When it comes to financing the growth of your business, you may find yourself facing a difficult choice between the lesser of two evils. Selling shares in your business can provide an immediate cash injection, but it means giving up some of your valuable equity stake. Borrowing money from a bank, on the other hand, can be costly to repay, can limit your growth, and often requires that you provide a personal guarantee.

However, there is a third option: customer financing. This approach involves convincing your customers to prepay for some or all of your product or service, providing you with the necessary working capital to drive growth. This method can be a great alternative to selling equity or taking on bank debt and gives you access to cash without having to sacrifice ownership or pay interest.

How Brad Lorge Got His Customers to Fund the Growth of His Business

In 2015 Brad Lorge founded Premonition, a technology company that provides logistics software to streamline delivery operations for large enterprise companies. While working with big businesses brought in good revenue, large enterprise customers were slow to make purchasing decisions, and when they did decide to buy, getting them up and running was slow and costly. If an implementation failed, Premonition risked losing months’ worth of work for nothing.

Rather than the traditional approach of financing a software start-up (rounds of dilutive funding), Lorge asked his customers to prepay. Having customers pay in advance allowed Premonition to utilize the cash from their customers to fund its growth.

By March 2022 Premonition had grown to $3 million in Annual Contract Value (ACV) when Shippit acquired it for $20.5 million—an implied valuation of just under seven times ACV. Better yet, because they used customer financing, Lorge and his partners still owned 80% of the equity in the company when they sold it.

Customer financing can be a powerful tool for business owners looking to raise money without giving up equity in their businesses. If you’re considering getting your customers to prepay, like Lorge, start by understanding your customer’s needs and motivations. Consider what’s in it for your customer to prepay. Could you guarantee delivery times in return for a project deposit? Could you offer incentives or discounts that make sense for your business and your customers?

Productize Your Service

If you offer a service, another strategy for getting customer prepayments is to consider productizing it. A productized service is a type of service offering that has been standardized and packaged as a product with a defined scope, price, and deliverables. It is essentially a predefined service that is delivered repeatedly to multiple clients in a similar fashion, with a fixed set of deliverables, processes, and pricing. Examples of productized services include website design packages, social media management plans, and content creation bundles.

The goal of productizing a service is to simplify the sales process, increase efficiency, and provide a predictable customer experience. By creating a standardized offering, service providers can reduce the amount of time and effort required to close a sale as well as minimize the need for customization, which can be time-consuming and expensive.

Best of all, when it comes to products, we are accustomed to paying in advance (e.g., you expect to pay for that box of cereal at the grocery store before going home to dig in). Therefore, if you package your service offering into a product, your customers will be more inclined to pay up front for some or all of your offering.

Productizing your services or asking customers to prepay can be effective ways to obtain the cash your business needs to grow while keeping a tight grip on your equity and avoiding the obligations of a hefty bank loan.

You know gross margin impacts your profit, but have you considered the impact it has on the value of your company?

When assessing your company’s value, acquirers and investors will often scrutinize your gross profit margin. Gross profit margin is the difference between a company’s revenue and its cost of goods sold. In other words, it’s the profit a company makes from each unit of product or service sold after accounting for the cost of producing or delivering that unit but does not include other fixed expenses. For example, if a company sells a product for $100 and it costs $70 to produce and deliver it, the gross profit margin would be $30, or 30%.

A high gross profit margin is a crucial factor for investors and potential acquirers as it indicates that a company has established pricing power through marketing differentiation and possesses a competitive advantage. A strong competitive moat is an indicator of a company’s long-term sustainability, making it more appealing to potential investors.

When a company’s gross margin shrinks, it indicates to investors that the company may be competing on price. This is typically a sign that the business lacks a unique value proposition or marketing differentiation and that competing on price is the only way to attract customers. A shallow moat leaves the company vulnerable to competitive threats and makes it less appealing to potential acquirers.

24 vs. 6 Times Earnings

To illustrate the impact of gross margin on a company’s value, let’s compare two companies: Apple and Dell. Apple has a strong competitive advantage and a healthy gross margin, whereas Dell’s competitive moat is weaker, and its gross margin is lower. In 2022 Apple’s average gross margin was 43%, compared to just 23% for Dell.

