Deck: Diversification is a sound financial planning strategy, but does it work for company building? How does Vitamix get away with charging $700 for a blender when reputable companies like Cuisinart and Breville make blenders for less than half the price? It’s because Vitamix does just one thing, and they do it better than anyone else. WhatsApp was just a messaging platform before Facebook acquired them for $19 billion US. Go Pro makes the best helmet mounted video cameras in the world. These companies stand out because they poured all of their limited resources into one big bet. The typical business school of thought is to diversify and cross sell your way to a “safe” business with a balanced portfolio of products – so when one product category tanks, another line of your business will hopefully boom. But the problem with selling too many things – especially for a young company – is that you water down everything you do to the point of mediocrity. Here are six reasons to stop being a jack-of-all-trades and start specializing in doing one thing better than anyone else: It will increase the value of your business When you sell one thing, you can differentiate yourself by pouring all of your marketing dollars into setting your one product apart, which will boost your company’s value. How do we know? After analyzing more than 13,000 businesses using The Value Builder Score, we found companies that have a monopoly on what they sell get acquisition offers that are 42 percent higher than the average business. 2. You can create a brand Big multinationals can dump millions into each of their brands, which enable them to sell more than one thing. Kellogg can own the Corn Flakes brand and also peddle Pringles because they have enough cash to support both brands independently, but with every new product comes a dilution of your marketing dollars. It’s hard enough for a start-up to build one household name and virtually impossible to create two without gobs of equity-diluting outside money. 3. You’ll be findable on Google When you Google “helmet camera,” Go Pro is featured in just about every listing, despite the fact that there are hundreds of video camera manufacturers. It’s easy for Go Pro to optimize their website for the keywords that matter when they are focused on selling only one product. 4. Nobody cheered for Goliath Small companies with the courage to make a single bet get a bump in popularity because we’re naturally inclined to want the underdog – willing to bet it all – to win. When Google launched its simple search engine with its endearing two search choices “I’m feeling lucky” vs. “Google search,” we all kicked Yahoo to the curb. Now that Google is all grown up and offering all sorts of stuff, we respect them as a company but do we love them quite as much? 5. Every staff member will be able to deliver When you do one thing, you can train your staff to execute, unlike when you offer dozens or hundreds of products and services that go well beyond the competence level of your junior staff. Having employees who can deliver means you can let them get on with their work, freeing up your time to think more about the big picture. 6. It will make you irresistible to an acquirer The more you specialize in a single product, the more you will be attractive to an acquirer when the time comes to sell your business. Acquirers buy things they cannot easily replicate themselves. Go Pro (NASDAQ: GPRO) is rumored to be a takeover target for a consumer electronics manufacturer or a content company that wants a beachhead in the action sports video market. Most consumer electronics companies could manufacturer their own helmet mounted cameras, but Go Pro is so far out in front of their competitors – they are the #1 brand channel on You Tube – that it would be easier to just buy the company rather than trying to claw market share away from a leader with such a dominant head start. Diversification is a great approach for your stock portfolio, but when it comes to your business, it may be a sure-fire road to mediocrity.

In an analysis of more than 14,000 businesses, a new study finds the most valuable companies take a contrarian approach to the boss doing the selling. Who does the selling in your business? My guess is that when you’re personally involved in doing the selling, your business is a whole lot more profitable than the months when you leave the selling to others. That makes sense because you’re likely the most passionate advocate for your business. You have the most industry knowledge and the widest network of industry connections. If your goal is to maximize your company’s profit at all costs, you may have come to the conclusion that you should spend most of your time out of the office selling, and leave the dirty work of operating your businesses to your underlings. However, if your goal is to build a valuable company—one you can sell down the road—you can’t be your company’s number one salesperson. In fact, the less you know your customers personally, the more valuable your business. The Proof: A Study of 14,000 Businesses We’ve just finished analyzed our pool of Value Builder Score users for the quarter ending December 31. We offer The Sellability Score questionnaire as the first of twelve steps in The Value Builder System, a statistically proven methodology for increasing the value of a business. We asked 14,000 business owners if they had received an offer to buy their business in the last 12 months, and if so, what multiple of their pre-tax profit the offer represented. We then compared the offer made to the following question: Which of the following best describes your personal relationship with your company's customers? I know each of my customers by first name and they expect that I personally get involved when they buy from my company. I know most of my customers by first name and they usually want to deal with me rather than one of my employees. I know some of my customers by first name and a few of them prefer to deal with me rather than one of my employees. I don’t know my customers personally and rarely get involved in serving an individual customer. 2.93 vs. 4.49 Times The average offer received among all of the businesses we analyzed was 3.7 times pre-tax profit. However, when we isolated just those businesses where the owner does not know his/her customers personally and rarely gets involved in serving an individual customer, the offer multiple went up to 4.49. Companies where the founder knows each of his/her customers by first name get discounted, earning offers of just 2.93 times pre-tax profit. When Value Is the Enemy of Profit Who you get to do the selling in your company is just one of many examples where the actions you take to build a valuable company are different than what you do to maximize your profit. If all you wanted was a fat bottom line, you likely wouldn’t invest in upgrading your website or spend much time thinking about the squishy business of company culture. How much money you make each year is important, but how you earn that profit will have a greater impact on the value of your company in the long run.

