Do Buyers of Businesses Pay for Potential?

I own a promising small business with considerable untapped potential. Our intellectual property portfolio, including valuable patents and closely guarded trade secrets, stands as a testament to this potential for growth. Will prospective buyers recognize and invest in this inherent capacity, or will their valuation primarily revolve around the current cash flow generated by my business?

Let’s delve into the essence of what buyers truly seek and why.

We’ll commence by setting down some undeniable facts:

• Fact #1: The nearer potential is to realization, validation, and revenue generation, the greater the value attributed to it by buyers.
• Fact #2: Buyers lean towards established businesses with proven revenue streams and cash flow, where potential has already materialized, rather than remaining in the realm of the “unrealized.”
• Fact #3: Virtually every business carries latent potential. The more proximate your business’s potential is to fruition, the higher the chances of it translating into value.
• Fact #4: Nascent ideas hold minimal value in the eyes of potential buyers.

Let’s illustrate this with a few scenarios of potential:

1. Targeting a New Customer Segment: Acme Corporation envisions a significant expansion by reaching a previously untapped customer segment. However, this notion remains in its infancy, lacking any history of successful sales within this segment.
2. Introducing a Novel Product or Service: Acme Corporation believes introducing a fresh product could lead to substantial revenue growth. Presently, this product is confined to conceptualization, devoid of development, user testing, validation, or revenue generation.
3. Pioneering a Revolutionary Product Idea: Ralph conceives a groundbreaking product idea with the potential to combat cancer. While equipped with a comprehensive business plan, progress stalls at the idea stage, devoid of validation or sales.
4. Embarking on an Innovative Business Idea: Roger has launched a visually promising business, investing over a million dollars. However, despite breaking even, revenue remains absent. Roger believes in the untapped potential, yet profitability remains elusive.

While these might appear as potential avenues, the reality of selling a business unveils a different perspective. Most buyers, you’ll discover, are disinclined to allocate substantial value to such potential. So, under what circumstances do buyers actually recognize and pay for potential? How can you position your business’s potential to command its deserved worth? Keep reading to unearth whether and when buyers are inclined to invest in potential, and if so, the specific conditions that facilitate it.

Characteristics of Potential

Outlined below are fundamental attributes indicative of potential:

• The concept, at this stage, remains in a nascent form devoid of concrete plans or substantiating data. Minimal progress has been made in terms of execution, and validation is pending. The actual implementation process is yet to commence.
• The entity in question, whether it’s a business, division, product, service, or concept, is yet to yield any revenue.

While an idea might hold promise, its potential lacks verification until revenue generation becomes evident. In the absence of substantiated revenue prospects, the idea, however compelling, retains its status as just that—an idea. Consequently, most prospective buyers are likely to attribute limited value in such scenarios.

What do Buyers Want?

And what constitutes their investment interest?

Buyers seek:

• Assured future revenue anchored within a contractual framework. Yet, the valuation can ascend significantly when you strategically time the sale post revenue recognition in your financial records.
• A product in active development that has already translated into revenue. The potency of validation directly influences the premium buyers are willing to offer. This is further amplified if you boast a track record of successfully nurturing and launching products.
• Potential synergies. However, it’s crucial to note that buyers tend to factor in synergies only when compelled by circumstances. Typically, it’s the larger enterprises that entertain paying for such synergies, particularly within competitive acquisition scenarios.

Don’t Venture Capitalists Buy Ideas?

Certainly, but here’s the twist.

It’s not solely the idea that’s up for purchase. Buyers are also investing in a team dedicated to transforming that idea into reality. Venture capitalists typically opt for a minority stake, backing a business where the existing ownership team remains intact to bring the concept to fruition.

Hence, venture capitalists aren’t merely buying into an idea; their investment is directed towards a business and its committed team, geared for long-term execution. During initial funding rounds, the emphasis often centers on team prowess over the idea itself. If your plan involves conceiving a groundbreaking idea and offloading it to a third party for execution, it’s time for a reality check. This route would yield limited returns, as vending an idea for external execution seldom translates into substantial compensation.

Action Steps

Considering these insights, here’s our seasoned counsel:

• When you’re harboring untapped potential, don’t hesitate to spotlight it for potential buyers. However, it’s important to acknowledge that the more raw and unverified an opportunity, the less substantial the anticipated compensation.
• View ideas as an added allure. Utilize them to inspire potential buyers to take the plunge, but don’t anticipate immediate returns for ideas lacking revenue substantiation.
• For a more vivid portrayal of potential, condense it into a concise one- to two-page business blueprint. Lay out your assumptions bolstered by concrete data. Better still, embark on a series of real-world experiments to validate these assumptions.
• Should the notion of synergies appear feasible, enlisting the guidance of an M&A advisor is advisable. They can assess the existence of synergistic potential and orchestrate a private auction, fostering competition among multiple buyers vying for your enterprise.

While your perception of your business’s potential is vital, it’s vital to acknowledge that it alone won’t serve as a robust selling point. Buyers are primarily enticed by tangible revenue and profitability. Hence, the more effectively you showcase the revenue-generating prospects woven into your business’s growth opportunities, the more compelling your proposition becomes to potential acquirers.