One of the major hurdles for business owners when trying to grow their businesses is deciding whether an investment is going to be worth it or not. Unfortunately, nobody has invented a working crystal ball yet, so we can never be 100% sure if it’s going to be worth it when we lay down money for a new piece of equipment or hiring a new staff member.
I sat down with Laura Bechard, founder and senior advisor with ProVision Business Advisors, who supports businesses in various advisory roles including succession and exit planning.
She had some fantastic advice about how to gauge whether a potential investment, like subscribing to a new service, starting a new marketing initiative, or buying a new piece of equipment, will actually be worth it.
Nobody can know how good a business investment will perform ahead of time, Bechard noted. Investments are forecasts and plans for the future and nobody can be sure how a plan will come together. Many factors can impact plans, including political decisions, major world-changing events, changes in technology, and changes in consumer tastes and preferences.
But, even though we can’t predict the future, there are some steps we can take to try and forecast whether a business investment will ultimately be worth it.
Bechard said that people think about “ROI” as “Return on Investment,” but it can also stand for “Return on Intention.” That means business people should know what their intention is when they are investing in something.
Businesses have competing priorities and usually have a limited amount of funds and they have to figure out the best use of those funds.
This involves some forecasting. If, for example, you invest in a new marketing initiative, what is the return that you expect on that initiative and does it fit the intention you have for the investment?
Know your timelines for expectation
If you’re investing in some shorter term initiatives, marketing being one of them, you would expect to see results by the end of the year at the latest if you made that investment in quarter one. (You may see results as soon as quarter two depending on what type of marketing it is.)
Similarly, if you invest in a new team member, they’re not going to be productive right away because you have to onboard and train them, but you want them to be contributing to the business at a higher level than the investment in their salary after no more than three months.
“Those types of investments, we expect to get a return on within the current year,” Bechard noted.
However, if you invest in equipment, real estate or capital, it may be a longer term ROI, especially when you’re investing in new systems or reorganization of your business. You sometimes don’t get a return on those investments until a second or even third year after you’ve made the investment.
Know how a potential investment will affect your exit strategy
When helping businesses increase their value, Bechard said, it’s important to know their timeline for exiting. If you’re planning to exit within two or three years, you’re not going to see any return on a strategic investment unless you have a longer time horizon.
For example, if you were planning to sell your business next year, it might not be worth it to move your operation into a new building that would slow down your business for a while and not produce any ROI for two or three years.
“From a buyer’s perspective, they’re just going to see your profit going down due to these investments because the revenue hasn’t yet caught up,” Bechard noted.
If you’re planning on exiting your business soon, it wouldn’t make sense to make a long-term investment in something that you wouldn’t expect to see results from prior to your exit. You want to leave on a high note to attract the best price.
Fit the right investment to the right goal
When looking at making business purchases, generally, people are looking to improve their business somehow, Bechard said. They’re looking to increase efficiency and effectiveness or looking at expansion into new markets.
You have to consider whether your investment will help you reach that goal and whether it’s the right investment for that goal.
For example, if you wanted to expand your market, would it be a better investment to automate some of your systems to make your businesses more efficient or would it be a better investment to purchase a smaller competitor and get their market share?
Know when it’s worth borrowing money for an investment (and what kind of borrowing)
Often, new business owners don’t want to take on any debt because they’re afraid of it, Bechard said. They’ll have some kind of story about how they or someone they know has gotten into credit card debt in the past and they just have a mindset now that debt is bad.
Bechard said she has to educate clients on making sure they have the right kind of debt for the right kind of investments.
“Most businesses cannot grow without becoming a friend with debt,” she opined.
There is generally not enough profit in a new business to grow it purely by reinvesting the profit into the business.
If a business only relies on its profit to grow, it’s likely going to grow slowly and painfully. To grow efficiently and quickly, businesses do often have to work with lenders.
You have to match the type of debt to the type of investment you want. The business advisor related a story about when she and her husband were taking over the family farm and he purchased a truck on the credit card they used for the farm. Bechard would have rather had him take out a term loan for a truck purchase and leave their credit card for operating costs.
You won’t be able to get a loan to put fuel in a tractor, she said as an example, so that’s what you want to save your operating line of credit for. The bank will lend you money for capital assets.
“Anything tangible, you want to talk to the bank about financing it,” she advised.
Especially with interest rates being so low right now, businesses can finance things using debt rather than through their generated profit.
While you do have to factor in the cost of debt, interest is tax deductible, which allows you to reduce your tax burden, whereas if you pay with your equity it is not tax deductible.
It’s nearly impossible for businesses to grow without the help of other people and banks have positioned themselves well as being financial partners to small businesses.
Business owners can also find help elsewhere. For example, lots of times suppliers will finance inventory. You can get inventory from suppliers and not pay for it until you sell it.
Bechard recommended using lines of credit more for operational items like payroll and rent and term loans or other types of loans to finance your capital or equipment.
While it will always be impossible to know how good an investment is before making it, if you have clear intentions for the investment, you know the timeline you will expect to see results and you fit the right investments to the right goals and borrowing vehicles, you should be able to have a more accurate forecast about whether it will be worth it.
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