The Fungibility of Businesses as an Investment

Executive Summary

How do I maximize the value of my business?

Start by making it appear less fungible. You can’t necessarily retool your product line overnight, but you can identify and promote specific aspects of your business that give you — and the new owner — an edge.

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, one $10 bill is interchangeable with any other genuine $10 bill or with any combination of bills and coins that add up to $10. Fungible commodities include water, food, precious metals, and, possibly, your business.

So, what does fungibility have to do with your company? In business, a fungible asset is one that can easily be substituted for another asset.

For example, machinery may be considered a fungible asset in certain types of businesses. Labor may also be considered fungible in certain industries.

In the world of mergers and acquisitions, a fungible business is one that can be easily substituted by the acquisition of another business.

For example, if a buyer is purchasing a business solely for the cash flow it generates, then that buyer can consider a variety of different types of businesses. When selling a business, you should consider the extent to which buyers may view your business as fungible or replaceable. The more fungible a buyer views your business, the less it will be worth.

In the article that follows, we’ll show you multiple ways to differentiate your business from the rest of the pack.

Buyer Types

Let’s examine this principle in the context of the two primary buyer types, individuals and companies:

Buyer Type #1: Individuals

Many individual buyers evaluate a business based on the income it can generate for them. Many individual buyers of small businesses will consider buying any business that they have the skills to operate that provides an income that meets their goals. This type of buyer is generally looking for an income stream and will consider any type of business that they are comfortable operating, understand, and feel they can learn.

These buyers are likely to consider businesses in a variety of industries. For example, they may be open to considering a service business, an online business, a retail business, or a wholesale business. Often, they have general criteria regarding a business, such as proximity to their home, work hours required, or licensing requirements.

Most individual buyers do not have skills that are limited in application to a specific type of industry or business. As a result, they usually won’t limit themselves to particular industries. They may have worked in the marketing department at a Fortune 500 company but don’t have a skill set that is limited to one particular industry. Or they may be a serial entrepreneur looking for their next business and be open to a variety of industries.

If you are selling your business to an individual, that buyer may be considering dozens of other types of businesses.

If you operate a business with $1,000,000 in EBITDA and are asking $4,000,000 (a 4.0 multiple), that buyer may be comparing your business to another business with $1,000,000 in EBITDA that is asking $3,250,000 (a 3.25 multiple).

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. These types of buyers focus heavily on the numbers in the deal, as they are often looking for the highest return on their investment. They scour the business-for-sale portals looking for businesses selling at the lowest multiple (asking price divided by SDE or EBITDA).

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 maximize the price, you will need to spell out for the buyer why your business is unique compared with other similar businesses — or, in other words, why your business is not fungible.

Buyer Type #2: Companies

Company buyers primarily consist of direct and indirect competitors and private equity firms.

These buyers will examine the extent to which they can replicate your business. It may be possible to replicate your business by starting a similar business from scratch, acquiring another similar company, or launching a new product line similar to what your company offers.

The more difficult it is to replicate your business, the higher the multiple you will receive. The degree to which your business is able to be replicated usually depends on the industry in which your business operates, your company’s competitive advantage, and how difficult that advantage is to copy. While other factors may influence the price, the degree to which your business can be easily replicated is one of the most important factors buyers consider when evaluating your business.

Certain industries have low barriers to entry, while other industries have high barriers to entry. Industries with high barriers to entry tend to receive high multiples because the buyer considers businesses in these industries to be difficult to replicate. In other words, they are not fungible.

If a company views your business as fungible, it will pay a lower price than if it were not.

Competitors also compare the cost of investing in your business with the cost of other corporate development options, such as joint ventures, partnerships, or strategic alliances. This does not apply to private equity firms unless they own a competitive business in their portfolio.

Buyer Types & Fungibility

Knowing the potential types of buyers for your business can help you maximize your sale price and properly market your business for sale to the right audience when the time comes, setting it apart from others like it.

The following is a list of differentiating factors that can increase the value of your business and make it appear less fungible:

• Absentee business
• Advantageous contracts with suppliers, vendors, or other third parties
• A business that can be easily relocated
• Cost advantages that are difficult to replicate
• Custom software
• Customer loyalty
• Distributor or supplier agreements
• First movers in industries with network effects
• Government regulations that restrict competition due to high barriers to entry
• High switching costs for customers
• Intellectual property, such as patents or trade secrets
• Licensing requirements that inhibit competitors from entering the market
• Long-term contracts with customers
• Minimal customer concentration
• Minimal seasonality
• Prime location with a long-term lease for retail businesses
• Proprietary technology
• Recurring revenue
• Repeat customer base
• Short cash-flow cycle
• Significant barriers to entry
• Stable customer base
• Steady, long-term revenue growth
• Trained management team
• Website with high search engine rankings

When planning to sell your company, you want to make it as attractive as possible to the buyer so you receive the highest price possible. To do so, make sure you show how your business is unique or how difficult your business would be to replicate.

In other words, you want to make sure your business isn’t fungible so that a buyer will choose to purchase your business instead of another one they may be considering.

If you’re unsure what to highlight about your business, a professional can help you with the process. They will know what sells and what doesn’t, so they can get you on your way to selling your business for the best price.