OK, hands up all of you who were shocked, amazed and (go on, admit it) a little jealous when you read about the recently announced purchase by Facebook of Instagram (a photo-sharing application developer) for £1bn? The deal has certainly caused a few raised eyebrows.
Instagram is a two-year-old, 13-employee business that has had around $10m in financing, although, about a week before the sale to Facebook, 10 per cent of its shares were sold to a venture capitalist (in what seems to have been a super-smart move on their part), raising $50m in funding and valuing the business at $500m. It has no revenues but has 30 million users while Facebook has a staggering 850 million users worldwide. It will be interesting to know how many of the Instagrammers are already Facebook users, not that merely grabbing access to additional users was the main motivation for the deal, I am sure.
Now we know that the techworld (yes, the one that produced more bubbles than an Aero or the Boleyn on a good day) is prone to exaggeration but many may have thought that the days of deals like this were long gone – seemingly not.
Whether or not the Instagram purchase represents the start or evolution of another tech bubble is not a subject we will debate in this article but it reminds us of a basic truth that the value of a business will substantially be what a buyer is willing to pay for it.
Without wanting to patronise, this is something that SME owners need to remind themselves of. If their future financial wellbeing substantially relies on the realisation of value from the sale of their interest in their business, then SME owners need to regularly tune into and focus on creating and developing a business that demonstrates the characteristics of what the market (its market of potential buyers that is) values.
Regardless of the sector that the business is in, these characteristics are likely to incorporate
- visible (AKA repeat, sustainable) revenues
- low debt (or at least comfortably managed debt)
- strong brand
- loyal, expanding customer base
- controlled costs
- retained staff
- scalable products and services and not incorporate
- heavy (over) reliance on owners
- reliance on one-off non-repeat sales
and, well, pretty much the opposite of all the positive characteristics listed above.
To not address what drives value in your particular business is to have a sub-optimal value realisation strategy. Now this is not so much of a problem if your aim is not to realise value but, instead, to have, say, a lifestyle business. You may love what you do so much that you will be a Nevertiree. Good for you.
That introduces different risks, most notably over the owner’s physical and mental ability to stay focused and vital and, also, if the owner wants to wind down but not sell, for example, just work a bit less, the ability of the business to continue to provide the finances to support the owner’s lifestyle. All entirely possible but not necessarily without its challenges…and all something that can be addressed by good financial planning.
As for a Nevertiree, an aspiring-value realiser should also spend a little time considering and then planning to counter any risks inherent in the chosen strategy. Hedging the risk that a sale of the business at the time you want to make it and for the value you would like to receive, with a contingency plan, for example, some non-business investments, is just putting in place a sensible asset allocation strategy.
Reliance on a single unquoted equity (which is what your business may be), so that you are, in effect, overweight in this asset class, inevitably brings risk.
Contingency planning, say through the use of business income to put in place a pool of non-correlated other assets in the form of pensions, Isas and other investments, will be well worth considering.