Strategies for increasing business value

From: alexhormozi

The majority of millionaires are made in real estate, while the majority of billionaires are made in private equity, due to the different approaches to accelerating value in a business [00:00:00]. This article explores the strategies used by private equity investors and business owners to increase a company’s value.

Real Estate vs. Business Value Creation

Real Estate Investment Model

When buying a house as a real estate investment, money is primarily made in two ways:

Appreciation: The value of the house increases over time [00:00:25]. This can be passive appreciation (happens over time) [00:00:49] or “forced appreciation” through improvements like fixing, cleaning, or adding features (e.g., a kitchen) [00:00:51].
Rental Income: Receiving regular checks from tenants [00:00:32].

Real estate is considered a simpler business model [00:01:11]. As long as population growth continues, real estate remains a good investment, though population decline (like in Japan) can negatively impact its market [00:01:30].

Private Equity and Business Investment Model

Private equity offers more ways to make money, and businesses can sometimes be acquired for very little or even given away for free, unlike houses which usually carry debt [00:02:08]. A business’s value can skyrocket from nothing to hundreds of millions in as little as 12 months, especially with breakthroughs like reliable customer acquisition channels or key hires [00:02:46].

A key difference is that with a business, you can fundamentally change its underlying risks and therefore its value, unlike a house where you cannot change its neighborhood [00:03:55]. There’s an “upside limit” to real estate (unlikely to get a 100x return), but 100x deals are possible in private equity [00:04:08]. The wealthiest individuals know how to create 10x to 50x returns in their careers through private equity [00:04:17].

The Arbitrage Opportunity in Private Equity

A business that generates $3 mi ll i o ninann u a l re v e n u e an d$ 1 million in profit might not be attractive to institutional investors due to its small size and potential key-man risk (reliance on the founder) [00:04:36]. However, a skilled private equity investor recognizes that this business, which might be picked up for almost nothing, could become very valuable with a few strategic moves [00:05:17].

For example, transforming the business to do $12 mi ll i o na ye a r in re v e n u e an d$ 5 million in profit makes it significantly more valuable [00:05:28]. A small business at $1 mi ll i o n p ro f i t mi g h t b eco n s i d ere d " r i dd l e d w i t h r i s k " an d v o l a t i l e, l e a d in g t o a l o w ore v e n zero m u lt i pl eo ni t s p ro f i t s < a c l a ss = " y t - t im es t am p " d a t a - t = "00 : 06 : 02" > [00 : 06 : 02] < / a > . Ho w e v er, b y makin g t h e b u s in ess m orere l iab l e an d l ess d e p e n d e n t o n t h e f o u n d er, i t s " m u lt i pl e " (h o w m u c hana c q u i rer w o u l d p a y f or i t s p ro f i t s) in cre a ses < a c l a ss = " y t - t im es t am p " d a t a - t = "00 : 06 : 38" > [00 : 06 : 38] < / a > . A b u s in ess d o in g$ 5 million in profit could get an 8x multiple, making it a $40 million business from an initial near-zero cost [00:08:09].

“How likely you think it will continue to make money if nothing happened” [00:06:30] determines the multiple ascribed to a business’s profits [00:06:17].

This “arbitrage” — the ability to create huge step-ups in value in a relatively short time (12-24 months) by reducing risk and improving operations — is where private equity investors make their money [00:08:20].

Core Levers for Increasing Business Value

The value of a business is fundamentally determined by two variables [00:09:35]:

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): Essentially, the profit a company makes before these specific deductions [00:09:00].
The Multiple: How reliable and consistently growing that profit is [00:09:48].

A business needs to be built to be valuable to anyone, not just the owner [00:11:18]. An unsellable business, even if profitable for the owner, has no intrinsic value to the marketplace [00:11:03].

Fundamentally, there are three ways to make a business more valuable [00:14:01]:

Increase the number of customers [00:14:06].
Increase customer value (Lifetime Value/Gross Profit): How much they pay over time [00:14:10].
Decrease risk: Increase the reliability of the business over time [00:14:22].

Every allocation of time or money in a business should clearly contribute to one of these three goals [00:14:31].

Advanced Strategies for Maximizing the Multiple

Several strategies for maximizing business profits and increasing the multiple are leveraged by sophisticated investors:

1. Debt Capacity

A business’s ability to carry debt is a function of its cash flow [00:15:50]. Businesses with significant cash flow can support more debt, allowing investors to acquire them with less upfront cash and achieve higher returns due to financial leverage [00:15:53].

2. Organic Growth

Consistent organic growth, driven by marketing, sales, and pricing strategies, increases the business’s multiple [00:16:28]. If a business can reliably grow 20% annually, an investor knows they will more than double their money in five years without additional effort, especially when leveraged with debt [00:16:46]. This is a core part of key business strategies for growth and business growth and scaling strategies.

3. Categorization

Re-categorizing a business can significantly increase its multiple [00:17:13]. For example, transforming a traditional service business into a “tech-enabled service” or a true Software-as-a-Service (SaaS) business by integrating technology [00:17:20]. Tech-enabled services have higher multiples than traditional services, and SaaS companies have the highest [00:17:38]. A $100, 000 in v es t m e n t in t ec hn o l o g yco u l d a dd$ 3 million to enterprise value for a business with $1 million in annual profit, representing a 30x return on capital [00:17:56]. This is one of the fast business growth strategies.

4. Size Premiums

Larger businesses command a “size premium” on their multiple [00:18:36]. A company making $100 mi ll i o nin p ro f i t i s w or t h s i g ni f i c an tl y m ore t han o n e makin g$ 100,000, not just linearly [00:18:50]. This is because institutional investors (like BlackRock or Blackstone) have minimum check sizes (e.g., $150 mi ll i o n) an d w i llp a y a p re mi u m f or l a r g er a sse t s t oe ff i c i e n tl y d e pl oyc a p i t a l < a c l a ss = " y t - t im es t am p " d a t a - t = "00 : 19 : 05" > [00 : 19 : 05] < / a > . O n ce ab u s in essre a c h es ab o u t$ 5 million in annual profit, institutional investors start to take notice, and crossing $10 million in profit can significantly boost the multiple [00:20:16].

5. Age of the Business

The age of a business generally makes it more valuable [00:21:16]. A 10-year-old business doing the same numbers as a 1-year-old business will be perceived as more stable and less risky [00:21:20]. A business’s value increases every year it continues to grow or even maintain, but declines sharply if it starts to go down [00:21:34].

The Power of Patience and Focus

These business growth strategies and challenges for creating generational wealth take time, often six years or more [00:22:40]. Many individuals fail because they lack the patience to stick with one opportunity, constantly chasing new “side hustles” every few months [00:23:00].

“A mediocre opportunity executed to infinity is going to do better than an inferior opportunity that you consistently switch to over and over again.” [00:24:39]

Most strategies for increasing enterprise value require sustained effort over time. By focusing on increasing cash flow, driving organic growth, improving categorization, achieving size premiums, and building a long-standing business, entrepreneurs can unlock significant value [00:25:01].

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