What does the buyer buy?

You can sell most profitably something that makes less money in your own hands than in the potential buyer’s hands.

Let’s explore the example. You have a profitable business. You have reached the majority of your target audience. The acquisition cost is down to a reasonable minimum. You can sell such a company, say, for three annual profits. The buyer can get about 12% per annum from the transaction. He will earn two-fold in six years, which is 12% per annum.

Now take a look at another case. We have a growing business in a broad competitive market which does not make any profit. Since the market is competitive, the acquisition cost is high, amounting to 50% of your revenue. Imagine that a much larger company wants to buy you. They have their own huge audience, with much more reasonable acquisition cost of 15%. If they can with the help of your product further increase their revenue by 50% per year on their existing audience, the profit will be 35% of the same revenue in the first year, and one and a half times more in the second year, etc. In the next six years, they will make a profit of about 7 initial revenues (not profits). Something which allows this buyer to buy your company at three revenues, not profits, and to earn the same 12% per annum for six years. 

In absolute numbers, thought these 12% per annum will be more than 12% from the previous case since revenue is more than profit.

What would you prefer to sell for three profits or three revenues? This shows us that growth rates and market width are much more expensive than profits.

Leave a Reply

Your email address will not be published. Required fields are marked *