HOW STARTUPS CAN ENHANCE VALUE

Enhancing company's value is not only CEO’s or CFO’s job. It is every department’s responsibility.. We will discuss it in this final piece on valuation.

Refer to my article on discounted cash flows to understand how a company is generally valued. In a nutshell, There are cash flows and discount rate. People also equate discount rate with weighted average cost of capital (WACC). Cash flows are discounted against WACC to come up with net present value of operating profits which serves as value of company. The article is here:

Here is how the value of company can be enhanced:

1)     Increase cash flows

2)     Increase growth

3)     Reduce risk or discount factor

4)     Push off the closure date so that the company can remain in high or mature growth period for more time

How We can increase cash flows? Higher operating profit margin by reducing unnecessary expenses or efficiently running your business. If a revenue stream can be increased by 5% due to efficiently running it or if you can reduce 5% cash expense to generate the same revenue stream. you can increase the value of cash flows.

How to increase growth? McKinzey did a study on what growth strategies result in increased company valuation. They considered the following growth strategies:

·        New Product or market development

·        Expanding an existing market

·        Maintaining share in a growing market

·        Competing for share in stable market

·        Acquisition

The winner was new product introduction from time to time. Think of Samsung and Apple phone series. The growth depends on new product introductions in these companies. Specially for apple where iPhone sales contribute significantly to Apple’s overall revenue. McKinzey found out that it is most efficient way to increase value. When Google was on peek of its growth in 2007, how they fueled their growth even further? By introducing Android and creating an altogether new market.

The second best strategy is to expand the existing products in new geographic or usage markets. For example, Uber taking its service to new continents. Or Uber introducing Uber eats leveraging the same network.

Surprisingly, Acquisitions ranked least in the list.

You can re-invest in existing projects within your business if the return on capital is higher than the cost of capital. You can apply the same principle and consider acquisitions to lower the production cost or acquire new users.

Thirdly, if you can keep the company in high growth and mature growth period for longer time, it will result in more value for company. In other words, try to avoid its products becoming dogs or cash cows (referring to BCG matrix). How is it possible? You can find new competitive advantage to build leverage over your competitors. For example, it can be a stronger brand name, an IP filed, reduced costs of product development, more switching out cost, less switching in cost etc. If one of this is already your current advantage, you can look to increase the existing advantage. For example, We buy Coca Cola, Apple or Nike because of strong brand names. It contributes heavily to their valuation.

The other way to elongate high or mature growth period is your product features. The more necessity it is for your customers, they are more likely to refrain from switching out. For example, Apple with all its product family is an ecosystem where customers have enough incentive to remain loyal Apple users.

Finally, reduce the cost of capital. That is, the capital that you require to expand your business must be available to you at reduced rate. I have covered the financing recommendations for startups here:

Firstly, You can change the debt and equity mix. Think about it this way. You are a really profitable company and have to pay off a 10% stakeholder whose worth is $100 million. You get this money ($100 million) in debt (lets assume, against 6% interest rate) and you buy back 10% of company. No dividends to be paid now to investor which means more cash available to reinvest in business. You can use this cash to meet debt contractual obligations and You can get tax reductions as well, since debt helps in reduced tax deduction. You did not have this leverage in previous model.

The other way is to reduce fixed costs of doing business. For example, outsource some of manufacturing. That will increase operating costs but you will reduce risks associated with doing business. Having fixed costs in a business is a risk. If you are operating on massive scale such as Apple, You can outsource at reasonable rates. Talking about fixed costs, You can have flexible wage contracts. Uber and Lyft had contractual fixed payment obligations with drivers initially but now they don’t have any periodic payment commitments. You earn the percentage of what you drive.