Saturday, January 12, 2008

Capturing Value in Creative Companies

Buying a creative company is very tricky. Successful creative enterprises can be very attractive targets. The profit margins can be outrageously high. The work can be exciting and high profile. The culture and work environments are often exhilarating.

On the other hand, it is really easy to overpay for a creative enterprise -- and I don't mean by just a little bit. Sometimes a buyer can pay multiples of the company's real value if he or she doesn't understand what's being purchased.

As I mentioned before, a really valuable creative company can't be judged just by its revenues and profits. You need to look behind the curtain and figure out why customers find it so attractive. You also need to evaluate the company's ability to continue to satisfy its customers and attract new ones. This can't be based just on the work of one or two people, but must rely on the company's proven systems, culture and management.

One good way to evaluate this is through general industry research. Talk to people in the business about your target company. Ask them what they think of it. If they do business there, ask them what they like and dislike about it.

After the external analysis, do an internal evaluation. Ask yourself (and the sellers), what would happen if...? Understand how the company actually creates its products and serves its customers, and how that would change if certain people left or if the industry landscape changed. This process will not only help you understand how much value you can actually capture in the sale, but it will be a first step in developing better strategies and systems going forward.

The lesson here is that you can't buy a creative enterprise based on typical financial due diligence. The real story is not in the numbers. The financial performance gives an indication of the company's proven potential and current status, but that can change quickly. The good part is that the changes can be positive, as well as negative. A creative company with good momentum and performance has the ability to quickly rise to even greater heights. So, while the volatility creates some risk of overpayment, it can also result in some incredible home runs.

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