Should you grow Cashflow 💵 or grow Enterprise Value📈?
As an Entrepreneur, one of the most critical decisions you face is whether to reinvest profits or focus on harvesting cash flow. Your Outsourced CFO can help. This strategic choice can significantly impact a business’s growth potential, valuation, and M&A opportunities. The right decision depends on understanding your business type, the industry landscape, and aligning your approach with long-term objectives. Broadly speaking, businesses fall into four categories—Rocketship 🚀, Golden Goose🪿, Hot Prospect ⛏️, and Rough Diamond 🪨. Each has its unique path, challenges, and strategies. Let’s dive into these categories and explore the best approach for each.
1. Rocketship 🚀: High Cash Flow, High Enterprise Value
Description:
A Rocketship is a business that’s soaring with strong cash flow and high enterprise value (EV). Think of it as a venture that has taken off, leaving competitors in the dust. These companies have a competitive edge, solid market position, and growth rates that make investors take notice.
Businesses like Rocketships are often found in industries such as healthcare, technology, or those with strong intellectual property (IP)—where barriers to entry create a moat around their market position. Typically, these companies see EBITDA and growth rates exceeding 30%, making them attractive for M&A deals and further investment.
Strategy: Reinvest for Growth
For Rocketships, the best way to maintain altitude is by reinvesting cash flow back into the business. Think of it as adding more powerful engines—through new ventures, acquisitions, or R&D. The market is paying attention, and it’s essential to capitalize on this by making strategic moves that fuel further growth. The best investment you can make is often in your own company, especially when returns are promising.
Investing in growth not only maintains your competitive advantage but also positions you well for potential M&A opportunities, as a strong growth story can drive up valuations. Keep growing until the margins thin out or growth becomes more challenging, but always adhere to the Rule of 30—ensuring that the combined growth rate and EBITDA remain above this benchmark to maintain a balance between profitability and expansion.
Example:
Consider a healthcare tech company that has developed proprietary software for patient management. The market recognizes its value, driving up the company’s valuation while cash flow remains strong from existing contracts. Here, investing in additional features or acquiring smaller, complementary companies can help maintain its competitive advantage and fuel further growth. As an Outsourced CFO, you can help businesses like this navigate M&A strategies and optimize their financial planning.
2. Golden Goose 🪿: High Cash Flow, Low Enterprise Value
3. Hot Prospect ⛏️: Low Cash Flow, High Enterprise Value
Description:
A Hot Prospect is like having a treasure map—rich with potential, even if the treasure hasn’t been fully unearthed yet. These businesses may not be generating significant cash flow at the moment, but their high valuation is based on future potential. This category often describes tech startups or companies with innovative healthcare solutions that are in their growth phase.
Hot Prospects can attract investors and partners who see the potential for future profitability and market disruption. However, they need to carefully manage their resources to realize this potential.
Strategy: Invest in Growth
For Hot Prospects, the focus should be on growing strategically to unlock potential. This might involve taking on debt or seeking investment, often guided by a Chief Financial Officer who can balance growth against cash burn. Outsourced CFO services can be especially valuable here, providing the expertise to model future cash flows, plan for dilution, and prepare for fundraising rounds.
At times, a Hot Prospect may choose to accept a 50% reduction in current profits for a partnership that could increase their EV fivefold. But they must never lose sight of the Rule of 30—ensuring that growth doesn’t compromise long-term financial health.
Example:
Consider a SaaS startup that’s developed a groundbreaking platform but is currently using most of its cash flow to acquire new users. Investors see the long-term potential of the product, driving up the company’s valuation. Here, using the capital to build out new features, hire key personnel, and expand the customer base can unlock future profitability and make the company more attractive for M&A opportunities. A Fractional CFO can guide this process, helping the company secure strategic investments.
4. Rough Diamond 🪨: Low Cash Flow, Low Enterprise Value
The Role of Industry Analysis in M&A Decisions
Before deciding whether to reinvest or harvest profits, having your Outsourced CFO do a thorough industry analysis is essential. Understanding what the market values (EV Multiple ✖️) allows you to position your business accordingly. You can’t force the market to pay a high EV for a low-value business, but you can align with industry trends to maximize potential.
For example, M&A trends have shifted in various sectors. HVAC businesses, once considered low-value, saw their EV surge when private equity entered the market. Similarly, accounting firms that were traditionally valued at 1x revenue now see higher valuations if they demonstrate market differentiation and quality. As an Outsourced CFO, our role is to help the business react to these shifts and plan strategically for M&A.
Which Category Is Your Business In?
Understanding which of these four categories your business falls into can help clarify your next move. Are you a Rocketship that needs to keep investing for growth? A Golden Goose focused on efficiency and cash flow? A Hot Prospect navigating the journey from promise to profitability? Or an Rough Diamond ready to transform into something new?
How an Outsourced CFO Can Help
As Fractional CFOs, we specialize in guiding businesses through these strategic decisions, helping them understand when to focus on growth, optimize for profit, or pivot for future opportunities. We provide the financial modeling and strategic insights necessary for effective M&A planning, helping businesses of all types navigate their unique challenges. Whether you’re a Rocketship looking to expand, a Golden Goose optimizing your cash flow, or an Rough Diamond seeking your moment to shine, we can help you reach your goals.
Contact us at info@teeupnextgen.com
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