Business Moat

Assessing the strength of the moat around your business is the next post in the series, “To Sell Your Business or Not To Sell Your Business — That is the Question“. Simply put, the wider and stronger the moat around your business, the more my advice is to avoid selling your business. The smaller the business moat, the more you should sell your business. This is because a business with a strong moat is likely going to have a greater financial return (and frankly, less stress or heartache) if you maintain ownership and allow the value to compound over time (unless someone offers you an illogical amount of money today).

What is a business moat? First, a business moat is not assuming that you can execute better than your competition. In every business I have visited, the owners believe they are executing better than the competition. Operational effectiveness is not a competitive advantage or differentiation — you should assume that every competitor will soon match any advantage in operational effectiveness that you have. A business moat is something inherently very difficult (if not impossible) for a competitor to match. Thus, a business moat is an assessment of how predictable the future cash profits are from your business because of some comparative advantage. If your business has some inherent advantages over the competition, then it has a business moat of protection. We can break this idea down further into two assessments that may help:

Business Moat Assessment

1. How certain is it that the revenue of your business will remain stable and increase beyond inflation? Please also remember that minimal revenue growth may not be enough to outpace inflation, continue to provide opportunities for your employees so that they can progress in their careers and gain financially, or provide the cash flow to invest in the future of the business.
2. How certain is it that you can maintain your gross margins and profit margins? I recommend that your default assumption is that margins will revert to the mean of your industry. If when you have an advantage, it is usually quite difficult to maintain it as your competitors or customers may see the margins and work to shrink them.

Furthermore, here is a starter list of questions that may help you think about the competitive advantages of your business and how likely it is that you can maintain your revenue and profit margins:

• How much competition is there in your field?
• Is the competition rational?
• Is there overcapacity?
• Are there close substituties?
• Can you increase prices?
• Is your field changing rapidly requiring your business to also change rapidly?
• Is your field trendy or are the customers fickle?
• Do your suppliers have leverage over you?
• Who will capture value creation in your field (you, your employees, the customers)?

As you do your assessment, if you come to believe that you truly have a wide moat around your business, then my advice is to not sell your business. Effective business moats are very difficult to create and very rare.