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July 27 - August 13, 2020
Walker shares a fantastic answer in Buy Then Build: ambitious entrepreneurs should buy an existing company and use it as a platform to build value, rather than start a business from scratch. There are three primary reasons: Startups have a little flaw: they mostly fail. Existing companies have the established infrastructure that many startups are trying to build in the first place. Acquisition entrepreneurs should match their resources and talent to transitioning businesses to create significant value in a company all their own.
He compellingly makes the case that existing businesses offer an inherent advantage because they provide a profit-generating infrastructure, a pool of existing customers, an operational history, and experienced employees.
Startups have an inherent flaw: they mostly fail. Even with overwhelming talent, outstanding early product trials, and an all-star team, success is still unlikely. We’ve all heard the statistic that one out of ten startups make it.
Acquisition entrepreneurs start by buying an existing business instead of starting one from scratch. From there, they bring an entrepreneurial approach to build value. The combination of an existing small business’ profitable and sustainable infrastructure with the innovation and drive of an entrepreneur is a magical recipe.
Simply by buying a company, typically one greater than $1 million in revenue, you can remove so much of the risk inherent to entrepreneurship.
There is a lot of opportunity inside small companies that operate on legacy systems, never upgraded to lean business models, or never developed sales teams or effective online marketing.
Banks offer loans to buyers for up to 90 percent of the purchase price, using the assets of the business as collateral.
Because companies under about $10 million in revenue tend to sell for lower multiples than middle-market or publicly traded companies, a $65,000 investment, paired with a 90 percent loan backed by the small business administration, could buy a company generating over $1 million in revenue, immediately launching an acquisition entrepreneur into the role of CEO of one of the largest 4 percent of companies in the US.
According to Harvard Business School lecturer, Shikhar Ghosh, even VC-funded startups—the ones that every MBA startup strives to attain—have a 75 percent failure rate. So, extremely well-financed startups with the support of the best investment teams in the world are successful in doubling the already minuscule success rate of non-VC-backed startups. But the large majority of these companies still never make it to sustainability.
Understanding that unicorn companies are more anecdotal than typical is simply a prerequisite. Starting a VC-backed company believing that you will be the next magazine cover success story is possible. But it might just be punishment for not understanding statistics.
In 1979, economist David Birch revealed that small businesses are responsible for creating the large majority of new jobs in his statistical report, The Job Generation Process.
Gazelles are defined by rapid growth and not size. To be classified as a gazelle, a company must have a starting revenue of at least $1 million, then grow at a rate of 20 percent every year for four years, resulting in the company doubling in size during that time.
Gazelles as job creation vehicles beat out the elephants (Fortune 500, think Wal-Mart or ExxonMobil) and mice (Main Street), which perhaps is a bit of a non-applicable comparison since the latter is defined by size instead of growth rate, so either could exist as a gazelle. That said, most gazelles are found neither on Wall Street nor Main Street, but in the middle market.
One of Acs’ findings could be surprising to fans of the “fast growth is only found in startups” myth. During a 2009 interview with Forbes, Acs revealed that gazelles tend to be twenty-five years old. These are the economy’s most productive enterprises—and they’re clearly not new companies coming out of accelerator programs. Instead, these are established, long-time companies.
An existing company with legacy systems and an outdated path to success has just as much need for innovation as a startup does. As a result, those who can recognize and execute this can capitalize on the benefit of an existing platform to build in the “new company” they wish to run.
In fact, it’s the old dogs with new tricks that have a higher probability of withstanding disruption within their markets. The old dogs have the benefit of existing revenue and earnings. They have infrastructure and invaluable industry insight. They have customers wanting to update to the trends.
It’s the combination of innovation and existing customers that wins in the war of disruptive technologies.
The boomers are already selling off their established, successful small businesses at record rates.15 These businesses provide an unprecedented opportunity for acquisition entrepreneurs to focus on running, growing, and innovating a business immediately, all while enjoying a stability not found in startups.
