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December 1, 2022
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Building a business backwards

Pavlo reflects on a business owner who had worked with Aurik and recently sold his company for 120 million. When Pavlo mentioned this purchase to another business owner, the response was: “He must be really lucky to land such a deal.”

Luck does count – where you are located matters, timing can matter but largely, it has very little to do with luck.  For a business to have a high valuation in the sale, the business needs to be built backwards, starting with the end in mind and designing it towards the end goal.

This business was built eight years ago with the intention to sell it in the long run. When asked how much he would sell the business for, the owner said 100 million, and he was adamant on that number. To reward his years of investment, risk, and sacrifice, this was set as the target.

The plan to act for tomorrow had to work backwards from that future date. He and Pavlo ran a few numbers. What they calculated is that five years forward he  would need to have a revenue of 85 million,  profitability running at least 15% to be able to  argue and justify a multiple of around eight. If you take the initial  85 million, multiply it by 15%, and multiply it by eight, you’ll get something like the 100 million target.

On average, most businesses are lucky to earn three or four multiples. But the reason for that is that when most people sell their businesses, they arrive at that point at the 11th hour after 10, 20 or even 30 years of successfully generating income. They learn that what they have built is a business that’s good at generating income but not a business that is transferable as an asset to the future buyer or acquirer. As a result, they are heavily penalised for the multiple.

The multiple is an indicator that effectively answers five questions.

In this podcast of The Money Show, Pavlo Phitidis breaks down the process of building a business backwards, and asks the 5 key questions:

To illustrate the point, let’s use an example of a furniture business:

  • There are 10,000 furniture businesses out there, and the buyer needs to see that you’ve distinguished yourself, and your brand positioning within the furniture industry is good. Your brand needs to be recognized and appreciated by your customers. That’s the one factor that would take you to approximately a three or four multiple.
  • The second question is, “How does the whole thing work?” What business systems have been put in place? If you have translated all your commercial activities into business systems, then effectively you’ve got a playbook as to how the business works, and that takes the  multiple up to four or five.
  • The third thing they will ask is:, “If you exit and are not there, who’s going to make it happen?” You need to show that you’ve got a team that’s engaged, that’s motivated, that has been there for some time, that sees a future, especially with the new acquirer, and if you can show this, you have an additional multiple.
  • Next question: “Will there be growth in the future?” If the business is to grow at a higher rate than you’ve grown the business in the last two or three years; the acquirer shouldn’t be paying for that. You need to have shown growth prior to exiting.
  • And then the last, and often toughest, question is: “Without you there, what happens to your suppliers? What happens to your team? What happens to your customers?” What is your influence in holding it all together and ensuring that the asset that is being bought from you today will perform the same tomorrow once you’ve left?

If you address each of those five levers, you’re taking a three multiple to an eight multiple. You’re adding an additional point in each  instance.

And that’s what we mean by an engineered approach, which requires you to start with the endgame, saying, “I want 100 million for my business.” and then design the business to deliver that eight multiple.

Why acquisitions fail to yield value:

A Harvard study from 2016  estimated that 82% of acquisitions made, failed to yield value for the buyer. Very often, these acquisitions are made by listed companies, where there’s quite a bit of pressure to demonstrate how your investments are yielding shareholder value. They identified all of the major reasons why these acquisitions fail.

  1. The first is a misalignment of customers. You acquire a business, you believe you might be deepening your ability to reach a new market that’s similar to the one you already serve. But often, there is a misalignment.
  2. Secondly there are massive issues integrating the team in the client business with your existing team. In other words, getting a cultural match.
  3. The third reason is that the functions of how the business runs and operates are profoundly different from the way your business runs and operates.
  4. And the final reason is that once the owner is no longer there, the culture, values, and numerous other elements that held everything together simply disassemble, fragment, and fall away.

Understand that when you are ready to leave a business, you need to serve and understand the needs of a new customer: The Buyer.

The problem is that most of us arrive at this point with three, four, five, or six months left because we want to get out at that point. We make the decision to get out, and yet we have never built the business in such a fashion that it fits neatly with what the buyer wants.

Start with the end in mind and build it backwards.

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