How is Building A Business Like Building a House?

By Tom Bixby, President & CEO, LEVEL Management Partners
Published May 18, 2020

Have you ever passed through a neighborhood and saw a house with carelessly designed additions? The homeowner may have needed more square footage and simply hired some framers to bolt on a new room or two based on convenience rather than aesthetics. Local building codes and permitting requirements may help prevent cases where the new rooms are structurally unsafe and a danger to residents, but they will not keep you from making a poor real estate investment.

I recently came across an article written by Kirya Duncan, an Architectural Engineer based in Snellville, GA. Kirya's article, "Bad Home Additions Can Adversely Affect Your Property Value", focused on the impact bad home additions can have on property value. If you own a business, I encourage you to read kirya's article and think about how those same principles could apply to decisions you might make building your business.

Just like upgrading a home, there are plenty of options to consider for building business value. Whether upgrading a house or a business, if you understand the return on investment (ROI) for those upgrades, you are sure to make better decisions. The key is thinking about your house and your business as investments. How can you achieve the greatest increase in value for the smallest investment? It pays to think this through before opening up your wallet and throwing money at ideas.

Adam Petricoff is the Owner of VR Business Brokers of Charlotte, NC, and a LEVEL Expert Network™ member. Over the years, Adam has met many business owners who have made unfortunate growth investment decisions. Adam shared a story about a service company he had sold where the new owner made some unfortunate growth investment decisions only 90 days after closing on the purchase.

The company served a niche market, with little competition. The new owner sought to grow the business by diversifying into a new market with many competitors, at margins about half of what their existing business enjoyed. To serve the new market, they invested $75,000 on new equipment and hired a new sales person with a significant salary. Three months later, they had not produced any sales from the new market. At the same time, they lost focus on their core business and began to lose profitable customers. They lost 15% of their revenue and increased expenses by well over $100,000. As a result of that, and the new owner's decision to draw a salary 50% higher than the prior owner, the company burned through its line of credit and faced a major cash crunch placing the company at risk only 6 months after the acquisition.

"There was no formal planning. The new owner, who had come from a Fortune 500 business, made many faulty assumptions based on their corporate experience. They spent the next 18 months on the edge of business failure. After two years, the business was worth 75% less than when they bought it. The owner should have built on the company's strengths, accumulated some cash, got to know the company and the marketplace better while carefully planning for any new market expansion." - Adam Petricoff, VR Business Brokers of Charlotte, NC.

Adam's story illustrates what can happen when a business owner doesn't understand the return on investment of a new market growth strategy. They didn't recognize how fierce competition would drive margins down and make it difficult to even cover their investment in equipment and increased salaries and related expenses.

ROI is a central factor in making investment decisions, and there are multiple forms of ROI to consider. As Adam's story illustrates, cash flow may be extremely important in the near term. You may need to begin with investments showing a high Cash ROI (New Cash Inflows / Required Investment) rather than focusing on Value ROI (Increase in Enterprise Value / Required Investment). If you do, you will find your long-term business Value Growth Program may quickly produce enough new sources of cash to cover your ongoing investments in high Value ROI projects.

Back in 2017, I set out to wrap ROI concepts around the practice of management consulting, helping clients make sound decisions when investing in growing their companies. Today LEVEL Management Partners combines Value Growth Architecture™ by EvaluSys® and wisdom from LEVEL Expert Network™ allowing business owners and private equity investors to design a 5-year action plan to confidently grow business enterprise value.

Adam's story demonstrates the importance of investing in a value growth plan to avoid making unsound strategic growth decisions. If you want to make good choices about increasing the value of your business, or your house, take time to consider the ROI for those investments and plan for success!

Use Value Growth Architecture™ to design a 5-year Value Growth Action Plan for your business.

© LEVEL Management Partners, Inc. All rights reserved.