Apple has a highly differentiated brand and controls the buying experience through its Apple Stores. Additionally, Apple has invested in a range of high-margin subscription offerings, such as Apple TV and Apple Music. The market is willing to pay more than 24 times Apple’s 2023 earnings forecast, and the company has a market capitalization of over $2 trillion.

By contrast, Dell offers commoditized technology products, which puts them in a weaker competitive position, requiring them to compete on price and resulting in a lower gross margin. The market is only paying around six times Dell’s 2023 earnings estimates, giving it a total market capitalization of around $30 billion.

Just as gross margin impacts the world’s largest publicly traded companies, it also impacts smaller businesses. Ron Holt started Two Maids & a Mop, a residential cleaning company, in 2003. Holt ran a lean business and enjoyed healthy gross margins and a net profit margin of around 30%. Holt invested his earnings in differentiating his business from mom-and-pop cleaning services. He built a network of 12 locations across the southern U.S. and had plans to expand across the country.

Holt was curious about franchising as a business model and attended a Las Vegas conference where he
had a chance encounter with Subway founder Fred DeLuca. Subway had more than 40,000 locations
around the world at the time, so Holt asked DeLuca for his expansion advice.

DeLuca cautioned Holt about actioning every idea from his employees as his company got bigger. He
told Holt, “Most of the time, employees bring you ideas to make their life easier, not to make you more money. Every time you make your employees’ lives easier, it comes at a cost.”

Armed with DeLuca’s advice, Holt grew Two Maids & a Mop from 12 to 91 locations and $40 million in
revenue without seriously compromising his gross margin. In 2021 Holt sold his business to JM Family
Enterprises for over ten times EBITDA.

Taking Action

Apart from raising prices or reducing input costs, an often overlooked approach to improving gross margin is to invest in carving out a point of differentiation for your business in the minds of your customers. When your customers see your business as unique, you are less likely to have to compete solely on price. Charge a premium for a differentiated product or service, and you’ll beef up your gross profit margin—and the value of your company.

Picture a magic slot machine. Each time you pull the arm, you make back a multiple of whatever you wagered. How much time would you devote to cranking that arm?

When it comes to the value of your business, you can make many bets, but only one has a virtually guaranteed return. Most companies are valued on a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA), so every dollar of incremental profit you earn in the short term will translate into a multiple of that down the road. 

Since most acquirers look at three years’ worth of financial reporting, squeezing out every extra dollar of profit makes even more sense if you’re considering an ownership transition in the next thirty-six months.

How Derek Morin Jacked Up the Value of His Business

For an example of a founder obsessed with finding every dollar of profit available, let’s look at Derek Morin. Morin founded Tabarnapp to create after-market sales applications for Shopify website owners.

The business was a success, but when his partner, who handled finance, left the company, Morin was forced to look closely at his profit & loss (P&L) statement. Morin saw potential improvements, so he made notes in the margin next to each line item he wanted to change. 

To save time, he started using a single letter beside each entry to represent the action he wanted to take:

P stood for “Plus,” something profitable, and he wanted more. 
U stood for “Unnecessary,” an expense he could eliminate. 
R stood for “Replaceable,” a cost that could be replaced with a better or cheaper option. 
E stood for “Equal” and was used for items that should be left untouched.

Morin realized his shorthand notes could be organized into a memorable acronym he referred to as “PURE.”

Morin treated the PURE method like a game. Every month he scrutinized his P&L with the same four-letter system. Morin engaged his team to act on each item that needed improvement. He became obsessed with squeezing out a few more dollars of profit every month. 

His game worked. In 2020 Morin had bought out his business partner in a deal that valued the company at around $400,000. Two years later, after applying the PURE methodology of improving profitability, Morin sold Tabarnapp in an agreement that implied a roughly tenfold increase in the value of his business.

The Downside of Using Your Company’s Bank Account as a Slush Fund

There’s a downside to treating your company like your piggy bank. Co-mingling personal and business expenses while letting other costs go unchecked may help you reduce taxes in the short term but could end up costing you more in lost value when you decide to sell your business. Instead, keep your P&L “PURE” to jack up the value of your business.

In 2012, Jaclyn Johnson founded Create & Cultivate, a media company that educates and inspires women to succeed in business.

By 2018, Johnson had grown Create & Cultivate to eight employees when an acquirer offered her a staggering $40 million. Unfortunately, the deal was too good to be true. When the acquirer discovered how dependent the business was on Johnson to succeed, they pulled out.

