Want to avoid the graveyard of companies? Look for durability

Föhlritz, Thuringia, Germany - April 23, 2022: Old abanded jewish graveyard in a forest in Thuringia

Walking through a graveyard is always sobering. All that effort; all those risks. They count for nothing in the end. The graveyard is a place of perfect equality.

There is no graveyard for companies. But if you scroll through a government register of businesses, you’ll find a lot more dead companies than ones that are still alive.

That’s why it’s a bit of a misnomer to say the stock market increases in value over time. Thumbing through the company registers, it’s probably more accurate to say the economy has lost more money over time than it has gained. Capital isn’t like energy. It doesn’t change form when a company fails, most of the time it simply disappears forever.

Sure, the average annual return over the past 150 years appears to be between 8-9%, but what this analysis misses is all the corpses of the corporations that collapsed in that time.

So, how do you avoid prematurely ending up in the graveyard of businesses? Survive longer than your competitors. That’s all it takes. The difference between a failed company and a successful company is durability.

What is this amorphous term “durability”? It’s a measure of a company’s intangible assets. These are all the things of value owned by a company that don’t appear on its balance sheet. The precise mix of assets – along with how well these assets are managed – is what makes a company durable, or not.

It’s easy to see a well-established company’s intangible assets.

A multinational like Coca-Cola, for instance, has an impressive constellation of intangible assets. It has things like brand, networks and relationships, data, trade marks, confidential information and dozens of other asset types. All of these have helped make that company extremely durable (and valuable) over its 131 years.

But what about small companies? How can an investor decide which start-up will generate a return?

Or, put another way, can durability be measured?

This is an important question because most projections for when a start-up will finally achieve a positive cash flow are at a minimum 10 years after its founding date – if they are lucky. Ten years is a long time for investors to wait to see a return, not to mention the fact the graveyard has plenty of space for companies that don’t make the cut.

“Many entrepreneurs focus only on short-term growth. They have an excuse: growth is easy to measure, but durability isn’t,” is a quote attributed to entrepreneur Peter Thiel, who added that the probability of cash flow is directly linked to the strength of the company’s underlying intangible assets.

Thiel’s point is that assessing a start-up’s durability requires identifying its intangible assets. There are many structured analytical techniques for doing this, however, investors often don’t have those skills. Even if they do uncover a firm’s assets, most investors likely don’t know how to leverage those intangible assets in a relevant market.

Without getting too much into the weeds of those analytical techniques, there are some basic questions investors could ask to better understand the durability of a target company.

For example, is the CEO an ambitious person with an excellent idea? That’s a good start. But a better question would be to ask if that CEO has access to the right networks, relationships and access to supply chains that could turn an idea into a million dollars. Relationships are tough to value, but they can create an impressive advantage for any investor who finds them first.

That same CEO may also have special data about the company’s ideal customers, along with an excellent plan to exploit those insights quickly. Perhaps someone in the company knows what projects the competitors are working on as well. Couple these two important pieces of confidential information together and they become enormously valuable intangible assets for the start-up.

Furthermore, after digging a bit deeper, you may discover that the start-up has retained key regulatory approvals and certifications long before its competitors knew to apply for them.

It’s even possible that the investor or the start-up founder may be able to lobby legislators for new regulations that benefit the company. After all, the squeaky wheel gets the oil, and legislators are often looking for help to write the best policies to boost a sector. So, it always pays to ask.

These are just the tip of the iceberg of the intangible assets that may be lurking inside a start-up. Each reliable intangible asset an investor can identify will only enhance the durability of the business.

With strong relationships, the start-up won’t be ignored when supply chains get tight. With unique customer data, the start-up can be ahead of customer behaviour. And with strategic regulatory approval, the company will never wonder why their goods are being held up at the border.

As the company grows, it will inevitably add more intangible assets like a stronger brand, better trade mark protections, industry expertise, deeper relationships and perhaps even wildfire network effects.

The stronger its intangible assets, the better the odds that the start-up will make it to cash flow profitability and avoid the graveyard. A durable company will dodge and weave as the economy throws its punches and stands a far better chance of generating a return on investment.

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