A Profitable Exit? Think Sustainable, Long-Term Growth
The good news for technology companies is that valuations have soared in recent years—and they are still climbing. Dropbox, Pinterest and Airbnb all raised venture and private equity rounds of more than $200 million in late 2013 and early 2014. In June 2014, Uber closed a $1.2 billion round and is now valued at $17 billion, up from $3.5 billion less than a year ago. These types of transactions have long-term growth at their foundation.
Attracting millions or even billions of investment dollars is the dream of every business owner. But it is not going to occur overnight - and it may never occur if the primary goal is to sell the business, rather than build the business.
The surest path to achieving a successful, sustainable business is to focus on long-term growth – and the investment interest will follow in due time. Investors do not want companies that are built to flip. They want companies that are built to last and that can sustain revenue growth. Investors are willing to pay top dollar for such companies.
“There are measures companies must take to position themselves for sustainable success, foremost of which is to instill a focus on long-term growth and profitability rather than short-term liquidity,” said Alex Castelli, Technology Industry Practice Leader. Such a strategy will inevitably make a company more attractive to investors.
CohnReznick has identified the following four issues that technology companies can focus on to maximize the long-term value of their business – for when a company demonstrates long-term, sustainable growth, the equity opportunities will inevitably follow.
1. Know Your Market Niche and Competitors
Many business leaders are so immersed in day-to-day responsibilities that they do not spend the time required to become intimately familiar with where they fit into the market and who their competition is. Companies should know how their product or service fills a need in the marketplace. They should know the size of their potential market, the size of their current market share, who their customers and competitors are, and how they are changing. By staying informed, companies can remain relevant in the midst of fierce competition.
Clearly, learning the market is not a one-time investment of effort for technology companies. It is an ongoing process, and business leaders must be engaged on a regular basis. Spending at least a few minutes each day to read industry journals and websites in order to stay on top of industry news is essential. Executives’ involvement in professional associations and their efforts to maintain open conversations about the market with their vendors is also helpful.
“In fact, vendors are an excellent source of ground-level market intelligence. They can provide information on competitors, describe what other industry players are doing, and help companies keep tabs on their own points of differentiation,” said Castelli. Too often, companies lose touch with their competition and do not know if they are losing their market advantage. Flat revenue is the first conspicuous sign—but good companies make adjustments before revenue sags.
Market knowledge is also an important avenue to growth. Organic growth is ideal, but at some point acquisition may become necessary to maintain or accelerate growth. Companies should be familiar with their competitors large and small, and should consider building causal relationships with them. These relationships can eventually lead to synergistic business opportunities. The best acquisitions do not come from business brokers. The best acquisitions come about because the business owner or management team knows the market and has personally identified targets they are interested in acquiring.
2. Drive Sustainable Revenue
Sustaining customer and revenue growth are vital for technology companies. Horizontal revenue means one thing to investors – it means they will not get the return they want from their investment.
To sustain revenue and minimize customer churn, technology companies must innovate and add services and products. They must continually introduce new and appealing features for their customers. Granted, a subscription model is a good way to sustain revenue, but subscribing customers also expect regular updates. These updates do not have to be new, blockbuster releases, but they should at least be useful and worthwhile. In today’s current business environment, it is quite feasible for customers to switch to a competing technology company. Companies can minimize churn by consistently delivering fresh new ideas and enhancements.
“Often, customers come to expect these enhancements—and get them without paying for them—but this is how companies keep customers. And a large part of sustainable revenue is the ability to retain current customers while attracting new ones,” said Christopher Mahon, a Partner in CohnReznick’s Technology Industry Practice.
3. Build a Scalable Business
Scaling requires action on a number of business fronts. In summary, it means adding products, services, and customers. It means keeping in mind that past results are no guarantee of future performance. In other words, the accomplishments that got companies to where they are will not get them to where they need to go.
Companies must ensure that their business model guarantees long-term growth and they must be up to the challenge:
- Quality: can they continue to deliver the level of quality that their customers expect?
- Quantity: can they take on new customers without suffering a decline in quality?
- Capacity: can their internal systems handle the weight of new customers?
- Capability: do they have a management team strong enough to handle growth?
“In fact, attracting and retaining a good management team is critical to building a scalable business, because an experienced and well functioning management team can address competition and identify opportunities to drive expansion in the market,” said Mahon.
4. Focus on Profitability
It is usually those companies that are not in dire need to sell that receive the highest valuation—those companies that are well managed, have products in demand, and profits.
Arriving at this desirable position means continuing to innovate to stay relevant and maintain competitive advantage. This is especially important in the tech space, where the landscape changes quickly and there are few barriers to entry.
Growth is an alluring word in the technology industry—in almost any industry—but creating profitable growth is the key to turning a small company into a large company. To fuel long-term profitable growth, companies must invest in a competitive advantage that entitles them to it. Companies can grow in a competitive market by cutting prices or increasing promotions, but those maneuvers do not increase competitive advantage and, therefore, do not fuel long-term profitable growth. They require a company to trade margin for revenue growth—and driving revenue growth for its own sake rarely creates the success that entrepreneurs want.
Companies must also understand their cost to acquire customers. If a company is spending one dollar to earn one dollar, that is not an effective business model. If that dollar comes from a customer that can be counted on for an increasing multiple over the long term, then this customer could be very valuable. If a company spends one dollar this year to earn one dollar this year—and earn another dollar each year for the next 10 years—then that is a more worthwhile investment.
What Does CohnReznick Think?
Technology company valuations are roaring back. In fact, as of the beginning of this year, at least 30 privately-held technology companies had valuations exceeding $1 billion1. However, buyers and investors seek companies that are built to last and can sustain increases in revenue. The time is now for technology companies to position themselves for success by focusing on building a strong foundation with sustainable customer growth and profitability, rather than short-term liquidity.
This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.