More lessons from Buffett and Munger
In April, I attended Berkshire Hathaway's Annual Meeting, otherwise known as "Woodstock for Capitalists." Berkshire's Chairman Warren Buffett and Vice Chairman Charlie Munger answered questions from shareholders and representatives from the press for nearly six hours, addressing a wide range of topics.
Last month, I wrote about some of the lessons I took away from the meeting, particularly as they relate to business owners and their decisions regarding major capital events for their business. Let's continue our discussion:
If you had $100 million, could you compete with the business you are considering buying? When Buffett and Munger look at companies to acquire, they ask whether there is a "moat" around the business that insulates it from competitive threats. Looking at your own business, could a new, well-funded competitor compete with you effectively?
For example, Berkshire's investment in Coke was principally based on the worldwide recognition and appeal of the Coke brand which allows Coke to earn excess profits from its sale of soft drinks (even though others can and do provide soda for a lot less). Similarly, when you examine your own business, to the extent you have something which protects your business from competition (a patent, brand, unique process, exclusive distribution or territory rights, etc.), your business will be more valuable.
If your business is of the "run faster, jump higher" variety (i.e., there is nothing unique about your business, and you must rely on superior execution to remain profitable), then your business will be worth less to an investor or buyer because there is nothing special protecting its position in the market. The lesson: Examine your business - are there ways to create Buffett's "moat" around your business? Although they may not be immediately apparent, these competitive differentiators will pay off not only in increased value on a sale, but also in the near term as you enjoy better pricing power and higher close rates.
Think about risk all the time. In previous articles, I have discussed the role of risk in determining the value of an enterprise: The higher the perceived level of risk in a stream of cash flows from a business, the lower will be the value of those cash flows. Business owners should be examining the level of risk in their business all the time. Risk comes in many forms: market risk, employee risk, customer risk, supplier risk, intellectual property risk, product/service substitution risk, and the list goes on.
The best business owners understand the risks in their business, how to prioritize them, and how to manage them. Sometimes there are risks you cannot mitigate, but you should definitely have your contingency plans in place. The lesson here is clear: Have a "What If" meeting with your team. Brainstorm all the different negative and positive events that could occur that would affect your business, and how you would respond if they happened. These can be very illuminating and will help you and your team think more strategically about your business, as well as prepare you for various market environments in the future.
Don't ask a barber whether you need a haircut. Coming from an investment banker, this advice may sound incongruous, but when you are discussing your capital plans and objectives, be careful whose advice you solicit. When you ask an investment banker about whether or not you should sell your business, you will often hear that "this is a great time to sell," "there is a lot of capital on the sidelines waiting for the right opportunity," and that you should "get into the market soon to avoid tax changes."
The fact is, the right time to access capital markets must account for a variety of factors, not the least of which is whether raising capital or selling your business will actually meet your needs. Before discussing whether the "time is right" to sell your business, spend time really analyzing and quantifying your goals and objectives.
This reflective time will help you assess whether going to market even has the potential to help you meet your objectives. The very best advisors will spend time with you to understand your needs and objectives in detail before providing any advice on going to market. Without this foundation, the discussion around timing will at best not be helpful, and at worst it will be confusing and could lead you down the wrong path.