One more thing: the information is all here, but just reading a book won’t do it. You need to commit your time to taking action. You need to commit to investing your own money and betting on yourself. You need to be willing to create a business plan and pitch it to banks or other potential investors. Finally, you need to be comfortable and willing to take calculated risks. Although we’re paving the way to a greater success rate for entrepreneurs, you are still the most important part of the equation.
While considering acquisitions as an investment, keep three fundamentals in mind: return on investment, margin of safety, and upside potential.
When evaluating a potential acquisition, the cash flow the company generates is what sets the sale price of the company. It’s the driver behind the valuation and ultimately what you’re paying for. Anything outside of the company’s ability to generate cash is commonly not worth paying for at all. At its core, what you are buying is an asset that provides cash flow.
This investment model wasn’t invented by acquisition entrepreneurs. This is exactly the business model driving the entire private equity industry. Doesn’t it make sense to apply it to entrepreneurship? Acquisition entrepreneurs simply borrow the business model of private equity rather than that of venture capital.
By investing when the price is favorable to the intrinsic value, it effectively limits the downside risk, building in a level of protection into the investment. Managing the downside risk is one of the great fundamental practices of the world’s most famous investors. It’s similar to the old adage in real estate, “You make money when you buy, not when you sell.” That framework is the anchor for real estate investors the world over.
This means the $1 million at risk when acquiring a business has about a 2 percent chance of failure. This is a drastically different profile than building from scratch. If you equate not failing with success, then buying a company has an approximate 98 percent success rate.
Like Graham, Dodd, Munger, and Buffet, acquisition entrepreneurs build in a margin of safety, simply by starting with acquiring profitable revenue first, then building from there.
If you were attempting to increase your appreciated value in real estate, for example, there’s not much you can do. The market moves, and the value of the homes move with it. It’s not even called “appreciation” in business, it’s just called building value. And after you buy, you are going to build.
Your business has one thing that no other investment has. You. And you are a value creator. Do not wait. Get to work immediately building value.
Traditional startups focus entirely on the “appreciation” lever—attempting to create something out of nothing—while starting with acquisition has the same outcome as most successful startups but provides a very bankable asset with a margin of safety and a promising ROI model.
Larger companies don’t innovate from scratch anymore; they are just too big. Google, for example, did not even invent Adsense—their enormous pay per click management platform—they acquired Adscape for $23 million and built it out from there.
All that said, let me be clear that although entrepreneurs have a wonderful vehicle for engineering long-term wealth in their companies, they are almost never driven by wealth creation. Entrepreneurs have non-financial benefits that drive them. We relish in the autonomy, problem solving, growth, and passion we have for our companies. These aspects are not lacking in the acquisition model. For a true entrepreneur, financial independence has been reached the moment they take ownership of a company or an idea, from the very beginning, because there is no separation between work and life. It is
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“Set your mind on a definite goal and observe how quickly the world stands aside to let you pass.” —Napoleon Hill
Starting with yourself, and aligning your “3 As” of attitude, aptitude, and action, will help identify the right parameters for your search. Aligning all three of these will allow you to move forward with conviction.
The first step toward being a successful leader of your own company is to think like a CEO in the first place. If you don’t cultivate the “right” thoughts, you’re defeated before you start. You need to eventually build a vision of where you are headed and how you will get there, but without the mental wherewithal to navigate the waters, it’s just a business plan.
On the contrary, a growth mindset is one that views the world as more malleable, believing success is achieved through effort. A growth mindset is the little difference that empowers people to have a sense of free will. They embrace rather than avoid challenge, and they persist during times of setback. A growth mindset views effort as the path to mastery. They learn from criticism and are inspired by the success of others. Hard work, good strategies, and input from others are the tools utilized by those who believe their talents can be developed. They put their energy into learning.
