Don't Overlook the Value of a Well-Defined Business Model
A well-definited business model sets you apart from the competition, especially if you've developed your barriers to entry.
One of the most direct, and often overlooked, ways to drive investor interest and improve business valuation is to demonstrate a unique and effective business model. Unfortunately, small business owners often overlook the importance of a business model and many simply don’t understand what a business model is.
When asked how they "do what they do," entrepreneurs describe their business with complexity rather than simplicity, and miss the opportunity to interest an investor. The ability to succinctly state your business model is core to creating the elevator speech needed when trying to attract investors.
While working with small businesses, helping them position for a sale or a fund-raising round, one of the first things I get them to do is tell me, in 30 seconds, how their business makes money. It’s not a trick question. I ask this because savvy investors want to hear the answer to this question before ever looking at a business plan.
Investors See Value in Unique Business Models
In my book, Moving On, I explain the value of presenting a unique business model and the pitfalls to avoid when presenting a business model to an investor. Some owners unintentionally devalue their business when they describe the model they use. This is true when the response given by the owner sounds weak… or comes across at about the level of “buy low, sell high.” If the business owner's answer sounds flip or doesn’t directly state what makes her business different from her competition, investors may not recognize the full value of the business or gain the level of interest to look further. Owners often understate the value of their business model as a unique discriminator for investing in their business. “Well if it’s that easy to do what you do, why do I need to buy your business?”
When a small business owner is preparing to sell their business, taking the time to prepare an effective business model is important to drive investor interest and give the investor a discriminator for the purchase of their business instead of another. This should make defining a business model a high priority. Grab a cup of coffee with some trusted friends and try to look at your business from 20,000 feet. Now ask, what makes my business unique? The feedback may surprise you.
Here is a common response when tech start-ups are asked about their business model: “Well, we have this breakthrough, advanced technology widget no one else has thought of… so we know we’ll sell lots of them.” That answer may help sell your products initially, but it isn’t a business model that will lead to the sale or funding of your business. It may even scare serious investors away.
Successful products are frequently copied and, with the advantage of your product as hindsight, the competitive product becomes an improvement over the original. Patents offer some protection, but they are expensive and, with the speed technology moves today, may not provide an effective deterrent to theft (but that is a subject for another time).
Your long-term sales strategy may require a different model. A stronger response would be: “Our business model includes staying ahead of our competition with annual product upgrades for at least the next five years.” Really? Please tell me more.
Proprietary Business Models Are Intellectual Property
Don’t forget to look beyond the obvious when defining a business model. It may be that the uniqueness of the product is the result of the method used for manufacturing it. The proprietary manufacturing process is a barrier to entry that keeps competitors from creating a competing product. The business owner needs to be able to explain this advantage to investors to get them interested.
Explaining a proprietary process comes with some risk, and the business model explanation may need to be less specific while providing sufficient disclosure, since the business model is typically discussed early in the sales/investment process. The business model can be designed to help the owner walk this line until full disclosure is needed. “We have developed a method to use XYZ when making our product”… without revealing what XYZ is too early in the process.
Before you start disclosing your manufacturing methods, be sure to capture them as intellectual property (a big valuation improvement). Defining your business model may help you see your business at a high level and help disclose where the true value lies in “doing what you do.”
Some Business Models Are Timeless… Some Fade Away Quickly
Most of us are familiar with some of the more popular business models, but fail to see how they are applied today. Business models tend to come and go in popularity. You've likely seen the retail business model that reaches out to children at home by sending ice-cream trucks around the neighborhood enticing them to buy ice-cream. The model relies on the children to convince their parents to buy. Today, the gaming industry has recycled this model by enticing children to buy extra points online while playing the game at home. There is a classic business model that gives away the razor in order to sell the blades. Now telecom companies give away a phone in order to get customers to buy their telephone time. These are old models with new applications.
To maximize the value of your business, it may pay to refresh the way you do things by updating your business model. Investors are cautious about buying into a failed business model (like a video rental store). Can you think of three or four business models that have come and gone in popularity? In Moving On, I describe current and past business models as a tool to help small business owners start thinking about their businesses in terms of the currency of their business model.
Make an “aaS” of Yourself
Some business models become popular and are sought by investors. A popular business model today is the aaS model (products sold “as a service”). The advantage of this model is the guaranteed (contracted) monthly income it provides. Under the aaS model, the business can count on continuous sales revenue compounding over time. This has obvious appeal for an investor.
Investors are seeking aaS business models because they like the predictability of monthly recurring revenue. More and more businesses are beginning to adopt the aaS model by selling periodic subscriptions that make it easy for customers to subscribe on a monthly basis rather than relying on “one-off” sales. Recurring sales offer greater returns over time. In Moving On, I use a bakery as an example of how a business can grow by offering Bread as a Service.
The aaS model has been well proven and tested by the software industry. The software as a service (SaaS) model offers an advantage over more traditional models because it emphasizes customer year-after-year “stickiness” as a measure of customer satisfaction. See if you can identify a way to implement an aaS model for your business. Keep in mind that aaS models bring higher revenue multiplier valuations because they allow to use valuations based on future rather than past revenues… a great benefit for a business owner that has overcome some bad years, but can demonstrate their potential.
Your Business Model Is Core to Your Elevator Speech
Giving your elevator speech by simply and succinctly describing the uniqueness of your business is a proven way to generate investor interest. Use the examples given here to practice writing a business model. Most small business owners are tempted to describe their business model as “buy low and sell high.” This turns investors off because it is too general.
Even a business as simple as a local retail store should be able to say why people come in their door instead of the competition's. “We hold a sale on Wednesdays because that’s when the senior center bus is in town.” Don’t overlook the advantage of a well-defined business model when speaking with investors.