen. I mean, the diligence meetings, they brought in everybody on the executive team who was able to talk through, in exacting detail, what their department did. Future projections of the business were off by pennies. They knew, at the end of every day, how much additional EBITDA they had generated in that business. They had operating manuals for all positions.
Really, there was very low risk to a potential buyer in acquiring that business because it was so well run. There’s a lot of danger that you’re going to be surprised by something. All we really had to concern ourselves with is more macro factors, not really what was going on inside the business. As a result, the valuation of that business is pretty high. So reduce risk. Really, that reduce risk is a big one. That’s going to permeate the other six. So, standardization, number three.
Number four, proprietary differentiated product. The more differentiated and proprietary your product is, the higher valuation you will have. You don’t want to be selling salt or sugar, right? Commodity products, hard to differentiate, much lower valuation versus the Apple iPhone, which, there’s only one Apple.
I was looking at a brand of artisanal honeys recently. Killer brand, and good distribution throughout small stores in the northeast, but the only issue would be the differentiated product. It’s differentiated on the brand, but the question I asked is how hard would it be to come up with another brand of honey? Unless the honey is being sourced from mountaintop that has some special advantage, it’s hard to differentiate that product. So the more you can put into differentiating your product line, and making it proprietary, something that no one else can copy, the better.
There’s a lot of ways to do that. Maybe I can get into it in a future podcast. For now, just think about how differentiated is your product versus your competition. The more, the better.
The fifth way you can maximize your valuation is to, I would say, diversify your traffic sources. Just get consistent, diversified sources of traffic. I’ve looked at some businesses where you see just these clear spikes. You’ve got this idiot savant of Facebook ads who is able to just ramp the business from zero to a million, but when you do some digging, man, all the traffic’s coming off of organic social.
Think of the viral news sites that did really well a couple years ago. I’m on the board of one of those now, and let me tell you, Facebook is cutting that traffic source to the bone. So the more dependent your business is on one traffic source, the lower the valuation, because there’s a lot of risk.
I think back to my own business. It was highly dependent on SEO. Because we were doing white hat SEO, that was great, but there are plenty of businesses that are also dependent on SEO doing black hat, or gray hat SEO, and every time there’s a Google change, that business gets cut in half, or gets cut 80%. So you want to, number one, diversity traffic in customer acquisition across a couple different channels. SEO, Facebook, paid, affiliate, whatever it is. Number two, consistent. Have it consistent throughout the year. People don’t like seeing spikes, spikes either way.
Amazon’s another one. A lot of people listening to this podcast are on Amazon. This is where a pure play Amazon business is deemed to be more risky by most buyers. You are 100% dependent on someone else’s race course. You’re running on someone else’s race course, just as the case with an SEO business or a Facebook driven business.
You know better than I do, Amazon can much with your traffic at any time. That carries some risk. My recommendation to pure play Amazon sellers is always build a brand off Amazon. At least diversify the business a little bit. You will more than make up for that effort in the additional valuation you fetch when you go to sell, because your business is now less risky to potential buyers.
The sixth and final thing you could do to increase your valuation is really, I think is network. I vastly underestimated this at my own business, but if you step back a second, and think about it, there are really two different kinds of buyers. John Warrillow, who wrote a book called Built to Sell, talks about this. There are financial buyers, which are private equity funds, and a lot of retirees, who just want an asset that throws off cash. That’s a financial buyer.
Then, there are strategic buyers. The strategic buyers are other companies, typically, to whom you represent one piece in the puzzle that they are trying to put together. Maybe you have a line of product that they deem to be essential to what they want to create, and it’s easier to buy you than to build it in-house. Maybe you have some technology that they want to add into their offering, and again, easier to buy you than to build it.
Well, the multiples kind of go out to the window with a strategic buyer. A lot of the multiples that I’ve talked about are financial metrics. They are something that a financial buyer will slap on your company. What he or she is calculating is what kind of return on investment they’re going to get, return on their capital. The strategic buyers, not that valuation doesn’t matter, but when a strategic buyer is interested in you, and feels that they can only get what they need by buying your company, then that’s where you get the astronomical valuations that you hear about.
Here, I’m thinking about my own business. We thought we were a great fit for, say, Room & Board, a company that really wasn’t doing a lot on … this is Design Public, my home furnishings retailer. Room & Board wasn’t doing a whole lot online at the time. We were certainly doing a lot more better, strategic, good use of eCommerce, so we kind of fit into their business, and they could just push their products through our pipe, and through our platform, and made a lot of money off the deal.
That would’ve been a strategic buyer. They would’ve paid a hell of a lot for us. Who did I know at Room & Board? Nobody. I didn’t know anybody there. So when it came time to sell my business, I had not done the networking required to make inroads with those strategic buyers. I compare that to AutoAnything, the business I just bought five years ago. They sold to AutoZone for a heck of a lot of money. That was a strategic fit. AutoZone wanted to get into eCommerce. Someone at AutoAnything knew someone at AutoZone, and that helped put the deal together there.
So just compare those two exits. We ended up selling to a financial buyer at Design Public. Great, great team, but they valued us on a multiple of owner’s discretionary cash flow, and not the hundreds of millions that Room & Board might’ve been able to pay, if someone at a board meeting there decided we were the right deal.
I would recommend that you network right now. Try to network into the potential buyers in your space, both financial and strategic. But at least make that short list. Always be thinking, talking about it with your advisors. Who could buy us? Who are the bigger players that might be interested in my brand? Who’s in corporate development there? Who’s in the role where they can deploy some capital?
Get on their radar. I never thought conferences were that valuable, but if you go to IRCE, or Shop.org, a lot of the big buyers are there. Try to appear on a panel with them. Just try to get to know those people, so when it comes time to sell your business, you are top of mind, because you would be surprised at how personal a lot of exits are. They are not that the big company looks at the entire universe of potential acquisitions, and narrows it down to the two or three best fits. More likely than not, it is CEO says something at a board meeting, and they decide they got to go buy a company, and someone, the VP of corp dev is like, “Well, I know these guys. They’re a leader in the space. Let me give them a call.”
So, something from personal experience. I wish I’d done that at Design Public. Now, I think networking is my business. It’s not what you know, it’s who you know, as my grandfather used to say. So spend the time to network now, and it will benefit your valuation later.
Those are my personal six picks of things you might do today to maximize your valuation tomorrow.
This is the Nerd Marketing podcast. Next episode, which I think will be the final one on buying and selling a business, I’d like to just get into a little bit of a who’s who, and talk about some examples of how you could start today, if you wanted to buy or sell a company. That’ll be a good one to check out. I’m going to open up my little black book a little bit, and give you some names. So tune in next time. This is Drew Sanocki. I will talk to you later. Bye.
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