Deck: Business valuation goes beyond simple mathematics, but to get some idea of what your business might be worth, consider the three methods below. Your business is likely your largest asset so it's normal to want to know what it is worth. The problem is: business valuation is what one might call a "subjective science." The science part is what people go to school to learn: you can get an MBA or a degree in finance, or you can learn the theory behind business valuation and earn professional credentials as a business valuation professional. The subjective part is that every buyer's circumstances are different, and therefore two buyers could see the same set of company financials and offer vastly different amounts to buy the business. This article provides the basic science and math behind the most common business valuation techniques, but keep in mind that there will always be outliers that fall well outside of these frameworks. These are strategic sales , where a business is valued based on what it is worth in the acquirer's hands. Strategic acquisitions, however, represent the minority of acquisitions, so use the three methods below to triangulate around a realistic value for your company: Assets-based The most basic way to value a business is to consider the value of its hard assets minus its debts. Imagine a landscaping company with trucks and gardening equipment. These hard assets have value, which can be calculated by estimating the resale value of your equipment. This valuation method often renders the lowest value for your company because it assumes your company does not have any "Good Will." In accountant speak, "Good Will" has nothing to do with how much people like your company; Good Will is defined as the difference between your company's market value (what someone is willing to pay for it) and the value of your net assets (assets minus liabilities). Typically, companies have at least some Good Will, so in most cases you get a higher valuation by using one of the other two methods described below. Discounted Cash Flow In this method, the acquirer is estimating what your future stream of cash flow is worth to them today. They start by trying to figure out how much profit you expect to make in the next few years. The more stable and predictable your cash flows, the more years of future cash they will consider. Once the buyer has an estimate of how much profit you're likely to make in the foreseeable future, and what your business will be worth when they want to sell it in the future, the buyer will apply a "discount rate" that takes into consideration the time value of money. The discount rate is determined by the acquirer's cost of capital and how risky they perceive your business to be. Rather than getting hung up on the math behind the discounted cash flow valuation technique, it's better to understand the drivers of your value when you use this method. They are: 1) how much profit your business is expected to make in the future; and 2) how reliable those estimates are. Note that business valuation techniques are either/or and not a combination. For example, if you are using Discounted Cash Flow, the hard assets of the company are assumed to be integral to the generation of the profit the acquirer is buying and therefore not included in the calculation of your company's value. A money-losing bed and breakfast sitting on a $2 million piece of land is going to be better off using the Asset-based valuation method; whereas a professional services firm that expects to earn $500,000 in profit next year, but has little in the way of hard assets, will garner a higher valuation using the Discounted Cash Flow method or the Comparables technique described below. Comparables Another common valuation technique is to look at the value of comparable companies that have sold recently or for whom their value is public. For example, accounting firms typically trade at one times gross recurring fees. Home and office security companies trade at about two times monitoring revenue, and most security company owners know the Comparables technique because they are often getting approached to sell by private equity firms rolling up small security firms. Typically you can find out what companies in your industry are selling for by asking around at your annual industry conference. The problem with using the Comparables methodology is that it often leads owners to make an apples-to-bananas comparison. For example, a small medical device manufacturer might think that, because GE is trading for 20 times last year's earnings on the New York Stock Exchange, they too are worth 20 times last year's profit. However, if one looks at the more than 13,000 businesses analyzed through the The Value Builder System , it’s clear that a small medical device manufacturer is likely to trade closer to five times pre-tax profit. Small companies are deeply discounted when compared to their Fortune 500 counterparts, so comparing your company with a Fortune 500 giant will typically lead to disappointment. Finally, the worst part about selling your business is that you don't get to decide which methodology the acquirer chooses. An acquirer will do the math on what your business is worth to them behind closed doors. They may decide your business is strategic, in which case back up the Brinks truck because you're about to get handsomely rewarded for your company. But in most cases, an acquirer will use one of the three techniques described here to come up with an offer to buy your business.

