Valuation teeter-totter

I go to a lot of investment and business conferences. One conference I went to, in Chicago in about 2008, we had a discussion about key performance indicators, or KPIs, and how to best use them to measure and manage your business. The presenter of the conference called me out in front of the group and said, “you’re making too much money.”  Of course, that sounded absurd, so he had to explain.

Berkshire Money Management, a partner of 10,001 Hours, was taking in revenue and enjoying a healthy profit margin.  Clients were being serviced well and recognizing the value of their fees. But the business wasn’t growing as fast as it should have.  We had taken a lot of important steps to defend the value of our company, but we weren’t emphasizing growth.  We had actually stopped taking on new clients and serviced only the one who were already working with us.  But it made no sense – we had all this extra cash to use.  So we consciously shrunk our profit margins thirty percentage points by quadrupling our workforce, expanding our services, and taking on new clients.  By spending our money, we made more money.  And now we are worth much more to a prospective buyer.

The “Teeter-Totter” is about cash in and cash out.  You, the seller, collects one check.  But the buyer must write two checks – one to pay you and another to fund operations.  If the check to run operations is fatter, your check will be skinnier.  Your business will be more profitable and more valuable if it is growing, but you must find the right balance between your revenue and your expenses.