It’s easy to get wrapped up in the day-to-day operations of your business. It’s also imperative that you take a step back now and again and take an informed and critical view of what your business might look like to someone from the outside. What would you do that for?
The decisions you make will eventually impact the valuation of your business one way or another. Consider how you make decisions around the following strategic areas . . .
Rather than looking at revenue in total, ask your accountant to generate a gross revenue by customer report. Most small businesses receive the majority of their revenues from a limited number of customers. For example, it’s not uncommon for the top 5 customers to generate 40 to 50% of total revenue in many small businesses.
In most cases, that small group of customers generally comprise highly profitable, long-standing relationships that are key to the success of the company. If this is the case with your business, you may have a “customer concentration problem” and you need to think about what that concentration could do to your business tomorrow.
For example, the loss of one of these key customers could financially cripple your company. Make sure everyone in the organization is taking care of these important customers but make sure they understand that it’s just as important to develop the same kind of relationship with new customers.
Customer concentration becomes a double-edge sword when it’s time to sell the business. Financial buyers tend to shy away from companies that derive a majority of their revenues from a handful of select customers. The loss of one of these important customers may result in the acquired company posting drastically lower revenue and profit figures. Due to this risk, financial buyers will generally apply valuation discounts to companies with a high degree of customer concentration. On the other hand, strategic buyers may pay a premium for these strong relationships with a particular clients.
Strong Vendor Partnerships
Like your customers, you pride yourself on the strong relationship you’ve developed with your vendors over the years. Most small businesses work almost exclusively with one or two key suppliers especially those who are able to serve as the “one-stop shop” solution. Keep in mind that developing a broad partnership network may play an important role in the success of your company. Getting to know other suppliers involved in similar or complementary products and/or services is vital to your business’ success.
For example, what will you do if your major supplier has their business interrupted because of a natural disaster (fire, flood, storm)? What if their quality suddenly becomes and issue and it’s impacting your ability to deliver quality products to your customer. Having several vendors will help offset these problems should they occur.
In the long term, buyers (both financial and strategic) are apt to value a diversified supply chain much higher than a narrow, prone to failure supply chain. Remember, chances are your suppliers are small business owners just like you. Don’t be afraid to call and ask them questions around how they’re going to survive, what their exit strategy is, etc. Not only will you create a personal peer support network for yourself, you’ll be able to find ways to diversify supply chain risk without risking a long-standing relationship.
Develop A Strong Management Team / Successor
Believe it or not, most small business owners are just like you: they tend to control every aspect of their day-to-day operations. If you plan to exit the company, this autocratic structure will be troublesome. Financial buyers are especially keen to this issue and will always ask the question, “if the current owner’s exit will cause paralysis at the company”. If that’s the case, they’ll have to spend time and money finding someone to run the business once you leave.
Bringing in new management may be too great of a risk for financial buyers to bear. They know that the new managers will not have the same breadth of knowledge of the company’s specific market niche, geographic atmosphere, and current client relationships as you do. You can avoid this problem: swallow your pride and develop some form of management team, so that all members are capable of running the firm’s operations and truly empowered to make decisions.
Long-Term Real Estate Leases
A long-term lease is generally a good business decision. It allows you to lock in your facilities payments and provides some assurance to your customers and suppliers that you’re “here to stay”. Be careful who the lease is with and how “long” it is.
For example, you (personally) may own the building that your business is operating in. 3 years ago, it seemed like a great idea to lock the business into a 10 year lease to match the underlying loan amortization. But a buyer may look at the same 10 year lease and realize that the business is trapped (either literally or figuratively) because of the length of the lease.
Customer diversity measures how reliant your business is on a specific industry niche. For example, you may have built a business that has become the ultimate supplier of pipe wrapping to the underground pipeline industry. Anyone who wants to put in underground pipe comes to you for their wrapping.
On the surface, you do not have a customer concentration issue as no one customer makes up more than 5% of your revenue. However, when you look at the industries your customers are in, you notice that 95% of your customers are in the oil & natural gas pipeline business. If there’s a down-turn in the oil & gas industry, chances are your customers businesses will also slow down. That spells trouble with a capital “T”.
Look for ways to diversify outside a particular industry niche either with your current product set or by offering new products. If that’s not possible, prepare yourself and your business for the impact a down-turn in the industry will experience – eventually.