Having a growth mindset is often regarded as the number one predictor of entrepreneurial success. It allows a leader to learn from their mistakes and adapt. Knowing that there is always risk that needs to be managed, that rough waters can be successfully navigated, and having an almost relentless commitment to ongoing improvement is what separates the growth-minded entrepreneur from the pack.
A recent interview with Dr. David Weller, founder of Leadership Alliance and a true expert in assessing top talent, told me that about a third of the variants for success are simple competencies. These include, but are not limited to: Possessing a drive for results and being able to get results from others The ability to make decisions, including unpopular decisions Strategic agility when dealing with ambiguity A certain level of risk tolerance Financial acumen Critical thinking, which is an innate trait Tactical ability Perseverance Self-awareness, which includes the ability to work through
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In 2002, the Journal of Business Venturing published a study36 that established ten behavioral areas of competence for entrepreneurs that have either a direct or an indirect impact on performance. Analytical Innovative Operational Human Strategic Opportunity Relationship Commitment Learning Personal Growth
Those who are dubbed “high achievers” are those who are motivated almost exclusively by the personal satisfaction that comes with accomplishing hard goals.
Most business activities are typically divided into two core, overarching functions. One side of the spectrum is revenue generation and the other is operational execution. Are you a grow the top line-oriented individual or are you interested in operational execution? In other words, do you want to sell more product, or make as much product as possible at the lowest cost? Everyone has a natural inclination toward one side or the other. If you are considering acquisition entrepreneurship, you will need to be able to function on both sides of this spectrum.
Gino Wickman, author of Traction: Get a Grip on Your Business and life-long entrepreneur, outlines two types of business owners: visionaries or integrators. His concept is similar to the revenue or operations spectrum we’ve presented here. He sees the visionary as the entrepreneurs who are able to see into the future. They can take an idea and run sixty miles an hour down the street until it sticks. The integrators pick up the pieces that have been left in the wake of the visionary, organize, and profitably execute. Ideally, every organization would have one of each, and in smaller businesses,
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Personal SWOT SWOT, a common business strategy practice, flushes out the strengths, weaknesses, opportunities, and threats of a particular business. Applying this common business strategy to yourself will fine-tune your self-understanding.
Spend time reflecting on yourself. The exercise will drive interest in opportunities that may have otherwise not appeared interesting. For the purpose of true self-discovery, ignore your passions and interests for a moment. Simply focus on the activities and functions you are well-equipped to execute. This is about getting in tune with what you’re good at and doing a deep dive into your skillset. At the end of this section, you should have a personal SWOT analysis and a resume written out for your review.
Your target statement will be the driver of your search and ascertain that you are communicating exactly what you are looking for to the right people.
The number one thing that I stress when helping people find the right company for them is to match the opportunity profile of the business to their personal strengths and goals.
A good goal would be a 10 percent year-over-year pace.
In Eric Reis’ The Lean Startup, he coined the term pivot to describe changes during entrepreneurial product development. Always turning to user data and customer feedback to tweak the next iteration of the product in order to build the product the market wants and attain product-market fit.
Now, I want you to clearly define the growth opportunity you are looking for. Is it a company that needs to build a sales team? Improved marketing? New distribution channels? Financial engineering? Operational improvement? Or a customer base in a certain market? The truth is, you already know. Identifying this clearly is the first part of what will become your target statement.
Instead, define the target by the amount of SDE. To review, the Seller Discretionary Earnings (SDE), is a measure of how much total cash flow the seller of the firm has been enjoying.
As listings move from Main Street to middle market, a definition largely defined by size, you’ll likely see Adjusted EBITDA as the metric used instead of SDE. They typically refer to the same thing. The difference is often that Adjusted EBITDA is the term largely used for passive ownership, while SDE refers to active ownership.
By measuring an acquisition target by SDE instead of revenue, you are defining the search by the cash flow it will provide and the transaction price you can afford, so it will become part of your target statement.
