One or Two Businesses

We had 15 CEOs in the room at our last CEO Breakfast briefing in Hong Kong. The focus of the discussion was on Growth Capital for mid-market companies. At some point in the discussion, one of the entrepreneurs shared his experience. The primary activity of his company had been struggling. He had identified and invested in a new opportunity that he believed had a lot of potential. He asked this simple question: “How to value my company?” Several other entrepreneurs and CEOs in the room mentioned that they were in the same situation, and were obviously interested in the answer.   The “technical” answer to this question could be rather simple, as stated by one of the panelists: you value each business line independently via DCF or other valuation methods, and the value of your business would be the combination of the two.   Unfortunately, and particularly in finance, one plus one does not equal two. Investors typically either invest in cash generating businesses or in high growth businesses. They very rarely invest in a business that combines both a low-risk and a high-risk profile.   So, what would be the CEO’s options? Let me articulate here a few ideas that CEOs may consider:    
  1. Launch the New business in the same entity if the level of synergy between the “Legacy” and the “New” businesses is high (same clients with cross-selling opportunities, using a service business to finance and launch a product business, use the service business as a premium option to the new product offering…). This is basically about business reinvention and transformation. In this case, the value of the “two” businesses cannot be separated.
 
  1. Create a subsidiary (or plan to do so) if the “Legacy” business enables to launch the “New” business faster and at lower cost than if it were launched as a different entity without using the assets of the Legacy business (clients, know-how…). That will make it easier for the CEO to finance the new company with growth-focused investors at a later stage. The natural option further down the road could be to get venture / growth capital and give its independence to the New business.
 
  1. Launch an independent company if the level of synergy / overlap between the Legacy and the New businesses is too low. Easy to do if the ownership structure is 100% in the hands of the entrepreneur, less so if it is not the case. It is precisely in this case that you may need a good valuation expert to make sure you don’t overlook your existing shareholders’ interests when launching a new idea.
 
  1. Kill the Legacy business and launch a new venture? This is rather extreme, but may be necessary if the Legacy business has no value and can’t generate enough cash flow to finance a new strategy or growth plan.
 
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