Friday, September 21, 2012

When the Sharks Come Sniffing

My last few posts have examined sports metaphors that have application to business and education. This one does as well.

Professional sports teams benefit by athletic development and training in college play and in the case of baseball, the minor leagues. In similar fashion, big business gets plenty of help in product and service development through small business. Although big business does not have much "skin" in the small business development engine, they certainly benefit from it. Businesses that may not be very good at organic growth and spend little on new product research and development, can still compete with new products and services through acquisitions. In our legal system and economy, they are able to pick and choose from hundreds if not thousands of small company opportunities.

To illustrate this point, say there is a company that offers textbooks and needs to develop new services to teachers that will attract adoptions and cement long term relationships with it customers. Often, textbook ancillary development can be more expensive than textbook creation itself. The textbook publisher acquires a company that has developed software that allows for easy creation and sharing of custom media-rich test bank questions. This new software may be the latest and greatest of many generations of such software developed over years. The company that is acquired fought its battles in the trenches with a few dozen other companies--most of which have gone out of business. The large publishing company buys the small company for an amount that equals four times its annual revenues. By making this kind of acquisition, the large company avoids a decade of new product in-house research and development work that may have cost the company ten times what they paid for the successful company they acquired. Besides, the small company already fought its competitive battles and has developed a winning product that is in demand. The large company represents a huge segment of the market and the remaining independent test bank providers are essentially driven out of business within a few years.

The down side of this kind of product development for the economy is that hundreds if not thousands of small business employees receive little reward for their part in the process just when the products in their marketplace are at their most valuable. They were not on the winning team although they may have contributed greatly to the competitive process that led to the state of the art creation on the part of their competitors. In the end, they lost their jobs, and the entrepreneurs who developed the products, lost their capital. Developing new product offerings by acquisitions allows companies to avoid traditional research and development expenses.

An athlete can be like that small company that has a terrific product of service to offer a team. Athletes of course now have agents who help them understand their potential value to a team and negotiate accordingly. A small business should be aware that there are professionals who can help them understand their value to a large company just like there are agents who represent athletes. The small business value to the acquiring company may be much greater than the small business assumes.

In business valuation, at the most basic level there is what is called a rule of thumb valuation. A retail business for example may be valued at 3 times annual revenue by a business broker. A hot dog stand may be valued the same way using a different multiplier--say 2.5 or 3.5 times revenue just for illustration. Rule of thumb valuations are fairly simple and are generally used in traditional small business sales. Businesses may use different and much more complex methods that require a complete business valuation report based on special standards and performed by a business valuation expert who is likely conversant in both accounting and finance. A business valuation collects an exhaustive amount of data and also makes a series of adjustments that allow values across a long period of time to be compared. For the small business that becomes a target of a large enterprise, a good business valuation can also look at something that might increase the sale price--the value of the business to the potential buyer. They may look at the projected value of the enterprise to the buyer.

Revenues from the small test bank ancillary company mentioned above, may have been limited to a small customer base. But if one of the largest publishing companies in the world was going to offer the product to its customer base, the value to the large company is likely to be many times over the calculation using the multiplier. When the sharks come sniffing by the small business pool, it may be time to call in the reserves--the trained certified business valuation expert. Copyright 2012 Sporting Chance Press.

Sporting Chance Press is the publisher of J.D. Thorne's The 10 Commandments of Baseball: An Affectionate Look at Joe McCarthy's Principles for Success in Baseball (and Life) and other fine sports books. The 10 Commandments of Baseball is a treasure of sports lessons for all ages. The 10 Commandments of Baseball is an enjoyable mix of professional baseball stories and the author's affectionate retelling of his own amateur baseball experiences. Whether male or female, young or old, the reader is pulled into great baseball moments that make the baseball commandments come to life with compassion and humor. The focal point of the book is the classic, but little-known, 10 Commandments of Baseball, the baseball principles created by Major League baseball's most successful manager, Joe McCarthy. To Order.