Category: Strategy

Last night EO Atlanta had an event on positioning a business for sale including how to value it. Typically a business that is bought by an acquirer actively browsing is worth more than when a company shops itself around to other companies. Let’s look at a few more factors in valuing a business:

• Concentration of customers (e.g. one big customer or lots of little customers where more customer variety usually is worth more)
• Gross margins (percent of revenues after only product/service costs are taken out with high gross margins being more valuable)
• Recurring revenue (percent of revenue that comes from monthly or annual fees with higher percentage of recurring revenue being more valuable)
• Profits over the last twelve months (a simple formula for an average company is that the company is worth 4-6x the previous year’s profits)
• Growth rate over the last twelve months (faster growth rate is more valuable)
• Liquidity of the shares (more liquidity like with publicly traded companies is typically much more valuable e.g. 50%+ more valuable)

As you can see there are many different factors in determining the value of a business. It comes down to what another company or person is willing to pay for it with the more profitable and faster growing businesses being more valuable. An example would be a company with $1 million in trailing twelve months revenue with $200,000 in profit (assuming founders and management had market rate salaries) might be valued at 5x the profit, or $1 million. Some companies with no profits are bought for many times revenue due to their strategic value whereas other companies with significant revenues are bought for only a fraction of revenue due to significant debt, losses, and a decline in the business (e.g. Newsweek for $1).

Valuing a business is tough as the market of buyers is usually very small. These guidelines can help you come up with a rough idea of what a business might be worth.

Customer service as a competitive advantage is one of the more difficult ones to sell as most people are jaded by companies that say they have good customer service but don’t deliver on the promise. Great customer service has to be experienced for people to believe it and therein lies the challenge: you have to convince them enough to even try it out. More tangible differentiators like we’re the only company with feature X or position Y are easier to defend and point to, but are also easier for competitors to adopt. Customer service is difficult to do well if it isn’t built into the culture from day one.

What companies do you think of when it comes to great customer service? Zappos.com, USAA, Amazon.com, etc. It’s really hard to do customer service well and the handful of companies that do it well are perennial growth stories.

Here’s what I’ve found works for making customer service a competitive advantage:

• Mention that you pride yourself on customer service but don’t spend too much time on it as people won’t believe it
• Work hard to get existing customers to do video testimonials and have them articulate why your company is so good
• Think of ways to get qualified prospects to use your support team as part of your customer acquisition strategy (e.g. proof of concepts, trials, etc)
• Track your net promoter score and use that to gauge your success
• Know that the benefit of high quality customer service will come from long run customer retention and employee satisfaction (employees want to work in organizations that truly care about their customers)

What else? What are other things to keep in mind when using customer service as a competitive advantage?

The great thing about startups, especially ones in small, fast growing markets, is that there’s no shortage of opportunities. One area that often comes up is larger, more established companies reaching out to talk about technical partnerships with startups in more cutting edge, complementary spaces. The bigger companies have a core competency that’s working, a limited number of engineers, and only so many resources. A tiny startup working in a related space is seen as a quick way to augment the bigger companies’ solution, often through a white label or OEM integration.

95% of the time startups should say ‘no’ to these opportunities.

When should you say ‘yes’ to an opportunity like this? Let’s look at a few potential reasons:

• The partnership has guaranteed revenue minimums for the startup, and the money is meaningful (I did one of these is 2002 and it was worthwhile)
• There is no custom technical work to be done (e.g. the startup has an API and the bigger company can do everything they need to without customization)
• Partnerships like the one being proposed are part of the startup’s core strategy and it will be the first of many that look the same

It is flattering to have these kinds of discussions with more established companies, but without a plan and strategy in place they can also drain a good deal of time and energy. My recommendation is to not get too enamored unless it meets one or more of the criteria listed above.

Did you know that 95% of startups never reach $1 million in revenue? That’s right, only 5% hit that major milestone. Entrepreneurs’ Organization (EO) requires a minimum of $1 million in revenue to apply, and has done so since inception almost 25 years ago. Of course, $1 million 25 years ago is more difficult than today, but achieving $1 million in revenue is hard regardless. Very hard.

Let’s look at a few examples of what it takes to hit $1 million in revenue:

• 50 services deals at $20,000 each (a little over four per month) delivered to completion
• 83.3 customers paying $1,000 per month at the beginning of the year (assuming no churn and no new customers)
• 1,666 customers paying $50 per month at the beginning of the year (assuming no churn and no new customers)
• 100,000 products at $10 each ($10 each selling direct or to a distributor that then marks it up further)

As you can see, it takes quite a few sales regardless of the type of business model to achieve $1 million in revenue. My recommendation is to think through what it will take for your startup to hit $1 million in revenue, and to have that as one of your goals.

As I mentioned yesterday, I believe the market is more important than the management team, assuming both are good at a minimum. For me, I focus on small, fast growing markets as opposed to large established ones. Why? Good question. Here are a few reasons:

• These markets usually have leaders that aren’t so large as to suck all the oxygen out of the space (e.g. what Omniture did to the high end of the web analytics market once they achieved scale and Google Analytics when they consumed the small-to-medium segment).
• These markets by their very nature don’t have incumbents that have to be replaced. Rather, you’re often the first vendor for a company making it easier to define the standards of the market.
• The fast growing nature of the market makes it more likely for several startups to flourish at a small scale.
• The functionality required rapidly changes making it even more fun to be part of the innovation.

What else? Why types of markets do you like?

My younger brother is in his final year at HBS and had as a guest speaker today a partner from one of the oldest and most prestigious venture capital firms. Here’s what the partner said they look for in startups:

1. Does it create value for customer and will they pay for it
2. What is required for strong execution of the idea
3. Who comprises the team
4. What’s the valuation and is there a big upside

One key aspect is that he didn’t directly mention the market as one of the four items. I believe you need a good management team but that a great market is more important than a great management team. That’s right, I’d prefer a good management team with a great market over a great management team with a good market.

There’s been a great deal of exposure and excitement about Web 2.0 companies, many of which are business-to-consumer (B2C) ventures. In fact, the majority of applicants to Shotput Ventures are B2C web companies. As for me, I’m focused on business-to-business (B2B) web companies. Here’s why I prefer B2B companies over B2C companies:

• B2B companies typically sell a higher priced product or service, requiring fewer transactions to build a nice business
• Business products and services are purchased to help make more money or to help save money, making it easy to highlight the requisite features and benefits
• Business sales and marketing processes are well established making it easier to control your own destiny by building things companies need and finding buyers

Now, you can’t argue with B2C fads like Beanie Babies, where Ty Warner, the owner of Ty Inc, personally made almost $1 billion in one year off the stuffed animals, but I’d rather focus on things I can control, and consumers aren’t one of them. B2B startups are for me.

What else? Do you like B2B or B2C businesses more?