A few years later, Johnson signed an acquisition offer from Corridor Capital for $22 million. While still a lucrative deal, it was a significant decrease from the original offer.

Like Johnson, if your company becomes dependent on you, it may end up costing you down the road. The most valuable companies don’t rely on the owner’s involvement to succeed. However, finding extraordinary talent to replace yourself can be challenging.

The Biggest Mistake Most Founders Make When Trying to Replace Themselves

Finding a general manager, second-in-command, or Chief Operating Officer to replace themselves is one of the hardest projects founders may ever tackle. 

Whether you rely on a recruiter, paid advertising, or your personal network to find candidates, one of the first steps to shortlisting talent is a comprehensive review of their background. That’s when many founders make the common error of being bamboozled by a Fortune 500 name on a resume or LinkedIn profile. While a stint at a big company may be impressive, the skills held in high regard at a Fortune 500 company tend to differ from what most young companies need. 

Big companies often have well-established processes, systems, and hierarchies that have contributed to their success. People that thrive in big companies tend to excel at winning within a predetermined framework. However, in a younger, scrappier start-up, there is no framework to follow, which is why big company veterans often struggle in a more entrepreneurial environment. 

Instead of basing your hires off an impressive name on a resume, look for someone innovative, comfortable with chaos, action oriented, and creative—someone with an entrepreneurial mindset.

Here are five strategies you can use to identify innovative candidates when making hiring decisions:

1. Look for problem-solvers: Innovation often involves finding creative solutions to problems. Look for candidates that have demonstrated the ability to think strategically and come up with innovative solutions to challenges they have faced in the past.
2. Ask about their approach to problem-solving: During the interview, ask candidates to describe their approach to problem-solving and how they have produced innovative solutions in the past. This will give you insight into their thought processes and willingness to take risks and think creatively.
3. Evaluate their learning agility: Innovative employees are often those that are open to learning and adaptable. Look for candidates with a history of taking on new challenges and learning new skills.
4. Assess their ability to work in teams: Innovation often involves collaboration, so look for candidates that have demonstrated the ability to work effectively in teams. Ask about their past experiences working in teams and how they have contributed to the success of those teams.
5. Consider their creativity: Look for candidates that have a creative portfolio or have pursued creative hobbies or projects outside of work. This can be a good indicator of their potential to bring new and innovative ideas to your organization.

Right now, your company probably relies on you for a healthy dose of creativity and innovation. But if your goal is to replace yourself, following these five strategies can increase your chances of identifying innovative candidates that will bring fresh thinking and creativity to your organization. 

Many factors drive your company’s value, but perhaps the most important is how your business would perform without you.

To get your company to flourish when you’re not around, you need owner-like effort from your team. Inspiring owner-like effort comes from cultivating a vibrant culture inside your business.

Here are three ways to get your employees to care as much as you do:

1. Cast Your Employees as Stars in a “David vs. Goliath” Movie

In 2008 Gavin Hammar started Sendible, a platform that allows companies to manage all their social media accounts from one place.

Sendible grew steadily until 2016, when a large competitor entered the space, causing it to hit a sales plateau. Hammar gathered his employees and explained the challenge they were facing. Rather than sugar coat the problem, Hammar encouraged his team to think of themselves as underdogs in an us-against-the-world battle.

Hammar set out to position his company as smaller and started a podcast, shared photos of his employees online, answered customer questions via asynchronous video, and sent personalized LinkedIn messages to every new customer.

With an enemy to hate, Hammar’s employees followed the boss’s lead and gave extra effort to humanize themselves and the company.

Sendible started to grow again. By 2021 the company was thriving, which is when Hammar accepted a lucrative acquisition offer from ASG.

2. Provide Perks Others Can’t

Another way to create a thriving culture is to offer perks your competitors can’t.

Natalie and Chris Nagele are the life and business partners behind the software as a service (SaaS) company Postmark. Unlike most hard-driving software executives, the Nageles were committed to creating a great place to work. Rather than take on outside investment and the corresponding pressures of demanding investors, the Nageles decided to self-fund their business.

Obsessed with helping her employees do more meaningful work, Natalie began researching ways to inspire her staff. She came across data from the Henley Business School suggesting implementing a four-day workweek created a healthier workplace culture.

