This article originally appeared in Crain’s Chicago Business on June 20, 2022.
Closely held firms have an opportunity to identify and enhance distinct competitive advantages
As an investor and adviser to small and midsize, founder-led and family-owned businesses, I’m constantly reminded that not all businesses are created equal, yet all business owners must make the most of the hand they are dealt. In navigating the current economic uncertainty and volatility in the markets, closely held businesses have an opportunity to identify and enhance their distinct competitive advantages by reflecting on key lessons from the “Oracle of Omaha.”
Warren Buffett’s decades of success as an investor are grounded in identifying well-run businesses that benefit from certain core business principles. Chief among these principles is having and maintaining an “economic moat” that cannot be easily replicated—that is, they have sustainable economic advantages over competitors that allow them to protect their long-term profits and market share. This often leads to other key business principles including “pricing power,” or the ability to increase the pricing of goods or services without materially lowering demand.
That further leads to steady and predictable cash flow generation and results in an above-average return on invested capital, or ROIC. These principles often go hand-in-hand, allowing companies to compound earnings and drive meaningful, long-term value creation. Unlike commodity businesses, businesses with durable economic moats do not have to invest much back into the enterprise to maintain their moat. As Buffett stated at one of Berkshire Hathaway’s legendary Meeting of Shareholders: “What we’re trying to find is a business that, for one reason or another—it can be because it’s the low-cost producer in some area . . . because it has a natural franchise . . . because of its position in the consumers’ mind . . . because of a technological advantage, or any kind of reason at all, that it has this moat around it.”
These principles came into play when my firm provided growth equity to a Chicago-based fixed wireless internet service provider, SilverIP Communications. SilverIP is a fast-growing, founder-led business with a technological competitive advantage that enables the business to operate at a lower cost. SilverIP offers a mission-critical service and, in passing on its savings to customers, continues to gain market share. We appreciate that this sustainable advantage allows the business to sign customers to multiyear service agreements, locking in contractually recurring revenues and supporting high customer retention upon renewal. Having learned from Buffett, we believe that so long as the business maintains its lowcost advantage, it will continue to benefit from higher-than-average returns on invested capital, allowing the enterprise value to meaningfully compound.
What if your business has neither a high ROIC or an economic moat? While perhaps not a great fit for Buffett, you can still build a great business based on his key principles. One of our clients operates a low-margin physical security business. Unlike its peers, the business benefits from meaningful brand equity that stems from highly targeted business development efforts and minority business enterprise, or MBE, ownership status. Its MBE certification, coupled with a highly reliable service delivery model, have helped it maintain long-term customer relationships and afforded the business more pricing power than competitors. While brand equity and resulting customer loyalty may not be directly evident in a business’ financial statements, these factors often result in a higher valuation relative to peers.
With inflation here to stay for now and some economists pointing to a looming recession, many business owners are distracted by the economic backdrop. There’s no better moment to intentionally embrace Buffett’s core principles and leverage them to best position your business to survive near term and thrive long term.
Duane Jackson is co-founder and managing partner at Author Capital Partners and an investor-in-residence at the Polsky Center for Entrepreneurship & Innovation at the University of Chicago Booth School of Business.
