What Is Your Business Worth To A Corporate Buyer?

How many times have you been told by business advisors that you would be better off with a small piece of a large pie than hanging onto your little pie – that is your very own business. I must have heard this many times in my entrepreneurial career and I always worry whether the bigger pie may somehow turn out to be even smaller than the one I have right now. What proof is there that this in fact works? Afterall, we know that 20% of venture capital backed firms fail and 50% of angel investments are write-offs or lose money. Doesn’t give you a great lot of confidence in the process.

Maybe we need to look at it from a different direction. If 80% of venture capital backed firms and 50% of Angel financed firms have positive outcomes then that may be a very good result given the nature of risks involved. Perhaps the question really should be – what would have happened without the additional capital injection? Would those failures have happened anyway? Alternatively, what success would the others have without the external finance?

You may be better of selling

If we look at the major causes of business failure, we can make a judgment call on these outcomes. We know from a substantial body of entrepreneurship research that the major causes of business failure are a poor idea, a lack of business acumen and inadequate funding. Given that the majority of Angels are successful entrepreneurs, we would hope that they would avoid the poor business ideas, contribute to the business knowledge of the venture and provide sufficient finance to overcome any funding shortage. On that basis alone, we would need to assume that they could dramatically improve a venture’s survival rate.

Even so, we still see a reasonable high failure rate. Clearly you cannot protect every investee firm from unforeseen competitive developments, man made and natural disasters or just plain bad luck. Emerging firms do get involved in situations where uncertainty about the future state of the market is the norm so some are destined to hit a brick wall. The remainder actually have a very good chance of very positive outcomes. If the investment screening is done well, chances are that some of those investee firms will return 10 to 20 times their investment with the occasional one producing returns of 100 times the investment. Would the entrepreneur by himself have produced such a result – probably unlikely.

Sometimes a little can be worth more than the whole

Should you take the money and be a small part of a larger pie? This very much depends on the likely size of the pie with and without the external funding. Clearly you are going to have to give up some equity in return for the external investment. If you firmly believe your venture would not survive without the extra finance then the answer is a resounding YES, take the money. If you believe that the venture can readily fund its own inherent growth and you have the management experience to drive the venture to a successful outcome - NO, don’t take the money. The problem really comes down to the grey area – what if you don’t know what the outcome is likely to be?

This is where a good understanding of high growth ventures is important. Angels invest only where there is high growth potential and where they can take the venture to a trade sale or to an Initial Public Offering. If you have the critical elements of a product or service which satisfies a compelling need, a well defined and sizable niche market and a good, sustainable competitive advantage, you have the underpinnings for a good Angel investment. High growth potential businesses consume cash and rarely generate sufficient cash themselves to fuel their expansion potential. Thus a venture such as this will be stunted without a cash injection and will not realize its potential. This is an ideal case for an Angel/entrepreneur partnership.

Raise investment to fund the exit

With the additional cash injection, the business is able to overcome its growth constraints and achieve its potential. However, growth is highly challenging even for the most experience management teams and so the risks are high. This is where taking a different direction pays off. Instead of growing the business, this type of venture is almost always better off seeking a strategic sale of the business. The potential of the business is executed by a large corporation which has the capacity and capability to do so. The Angel investment is used to prepare the venture for sale and to set up the deal.

Strategic sales can achieve large multiples of EBIT or many times revenue in sale proceeds, probably well beyond what the entrepreneur can achieve by growing the business organically. The sale price is based on what the large corporation can achieve with the business not what the entrepreneur could do by themselves. So a business strapped for cash with high growth potential should seek out an Angel Group which can help prepare the business for sale and provide the knowledge on how to set up a strategic sale. As a cashed up entrepreneur you then get to do another one, go fishing or join your Angel friends in investing in the next venture.