Inspired by Natalie’s findings, the Nageles considered implementing a four-day workweek. They didn’t need the permission of their board or outside investors, because the couple owned the company outright. After a short discussion, the couple decided to try it.

Transitioning to a three-day weekend created a culture in which their employees enjoyed working, resulting in consistent growth for Postmark until 2022, when the Nageles sold the company in a life-changing exit.

3. Gamify Your Business

Another way to inspire your employees to give owner-like effort is to gamify your business. 

Josh Davis is the founder of the freight brokering company Speedee Transport. Brokering freight is all about gross margin—the difference between what you charge the customer and how much it costs to hire a driver to move the stuff.

Rather than simply telling his employees to focus on gross margin, Davis made a game of it. He created quoting software with a virtual gross margin scoreboard for his employees to see. The software gave each employee a very public, objective, and transparent scoreboard they could follow daily to know whether they were winning or losing that day.

Davis then tied his employees’ compensation to gross margin, which created a healthy competitive culture within the company. 

After gamifying his business, the company saw tremendous growth. Within two years, Speedee Transport grew from two to forty-five employees, which caught the attention of an acquirer, who offered to acquire Speedee Transport for a truckload in 2019.

In Review

One of the secrets to building a valuable company is to get your employees to work as hard as you do. Owner-like effort comes from making your people feel like part of a shared mission and giving them a working environment that brings out the best in them.

There is never enough money to invest in developing products when you’re running a self-funded business. When you’re running your company out of cash flow, most of your resources go into selling your existing products and services, leaving little left over to fund your new product ideas.

You could keep plugging away with your existing product or service lineup, but you will leave yourself exposed to competitors that dream up a better offering. The other option is to develop unique new offerings for customers that ask you to customize your solution, but that can eliminate any scale in your business as you develop a unique thing for every opportunity.

The other option is to offer to develop a custom product for one client with the understanding that you will retain the rights to the intellectual property (IP) associated with developing their unique solution.

The most famous example of getting your customer to fund your new product development comes from Microsoft. As legend has it, co-founder Bill Gates negotiated a deal with IBM that paid Microsoft $430,000 to develop the DOS programming language, which IBM was given a license to use. However, Gates retained ownership over the code, which allowed him to sell it under the MS-DOS brand.

How Brian Ferrilla Got a New Product and a Premium Valuation

In a more recent example, Brian Ferrilla ripped a page out of Bill Gates’s playbook when he started Resort Advantage to help casinos adhere to new anti-money-laundering laws. Criminals were laundering money through casinos, and Ferrilla’s software helped casinos spot the bad guys.

Ferrilla started by selling a simple version of his product to small casinos and eventually got a call from MGM, the granddaddy of casino operators. MGM needed extensive customizations to Ferrilla’s product, but instead of building a custom solution that MGM would own, Ferrilla offered to waive the customization charges in return for retention of the ownership of the product.

Ferrilla reasoned that since MGM was one of the biggest players in the gaming industry, whatever levels of security and features they wanted, other operators would also value.

MGM got their custom solution, and Ferrilla retained the rights to an underlying product that the entire gaming industry valued. In the end, Ferrilla was glad he kept the rights to his IP when his $3 million business, with just 15 employees, was acquired for more than $10 million.

Had he slipped into the trap of making custom software for each of this customers, Ferrilla’s business would have likely been worth less than half that as custom software development shops offering a unique solution for each customer usually trade at around one times annual revenue.

The next time a customer wants you to develop something just for them, consider agreeing provided you maintain ownership of the IP behind your work.

Have you ever noticed that you get some of your best ideas in the shower? Every morning, you’re stuck there for a few minutes doing something you’ve done since you were a child. Your mind knows it has a couple of minutes to think.

Employees get the same mental holiday when you specialize and give them systems for routine tasks.

How Ethos3 Unleashes the Creativity of Their Team

Ethos3 is a Nashville-based design company specializing in creating presentation designs. Doing
just one thing allows them to systematize their processes much more efficiently than most other design firms. They have a standardized business development method. It’s a templated proposal that includes the number of slides you’ll get, the number of revisions, and the pricing formula. For project management, they use teamwork.com. Again, there’s a set of templates for each stage of the development process, and the project delivery approach is the same every time. It’s a recipe – just add water.

