As all business owners will agree, it’s harder to make profit today than in the “good old days”. Over time, more competitors enter your given market and profits gets eroded. When you look to exit, if you are an average business, then you will earn average profits and get an average multiple applied to those profits, resulting in … an average valuation.
You can break through the average ceiling and vastly increase the valuation of your business through economic moats. An economic moat, popularised by Warren Buffet, is something that provides a long-term, maintainable competitive advantage enabling a business to protect its profits and market share. Here are three examples:
Brand: a classic example of a moat. Coca Cola, considered to be one of the most valuable brands in the world, can charge more than a generic cola producer.
Margin leadership: Amazon’s scale affords it efficiencies is so good that it can almost always beat anyone else on pricing and still make more profit.
Switching costs: e.g. Microsoft’s cloud-based services (Office 365, SharePoint, Teams, Power Platform) are now so interconnected that leaving a single product or abandoning the full product stack is impossibly painful for most customers.
These examples are not unique to big business: smaller companies can also successfully build similar economic moats within their locality or market segment. For example, our partner business Wilson Partners has built moats by developing a strong brand name in the Thames Valley region and providing quality corporate finance advice at highly competitive rates.
With one or more economic moats, a business has an inimitable advantage (very often built over a long time) which will enable that business to command a strategic multiple from an acquirer. As well as an above average multiple, the effect of the moat(s) often means that higher than average profits have been achieved too.
The result is that a higher multiple is applied to a higher profit number, and the valuation sky rockets.
Get building those moats!