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Two Criteria Buyers use when Evaluating a Small Business

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When the future feels foggy and uncertain, confidence is necessary in order to proceed. A buyer looking to purchase a small business must feel confident that the business will produce a payoff in the future.

Therefore, small business owners ought to make decisions today that position them to be worthwhile investments that potential buyers would feel confident making. Some of the best business-savvy individuals build their business with the mindset of selling it, even if they have no intention of doing so.

Why would a buyer consider a small business?

Investopedia describes an investment as “the outlay of some capital today—time, effort, money, or an asset—in hopes of a greater payoff in the future than what was originally put in.” If a small business can prove that investing in it now will generate a significant payoff in the future, buyers will want to evaluate such an opportunity. An investor will evaluate what type of risk the money they might invest in your business will be exposed to and whether that money can generate a healthy return compared to a different investment. 

Often investors will evaluate businesses to expand and fill gaps in their own portfolios. They will evaluate and search for businesses that work well within their asset allocation. Asset allocation refers to the decisions investors make when pairing multiple investments into a single portfolio. Typically, an investor will allocate funds to a highly risky investment along with a less risky investment. 

Why small businesses specifically? There are two potential reasons for this changed behavior. For one, inflation is on the rise, which means investors want to have the ability to have local pricing power. Local small businesses can have this ability if done correctly. The second is that the stock market, along with other traditional investments, is becoming less and less attractive. Investing in a small business requires the investor or buyer to put up more risk, but that risk is perhaps less risky than investing in a large corporation exposed to too much debt. Many investors are looking at options they usually wouldn’t look at.  

What are buyers looking for in a small business?

Buyers want to feel confident in their investments. Investment confidence consists of two critical factors:

  • Is there recurring revenue?
  • Can the business operate without the owner?

The best small business investments are those that have low risk, produce predictable or recurring sales, and can do so without the owner being present. To the first point, recurring revenue “is the portion of a company’s revenue that is expected to continue in the future” (Investopedia). In other words, it’s revenue that is predictable. Mature business owners go from the eat-what-you-kill mentality to predictable and consistent sales. 

A business that works in the eat-what-you-kill mentality is a business that tends to get caught in the cycle of cash-rich and cash poor. The business might have a crazy sales month and the following won’t produce any sales. 

To the second point, key players are important, particularly starting out, but as the business matures, the key players should also mature and build the business to endure without them. 

If a small business relies on the owner to produce sales, hustle, and find the right clients, the business is at risk. Too much reliance on key players exposes a business to certain risks that are difficult to take into account. Things like health, work-life balance, and burnout.

Ideally, a small business looks like a well-oiled machine. A business that doesn’t require the owner’s day to day engagement is one that is using everyone’s gifts and talents properly. The owner, after getting the business to where it is now, is in charge of working on the business and not in. The more evidence to suggest the owner is working on or above the business, the more confident investors and buyers have in investing in that business.

Without these two components of recurring revenue and smooth operation without the owner needing to be there, investors and buyers will have a tough time moving forward with confidence. The risk of not knowing where the next sale will come from and the reliance on certain key players is too great.

What decisions can an owner make today to set their business up for the future?

If a small business owner wants to sell or is open to selling their business in the future, or if they just want to establish freedom for themselves, (meaning the ability to take a month off and the business not be affected), they need a paradigm shift, a fundamental change in approach and underlying assumptions. They need to make the “System Shift.”

Decisions that owners make today must filter through “system” thinking. A system is defined as multiple functions coming together for a common goal. The System Shift starts by asking the following questions:

  1. What am I doing now that someone else can do?
  1. What needs to happen in order for someone else to do those things at the level I want them to be done?
  1. What’s holding me back from making this change happen?

The business demands the owner to take responsibility for the whole process. We don’t mean “take over and do the work,” but rather have the drive and ownership to document what needs to be done and identify metrics to help evaluate the process, then communicate, train and coach individuals to do the work with the same care and attention as the owner. The entire process must be systemized to track, optimize, and improve current tasks.

How does marketing play a role in building buyer confidence? 

A marketing system has the ability to generate short term income and establish predictable sales, which satisfies the “recurring revenue” criterion. When it comes to marketing, one-hit-wonder campaigns won’t cut it. These campaigns fall into the category of the “eat-what-you-kill” mentality. You might think delegating some work to an agency or a team to conduct a large sale or promotion is system thinking but it’s not. When that sale or campaign is completed, can it be replicated without decreasing the value of the overall brand? If the answer is no, you have an eat-what-you-kill campaign.

Each company has a marketing system.

We encourage all owners to build a marketing system to instil confidence in buyers when they are ready to sell.

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