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The Fungibility of Small Businesses as an Investment
Fungibility is the ability of individual units of a good or a commodity to be substituted for one another. Essentially, it means the goods are interchangeable. For example, an ounce of silver is equivalent to any other ounce of silver. Fungible commodities includes water, food, currency, and possibly, your business. You may be wondering what fungibility has to do with your business. In the business world, fungibility is when a potential buyer can easily substitute another business for your business. This article examines the fungibility of your business and makes specific recommendations for what you can do to not only increase the value of your business but also make it easier to sell.
Many buyers are not looking at your business as a business. Rather, they are looking at it for the income it can generate for them. Many buyers of small businesses will consider buying any business that they have the skills to operate that provides an income for their family. Buyers that are looking for an income stream will consider a number of alternative businesses. They may often look at service businesses, online businesses, retail businesses, or wholesale businesses. Oftentimes, they have general criteria regarding a business, such as they want it to be close to their home and require no weekend work or special licenses. If a person is looking for a general business, they usually won’t be looking for a specific industry, such as a plastics manufacturer, a coffee shop, or an auto repair shop.
When examining if your business is fungible, you have to look at the different buyer types. Knowing the buyer types can help you market your business for sale properly when the time comes, setting it apart from others like it. Below are the two main types of buyers.
Buyer #1—The first type of buyers comes from the corporate world, and they do not have skills that are specific to a certain industry or business type. They may have worked in marketing at a Fortune 500 company and may not have specific industry experience that is relevant to the purchase of a small business. This type of buyer is generally looking for an income stream and will buy any type of business that they are comfortable operating, understand, and feel they can learn.
Buyer #2—The other type often has highly specific skills, such as those needed to do auto repair or work as a chef, and these buyers are only looking for a business in that industry. For instance, they would only be looking for a mechanic shop, or a restaurant. Because they are looking for a specific type of business, their criteria is limiting, meaning they may have to pay a higher price for the business they want.
If you are selling your business to Buyer #1, that buyer may be looking at dozens of other types of businesses. If you operate a retail business with $100,000 in profit and are asking $200,000, then that buyer may be comparing your business to another business with $100,000 in profit that is only asking $150,000. These types of buyers focus heavily on the numbers in the deal, as they are often looking for the best deal. They scour the business-for-sale websites looking for businesses selling at the lowest multiple (Asking Price/Profit). If the buyer is simply comparing the numbers on your business to other businesses on the market, then your business is “fungible,” or easily replaceable.
If your business has no differentiating factors from other businesses for sale, then your business is similar to a fungible commodity because the buyer does not have to buy your particular business to be happy. On the other hand, if you are looking to sell to buyer #2, hopefully for a higher price, you have to establish what makes your business different. Even if you are selling to buyer #1, you need to spell out for the buyer why your business is unique in comparison to other similar businesses so that she will by your business.
The following is a list of differentiating factors that can increase the value of your business and make it appear less as a fungible commodity:
- Absentee business
- Advantageous contracts with suppliers, vendors, or other third-parties
- Business that can be easily relocated
- Cash-based business
- Competitors must spend large amounts on R&D to compete
- Cost advantages
- Custom software
- Customer loyalty
- Distributor or supplier agreements
- First movers in industries with network effects
- Franchise with exclusive territory
- Government regulations
- High switching costs for customers
- Home-based business
- Licensing requirements that inhibit competitors from entering the market
- Long-term contracts with customers
- Low, fixed operating expenses
- Minimal customer concentration
- Minimal seasonality
- No night or weekend hours required
- Operations manual provided
- Owner not involved in the business full-time
- Prime location with long-term lease
- Proprietary technology
- Recurring revenue
- Repeat customer base
- Short cash-flow cycle
- Significant barriers to entry
- Stable customer base
- Steady, long-term revenue growth
- Trade secrets
- Trained management team
- Website with high search engine rankings
- Zoning or other licensing requirements