10 Traits of a Great Business

What makes a great business?

When I worked in the investment industry studying and investing in public companies, I was often searching for "great businesses" and over my career developed a short list of characteristics that (I think) make a company great.

Why should this matter to you?

1. For starters, great businesses make more money
2. They're easier to run, meaning fewer hours for the owner
3. They sell for more money, providing a nice retirement package

These traits are in no particular order, are not definitive, and apply to both public companies (i.e. stocks) and private companies (i.e. small and medium businesses).

Here is my checklist:

1. Consistent cash flow – Good companies produce consistent and predictable cash flow. As such, they almost always command the highest valuations or sale prices. This should be a goal for everyone.
2. Low levels of debt (or leverage) – Debt can be a good thing when used responsibly. Thoroughly analyze what you need it for and avoid overextending yourself.
3. Operating leverage – This leads to better margins as sales grow. A business with operational leverage can take on more sales while keeping fixed costs relatively flat (do more with the same or less).
4. High returns on capital – Stated another way, businesses with low needs for physical things or working capital. Think of it this way: fewer profits need to "reinvest" back into the business each year.
5. Repeat customers or recurring revenue – Stability and predictably are very valuable. Both for peace of mind and business value.
6. Competitive advantages – Instead of the term "advantage," I like to think "different." How is your business different from competitors? Having something unique to you makes it easier to charge a premium, grow sales, and increase business value.
7. Growing industry or niche – It helps to swim with the current instead of against it. Even if you operate in an industry with shaky growth prospects, there are likely to be growing niches within it. Find those.
8. Well managed – I like Warren Buffett's thought process here... I want a business that even a ham sandwich could run. We're talking systems, processes, consistency, and dependability.
9. High switching costs – Great businesses have such great products or services that it would be far too expensive for their customers to switch to another supplier. This encompasses everything from price, service, speed, etc.
10. Low costs or lean operations – The best businesses are constantly fighting expense creep and running lean machines.

I'm trying to avoid things that are intangible or soft skills (like "good customer relationships"). Yes, maintaining good customer relationships is important, but in the end you could have the best customers and still get steamrolled by a debt-laden balance sheet in a highly competitive industry.

Don't fret if your business doesn't meet these criteria!

Mine sure doesn't. Instead, I work toward a handful of these traits that are within my control to make my business more defensible and (hopefully) valuable.

Homework

This week's assignment – Pick one attribute from the list above to work on this quarter. Just one. Ideally one that's not already in place at your company or client, or it's currently a weak spot. If you want some ideas, send me a reply.