July 23, 2020
When I speak with growth stage entrepreneurs, they always love to ask what kind of return they can expect in the markets. I then cite the standard stats that state, depending on risk tolerance and markets, you can plan for anything between a 3% to 12% return, annualized, over a 10-year period. They then proceed to laugh me out of the room.
You see, they’re not coming from their investments like the standard buy-and-hold investor might. Many entrepreneurs see returns of 60% to 300%, annually, particularly in the early stages of a successful company launch — albeit it requires a high level of risk and guaranteeing private assets to push those kinds of growth targets. When in the thick of a growth cycle like this, these entrepreneurs have a clear understanding of their return on invested dollars as they seek more funding via banks or investors. With these types of returns, the restrictions to fueling more growth is often limited by the access to capital and the speed with which the funds can be deployed. But when you’ve experienced this type of business cycle, you start to think differently and the standard market returns simply make you laugh.
As a teenager, I worked a summer job as a server and bartender at a local restaurant. One night, I tended the bar as the restaurant hosted a networking event for local business leaders. During the event, the president of the local Chamber of Commerce approached my boss and I to share her wisdom. “If you want to teach this kid anything about business, tell him to stop worrying about percentages and start thinking in multiples,” she exclaimed.
This sentence has stuck with me for many years. As a soon-to-be university business student, I couldn’t wait to learn how to put this sentence into action. Fast forward seven years, with a Master’s degree in business under my belt, and I still didn’t have the answer. It wasn’t until I launched my own businesses did I begin to figure it out. She meant, only focus on large margin investments and turn inventory quickly. It’s also using sales and profits to prepare valuations, to further increase capital or funding.
The mantra "think in multiples" has become a consistent reminder to me as an entrepreneur as to how to approach business and financial decisions. It’s what those entrepreneurs who earn 300% of their invested dollars understand. This approach will change the way you address business planning, but it takes some understanding of the mentality in order to make it work for you.
You can not find an investment with multiples in return, without taking on risk. Want to make a real estate agent chuckle? Ask her how to get a non-recourse loan. In other words, how can you invest in a can’t-miss property without putting your own assets at risk if something goes wrong. They will laugh — or grimace — because it’s not possible.
Either you put some skin in the game or you don’t play. Large real estate investors can obtain non-recourse loans via their corporations, since the organization has assets to lose with track records that lenders feel comfortable with. You do not get to start at this level, though.
For other businesses, this means you’ll have to risk personal assets and spend money on goods, equipment or staff, in order to make your multiple. You do this in an intelligent way, with a strategy for maximizing such an investment. But you can’t attract the multiple, especially for very long, unless you are willing to take on the risk.
It’s important to warn you, at this moment, that when seeking multiples, you’ll make mistakes and some of your investments in the business will not pay off. Your goal will be to reduce the impact of those mistakes and increase the payoff of your smarter or more strategic purchases. But in order to make multiples, you’re required to spin your successes forward. When you have lofty goals, your actions must reach equally high. This means you’ll need to keep profits invested in your company to increase your capacity to earn. It’s difficult to make some money initially, and not spend it on yourself. These profits, though, will help you fund your company’s financial, marketing and staffing needs moving forward. This will lead to further, proactive growth.
This also means understanding what has the greatest impact on your ability to earn. Are your products and services on brand? Do they focus on your core competencies? Are you nurturing partnerships and referral networks? It’s your responsibility to make sure you’re building your company in a way that gives you the most opportunity for success, long term.
Understanding where the highest value in your business lies - and placing your focus on it — will make a huge difference on your ability to obtain a better multiple.
When we talk about making multiples on a business, this often refers to how much the entrepreneur made when he sold the company. Knowing when to sell, how much of your company to sell and for what price will determine whether you make multiples or not. Some sell businesses or assets early, to obtain cash to invest in other companies. Others hold onto a company, seeking to secure an even larger multiple down the line. Either way, you need to understand what metrics your industry uses to evaluate businesses. When you understand how you’re valued, you can then better make decisions about bringing on outside investors, securing funding for further growth or exiting entirely.
Serial entrepreneurs are willing to grow and sell profitable businesses when they find greener pastures or when they believe their current company has reached the height of its value. And the longer the track record of said business, the higher the valuation it will typically command.
Since successful entrepreneurs understand how to make a solid business and plan for an exit, you see why they’re often not jumping at the 3% annualized return strategy. Having the ability to view a business through this mindset, though, can help you secure multiples in other areas of your finances, creating your own growth stage.
By Timm McLean, MBA |
CEO at WLTH