The Two Most Important Factors in Building a Sustainable Business and Maximizing Valuation at Exit
There is no lack of startup business models. My friend and colleague, Dave Parker, writes about business models and their trade-offs. He taught me most of what I know about choosing the right model. In fact, it wasn’t until I took his course at The Founder Institute(Seattle) that I realized I spent 10-years of my life building a business that had a sub-par model. Dave describes 22 different business models in this piece: Startup Business Models
It should come as no surprise that the easiest business models to implement provide the least opportunity for building a sustainable business and realizing a high valuation at exit. Many aspiring entrepreneurs gravitate to these models because the cost to entry are low. Yet, when it comes time to exit, they are often shocked at how low their business is valued by shrewd buyers.
The smart entrepreneur understands these nuances from the get-go.
There are two very important factors that determine how sustainable a business will be in the long run and how attractive it will be to buyers when it comes time to sell:
1) Owning the Customer Relationships, and
2) Controlling the Money
Seems obvious, right? So why do so many aspiring entrepreneurs launch businesses that fail to do this? As I said, it’s because they are easy. The barriers to startup and growth are low, but the underlying value drivers are weak. This is especially true in the age of digital media and eCommerce.
Consider the matrix below. In which quadrant does your startup or idea fall within? If you own the customer and control the money, you have the best business model. If you fall within any of the other three quadrants – and many startups do – you may find it a challenge to raise investment capital or fetch a high valuation at exit. Let’s explore the tradeoffs.
Doesn’t Own the Customer: Doesn’t Control the Money
This is the most prolific business model in the age of the Internet. It is driven by Google AdWords and Affiliate Marketing. Entrepreneur launches a web site or mobile app. S/he creates unique content and builds a following. S/he monetizes the site with AdWords (or other advertising system) and gets paid a revenue-share through affiliate marketing (like having an Amazon Bookstore). In all these cases, Google and Amazon (and their like) own the paying customer (the advertiser) and control the money. The business is dependent on the ad-sharing and affiliate commissions – mere scraps in most cases.
I know some businesses that generate hundreds of thousands of dollars with this model. More power to them, but these businesses are not sustainable and can’t be sold at a high valuation unless and until they change their business model. Go on Flippa.com, for example. You will see thousands of these businesses and can buy most of them for a pittance.
Controls the Money: Doesn’t Own the Customer
These models include certain aggregators, lead generation businesses, marketplaces, exchanges, and payment processing gateways. They are classic “middle men” taking a cut between buyers and sellers. They typically collect and disperse the money between the parties, but they don’t own the relationships. Its nice to ‘follow the money,’ but money comes from customers, so if you don’t own those relationships, it can dry up quickly.
I ran a business like this, I know the model well. At iCopyright, for example, we processed reprint and eprint licensing transactions. We controlled and dispersed the money, but the agreements were between the publishers and the users. The publishers owned the customer relationships. The fact we held the money before taking our cut and distributing the balance to the publishers, made us attractive as an acquisition target for certain other aggregators, but at a low valuation. The challenge with all middlemen is they are replaceable, so the long-term sustainability of these businesses is questionable.
Owns the Customer: Doesn’t Control the Money
So, these models are on the other side of the aggregator, lead gen, marketplaces, exchanges, and payment processing gateways outlined above. Some middle-man takes and disperses the money, but the business owns the customer relationship. The problem with this model is the business can often wait a looong time to collect the money. And how do they really know they are getting what they are due?
I recently booked a hotel room at Marriott through what I thought was Marriott reservation central. Turned out it was a third-party booking agent that had created a reservation site that looked a lot like Marriott’s direct booking site. When I checked in, Marriott informed me I owed them for the room I had already prepaid for. Turns out, the third-party booking agent went out of business and, snap, just disappeared overnight. Of course, I told Marriott it was their problem, not mine, and because they owned the relationship with me they had to make good on it.
Owns the Customer: Controls the Money
This is the way business used to be done – before the Internet and e-Commerce. It’s still the best business model. These businesses own the relationships with all the customers and collect the money directly from them. No middlemen. No over dependence on advertising, affiliate marketing, lead generation, and marketplaces. These businesses are the most sustainable and fetch the highest valuations when they are ready to exit.
Don’t get me wrong. I’m not advocating a startup by-pass these other models. They have their place. Even well-established businesses leverage them. They just don’t abdicate their core business to them. Use whatever model you need to launch. Get a foothold, then adjust. If you want to build a sustainable business that fetches a high valuation at exit, own the customer relationships and control the money!