When you give people a procedure to follow for the boring stuff, they can stop worrying about what to do and pour their creative talent into how to do it. Ethos3 has finished second in the World’s Best Presentation Contest, and Apple pioneer Guy Kawasaki is among its fans.

As entrepreneurs, it’s easy to assume that everyone likes the adventure of bushwhacking their way through life, not knowing what’s around the next bend. In fact, a lot of your employees would prefer some consistency and structure.

Systems are not the enemy of creativity. And author and consultant Kathy Kolbe has developed a personality test that proves it. The so-called Kolbe Index ranks users on four personality attributes.

Fact Finder describes the extent to which someone likes gathering data before making decisions.

Follow Through measures how much someone likes systems, structure, and routine.

Quick Start quantifies one’s inclination to start new things.

Implementer measures one’s knack for building stuff.

Kolbe’s test shows that we all have a little bit of each attribute, yet we all also have a dominant operating style. Most entrepreneurs score high on “quick start” and low on “follow through.” It’s a classic combination. Most of us love starting things but quickly tire of the details.

Most of your employees will score higher than you on follow through, which means they need more structure to thrive. They may also score higher than you on fact finder, suggesting they need more data than you would before making a decision.

Specializing, and giving your team standard operating procedures, gives your employees the mental breathing room to be creative and the structure they need to thrive.

Republished with permission from Built to Sell Inc.

Specializing in one product or service allows you to focus on delivering that thing better than everyone else. It enables you to hire (or train) specialists in your field, improving the quality of your work, which leads to happier customers. And satisfied customers buy again and refer their friends.

That’s why specialists often grow faster even while they are spending less on marketing, leading to better profit margins and, ultimately, a more valuable company. Specializing in a specific product or service has tremendous benefits, but what if your customers expect you to deliver a range of offerings?

That’s when the second form of specialization can help: focusing on a specific industry.

The Benefits of Becoming an Industry Expert

Specializing in serving a specific industry confers several benefits. First, offering your products or services to one industry allows you to learn the language spoken in that sector. Every industry and profession has a unique language, and being able to speak the jargon can benefit your company. Knowing your industry’s lingo can indirectly communicate to your customers that you are experienced, knowledgeable, and able to navigate the space.

Furthermore, focusing on one sector ensures you stay current with industry trends, which will result in being able to identify new opportunities for your customers sooner than a competitor who serves multiple industries.

Most importantly, specializing in one industry allows your employees to become experts in a sector. You may be an expert in an industry, but chances are, they’re not (particularly when you first hire them). Focusing on a sector accelerates how quickly your staff can become fluent in your industry’s lexicon, which allows you to delegate customer relationship management faster and more successfully.

Specializing in an Industry Led to a 20x Increase in Revenue

For example, look at the story of UK-based founder Raman Sehgal. Sehgal started a small marketing agency called ramarketing in 2009. By 2015 the business had grown to the Pound Sterling equivalent of around $500,000 USD in revenue, but the company was losing customers as fast as they were winning new ones.

Frustrated with his company’s lack of progress, Sehgal decided to do a complete analysis of his business. He found that ramarketing’s most valuable customers (low maintenance, sticky, high gross margin, etc.) were in the pharmaceutical industry. Sehgal decided to pivot his business to solely serve clients in the pharmaceutical supply chain. 

Beginning to serve one industry created a sequence of positive events for ramarketing. 

Becoming an industry specialist allowed ramarketing to stay up to date with industry trends, learn the lingo, and ultimately improve the quality of their work. An increase in customer satisfaction led to more referrals and a strong reputation in the sector.

His employees began to understand the intricacies of the industry. In the pharmaceutical space, there are many rules and laws to adhere to. Understanding the regulations allowed Sehgal’s employees to better serve their customers.

Subsequently, the business boomed. 

The Proof Is in the Pudding

Sehgal’s once stagnant marketing agency grew from $500,000 in turnover in 2015, to over $10 million by 2022, which is when Sehgal accepted an acquisition offer from NorthEdge Capital of more than 10x EBITDA.

In Summary

Sehgal’s bold decision to specialize in the pharmaceutical industry led to a 20x increase in revenue and, ultimately, a lucrative exit.

Narrowing your product or service line is the most common way to increase your company’s value but specializing in one industry carries many of the same benefits.