Why are Amazon, Apple and many of the most promising Silicon Valley start-ups leveraging a subscription business model? Subscribers not only provide steady revenue; they make your company more valuable in the eyes of an acquirer. In a traditional business, customers buy your product or service once and may or may not choose to buy again; but in a subscription business, you have "automatic” customers who have agreed to purchase from you on an ongoing basis. There are at least nine subscription models that can be leveraged by businesses ranging from service companies to market research firms to manufacturing concerns. Recurring Revenue Recurring revenue—the hallmark of a subscription business—is attractive to acquirers and makes your business more valuable when it’s time to sell. How much more valuable? To answer that, one has to first look at how your business will be valued without a subscription offering. The most common methodology used to value a small to midsize business is discounted cash flow. This methodology forecasts your future stream of profits and then discounts it back to what your future profit is worth to an investor in today's dollars, given the time value of money. This investment theory may sound like MBA talk, but discounted cash flow valuation is something you have likely applied in your personal life without knowing it. For example, what would you pay today for an investment that you hope will be worth $100 one year from now? You would likely "discount" the $100 by your expectation for a return on investment. If you expect to earn a 7 percent return on your money each year, you'd pay $93.46 ($100 divided by 1.07) today for an investment you expect to be worth $100 in 12 months. Using the discounted cash flow valuation methodology, the more profit the acquirer expects your company to make in the future—and the more reliable your estimates—the more your company is worth. Therefore, to improve the value of a traditional business, the two most important levers you have are: 1) how much profit you expect to make in the future; and 2) the reliability of those estimates. At ValueBuilderSystem.com, one can see the effect of this valuation methodology. Since 2012, this methodology has been used to track the offers received by business owners who have completed the Value Builder questionnaire. During that time, the average business with at least $3 million in revenue has been offered 4.6 times its pretax profit. Therefore, a traditional business churning out 10 percent of pretax profit on $5 million in revenue can reasonably expect to be worth around $2,300,000 ($5,000,000 x 10 percent x 4.6). Then compare the value of a traditional company with the value of a subscription business. When an acquirer looks at a healthy subscription company, she sees an annuity stream of revenue throwing off years of profit into the future. This predictable stream of future profit means she is willing to pay a significant premium over what she would pay for a traditional company. How much of a premium depends on the industry, and some of the biggest premiums today go to companies in the software industry. Subscription-based Software Companies To understand what is going on in the valuation of subscription-based software companies, look at Dmitry Buterin. Buterin runs a subscription software company called Wild Apricot. He has also formed one of the world's first mastermind groups of small and midsize subscription company founders, and each month the group meets to discuss strategies for running a subscription business. Members of the group were constantly raising money or being courted by investors, so the topic of valuation came up a lot in their conversations. Buterin found that the consensus valuation range being offered to member companies was between 24 and 60 times monthly recurring revenue (MRR), which is equivalent to two to five times annual recurring revenue (ARR). One way to validate Buterin's numbers is to check with another guru from the world of subscription-based software companies. Zane Tarence is a partner with Birmingham, Alabama-based Founders Investment Banking, a company that specializes in selling software companies that use the subscription business model. Tarence estimates the valuation ranges he sees as belonging in one of three buckets: 24-48 x MRR (2-4 x ARR) These are typically very small software companies with less than $5 million in recurring annual revenue. Companies in this first bucket are usually growing modestly, with subscription cancellation rates (i.e., "churn") in the area of 2-4 percent per month. 48-72 x MRR (4-6 x ARR) These are larger software companies with recurring revenue of at least $5 million annually, which they are growing at the rate of 25-50 percent per year. Their net churn is typically below 1.5 percent per month. 