Did you know that your business’s initial impression on potential investors greatly affects your company’s value when selling or raising capital? When raising capital, investors’ initial perception of your business significantly impacts their valuation, affecting both the equity you’ll need to give up for growth and the company’s value when selling.
This isn’t just hearsay, and Jeremy Parker knows it all too well. When he pitched Swag.com to investors, they classified it among other promotional product companies and offered him minimal equity and a low multiple of earnings.
Undaunted, Parker re-strategized, presenting Swag.com as an e-commerce platform with a memorable domain name and a world-class, elegant, direct-to-consumer buying experience. This shift in perception transformed Swag.com from a simple distributor to a technology company in investors’ eyes. As a result, Parker received an acquisition offer that valued his $30 million company at a healthy multiple of revenue.
However, being categorized incorrectly isn’t the only factor that could hurt your business’s valuation. Diversifying into unrelated offerings could also make investors perceive your business as unfocused, ultimately lowering its valuation.
Alibaba: A Lesson In How Diversification Can Hurt Your Valuation
It’s not just start-up or small-medium companies that can be categorized incorrectly inside the minds of investors. Consider Chinese Internet giant Alibaba when they announced its intention to split into six separate businesses. In the two weeks following the announcement, Alibaba’s market value increased by $19 billion.
Why would investors welcome such a move? Alibaba consists of a range of very diversified businesses resembling those of Amazon.com, including e-commerce, logistics, and cloud storage. Before the announcement, Alibaba was valued at just ten times their earnings forecast for next year. Yet each individual business as a focused standalone will likely fetch a much higher multiple.
Investors often discount businesses like Alibaba, as they are compelled to purchase diversified assets they may not be interested in. They frequently apply the lowest value multiple of a particular business to the entire group of companies.
Amazon faces a similar situation. The Bloomberg Intelligence Unit estimates that Amazon’s cloud storage division, AWS, could be valued at $2–3 trillion as a standalone business. However, as a collection of various diversified services — from e-commerce to audiobooks and cloud storage — Amazon’s entire market capitalization is less than half (around $1 trillion) of what Bloomberg analysts believe just one of its divisions could be worth as a standalone.
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Focus or Diversify? Striking a Balance Between Revenue and Valuation Goals
Investors typically prefer businesses that concentrate on dominating a single product or service rather than diversifying into various unrelated offerings. A diversified portfolio may lead investors to perceive your business as unfocused, which can result in a lower valuation. The same principle applies when you decide to sell your company. If your business appears scattered, potential acquirers may focus on your least valuable division and apply that multiple to your entire organization.
It’s essential to prioritize your goals. Do you aim to grow your business by increasing revenue or enhancing its value? While these objectives are related, they require different strategies.
Pursue diversification if your primary goal is to boost revenue. However, if you’re striving for a more valuable company that could potentially be sold, maintaining a clear focus is crucial.
If you’ve got questions about how first impressions can drive the value of your business, let’s talk.