Tuesday, 23 October 2012

Barriers to entry help business value

As a business owner you probably are aware that there are many different factors that impact the value of your business.  A major impact to value is the amount of cash flow your business produces.  This makes sense considering buyers are buying business for the income they produce, so the more cash flow a business produces the higher value you would associate with that business.

But one company’s cash flow may be more valuable than another.

Why?  These factors are commonly referred to as value drivers. And they are elements that help make one business more attractive, less risky or more appealing than another. 

There are a number of value drives to consider.  For example, size of the business plays a heavy influence.   The perception that smaller companies are riskier than larger businesses drives prices down on small business and helps protect value on larger companies.

An interesting factor impacting value is best described as ‘Barriers to Entry’.   As a general statement, the easier it is to enter a particular industry, the less a purchaser will be willing to pay.  On the other hand, if there are substantial barriers to entry the less resistance you should get to a higher price.

How can you influence your industry’s ‘barriers’?

In many ways barriers or lack of barriers are specific to the industry you are in.  For example, the restaurant industry is widely understood as a very low barrier industry, while capital intensive industries such as manufacturing tend to have a high degree of barriers to entry. 

Regardless of your particular industry, I would suggest taking a close look at 3 factors to build a layer of protection in your market place…

Market Share:  The higher your share of the market the more likely you are able to differentiate your product or service from the competition.  Being able to stand alone protects pricing from becoming commoditized and further insulates you from new competition.

Customer Base:  Build a diverse cross-section of customers to protect business value.  If you have one customer that represents greater than 10% of your overall gross sales, you are exposing your business to risk of losing that customer and largely effecting profitability. Buyers tend to associate higher risk to businesses with one or two large customers, and pay a lower premium for those businesses.

Proprietary product: Things like patents, and licenses protect your business from competition.  They allow you to ensure profitable margins and they make your business more valuable to buyers.  In a world where buyers are using historic cash flow results to predict future profitability, proprietary products helps mitigate the risk of the competition duplicating products & services and stealing customers.

Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.


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