72-96 x MRR (6-8 x ARR) These are the rare, fast-growth software companies that are growing more than 50 percent per year, with at least $5 million in annual revenue and net churn below 1 percent per month. These companies usually offer a solution (typically an industry-specific one) that their customers need to use to get their jobs done. The software business is an extreme example of the benefits of subscription revenue, but no matter what industry you're in, your company will likely command a premium if it enjoys recurring revenue. From Alarm Systems to Prescriptions to Mosquitoes For example, security businesses that monitor alarm systems and charge a recurring monthly monitoring fee to do so are worth about twice as much as security businesses that just do system installations. Retail pharmacies with a large pool of prescriptions for drugs that people take every day, like Lipitor and Lozol, command a premium over a traditional retailer because customers re-up their pills on a regular basis, creating a recurring revenue stream for the pharmacist. Even tiny companies are worth more if they have subscription revenue. When my colleagues over at the Value Builder Score analyzed very small businesses with less than $500,000 in sales, they found that the average offer these small businesses attract is 2.6 times pretax profit. Compare that to the average Mosquito Squad franchise. Mosquito Squad is a Richmond, Virginia-based company that offers to keep bugs off your patio by spraying your backyard regularly with a proprietary chemical recipe approved by the Environmental Protection Agency. Mosquito Squad franchisees target affluent home owners with an average home value north of $500,000 who entertain in their backyard and don't want to be bothered by mosquitoes. Mosquito Squad operates on a subscription basis. You subscribe to a season of spraying, which includes 8 to 12 sprays, depending on how buggy it is where you live. Mosquito Squad is a franchise business, and the impact of its recurring revenue model on its valuation is remarkable. According to Scott Zide, the president of Mosquito Squad's parent company, Outdoor Living Brands, Mosquito Squad franchises that changed hands over the most recent five-year period had revenue of $463,223 and sold for 3.7 times their pretax profit. That's a 42 percent premium over the traditional value of a company with less than $500,000 in sales, and it’s because Mosquito Squad operates on a recurring subscription model and 73 percent of its annual spraying contracts renew each year. Whether you plan to build a subscription-based software application or the simplest personal services business, having recurring revenue will boost the value of your most important asset.

Business owners have been known to refer to due diligence as "the entrepreneur's proctology exam." It's a crude analogy but a good representation of what it feels like when a stranger pokes, prods, and looks inside every inch of your business. Most professional acquirers will have a checklist of questions they need answered if they’re considering buying your company. They'll want answers to questions like: When does your lease expire and what are the terms? Do you have consistent, signed, up-to-date contracts with your customers and employees? Are your ideas, products and processes protected by patent or trademark? What kind of technology do you use, and are your software licenses up to date? What are the loan covenants on your credit agreements? How are your receivables? Do you have any late payers or deadbeat customers? Does your business require a license to operate, and if so, is your paperwork in order? Do you have any litigation pending? In addition to these objective questions, they'll also try to get a subjective sense of your business. In particular, they will try to determine just how integral you are personally to the success of your business. Subjectively assessing how dependent the business is on you requires the buyer to do some investigative work. It's more art than science and often requires a potential buyer to use a number of tricks of the trade, such as: Trick #1: Juggling calendars By asking to make a last-minute change to your meeting time, an acquirer gets clues as to how involved you are personally in serving customers. If you can't accommodate the change request, the acquirer may probe to find out why and try to determine what part of the business is so dependent on you that you have to be there. Trick #2: Checking to see if your business is vision impaired An acquirer may ask you to explain your vision for the business, which is a question you should be well prepared to answer. However, he or she may ask the same question of your employees and key managers. If your staff members offer inconsistent answers, the acquirer may take it as a sign that the future of the business is in your head. Trick #3: Asking your customers why they do business with you A potential acquirer may ask to talk to some of your customers. He or she will expect you to select your most passionate and loyal customers and, therefore, will expect to hear good things. However, the customers may be asked a question like 'Why do you do business with these guys?' The acquirer is trying to figure out where your customers' loyalties lie. If your customers answer by describing the benefits of your product, service or company in general, that's good. If they respond by explaining how much they like you personally, that's bad. Trick #4: Mystery shopping Acquirers often conduct their first bit of research behind your back before you even know they are interested in buying your business. They may pose as a customer, visit your website, or come into your company to understand what it feels like to be one of your customers. Make sure the experience your company offers a stranger is tight and consistent, and try to avoid personally being involved in finding or serving brand-new customers. If any potential acquirers see you personally as the key to wooing new customers, they'll be concerned business will dry up when you leave.