Increasingly, I have come to the conclusion that unless you really know what you are doing, startups are a mug’s game. Why risk everything on a 10% chance of success? You are better off buying an existing business with clients, cash flow, distribution channels and infrastructure and become an acquisition entrepreneur.
What is your number
I have the pleasure of knowing Eelco Smit, the number one exit coach and author of “The Not So Secret Rules to the Game of Life”. At the tibor.nl Mankracht retreats he talks about the lack of happy exits. According to Eelco, only 5% make a happy exit. That is very low if you consider all the hard work you are putting in your business (5% of 10%). It is something you need to think about. If you want to put it bluntly, are you building a business or are you building a hobby? It is not that black and white, but if you want to to be financially independent, you need to have a number. For most, it is around 1,2 million Euro. You either have that in the banks when you retire, or you have a business with that or more value.
As entrepreneur-in-residence for Sustainable Nation, I have been working on intrapreneurship for a while. Slightly different angle but with the same starting point, namely that startups are too risky and too slow to make real impact. If you can galvanise the resources of an existing business (clients, distribution, talent, money), you have a much higher chance of succeeding. If you consider that, then it makes more sense to buy a business than to start one.
Buy then build
Hence “Buy Then Build: How Acquisition Entrepreneurs Outsmart the Startup Game”. Startups are over-hyped and buying a business is deeply under-appreciated. Ambitious entrepreneurs should buy an existing company and use it as a platform to build value, rather than start a business from scratch. Because startups have a little flaw: they mostly fail. Even with overwhelming talent, outstanding early product trials, and an all-star team, success is still unlikely. Existing companies have an 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. The goal for entrepreneurs is to run and operate a successful business. Acquisition entrepreneurs start by buying an existing business instead of starting one from scratch. The combination of an existing small business’ profitable and sustainable infrastructure with the innovation and drive of an entrepreneur is a magical recipe. You can acquire a successful business and then using the cash flow to innovate and upgrade the offering and the talent.
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. The author’s team more than doubled the marketable value of the company, by merely bringing a complimentary level of innovation into an established and stable business. It was accomplished at a fraction of the cost and a fraction of the time and provided 100% ownership of the company.
The good news
In the USA, the baby boomer generation owns more businesses than any other generation ever in history. In 2013, they owned 12 million small businesses, which is 43% of all small businesses. By 2021, baby boomers will be retiring at a rate of 11,000 per day. The boomers are already selling off their established, successful small businesses at record rates. This substantial increase in the supply of available companies for sale is expected to result in a buyer’s market as we have never seen. There is no reason to believe that it is different in Europe.
An acquisition is more affordable than you think. Banks in the USA offer loans to buyers for up to 90% of the purchase price, using the assets of the business as collateral. In Holland, it is 75%. Love to hear the numbers in Europe. Drop me a line.
Innovation and existing customers
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 recognise and execute this can capitalise on the benefit of an existing platform to build in the “new company” they wish to run. It’s the combination of innovation and existing customers that wins in the war of disruptive technologies. You need to commit your time to take 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.
Do you want to be a millionaire
Effectively 100% of non-retired millionaires who live in the United States own their own businesses. Out of that group, about 20% are professionals running a medical or service business, and the balance are entrepreneurs and small business owners. Owning your own business is not only an opportunity to provide value through products and services, but it’s arguably the best way for most people to build real wealth.
Cash is king
When evaluating a potential acquisition, the cash flow the company generates is what sets the sale price of the company. At its core, what you are buying is an asset that provides cash flow. Anything outside of the company’s ability to generate cash is commonly not worth paying for at all.
Risk is relative
In the USA the amount of small business loans that go delinquent on the national level has been running under 1.5% since 2012. That means the $1 million at risk when acquiring a business has about a 2% chance of failure. If you equate not failing with success, then buying a company has an approximate 98 % success rate as distinct to 10%.
Acquisition entrepreneurship is an active, rather than a passive approach to investing. By aligning your work with your asset, you’re able to take wealth building into your own hands and build something worth working for.
What to do
- Write your personalised target statement. 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. Identify the type of opportunity you’re looking for, work through the size of the company you’d like to target, and defined your industry type and apply any limiters.
- 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 particular market?
- Match the opportunity profile of the business to your personal strengths and goals.
- Understand the length of time your cash is tied up.
- Understand the company’s cash cycle and the demands of each cycle.
- Ask for income statements on a cash basis versus an accrual basis.
- Look to identify the path to growth and the amount of upside potential. How big can this business be?
- Look for the opportunity in the company and in the industry. Identify how good the company is at being able to execute on the opportunity—what it has and what it lacks.
- Always turn 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.
- Calculate your SDE. Seller Discretionary Earnings (SDE), is a measure of how much total cash flow the seller of the firm has been enjoying. It is calculated by taking the pre-tax earnings of a company, then adding back any interest and non-cash expenses like amortisation and depreciation (which will give you Earnings Before Interest, Taxes, Depreciation, and Amortisation). Finally, adding in any seller benefit such as salary, personal insurance and vehicles, and any one-time expenses the company had during that time.
- Consider Accounts Receivable minus Accounts Payable and Inventory, as well as any additional working capital you might choose to add.
- Understand that accounting is not the driver of value. It is the reporting mechanism for what happened.
- Determine whether you are looking for a product, do you want to be a manufacturer or simply a reseller of that product?
- Set your geographic preferences.
- Define the industries you absolutely will not work in.
- Finding a business is 90% networking. Skip the internet, don’t commit to one broker, and don’t depend only on listings.
- Have the right mindset during the search and include your absolute commitment to finding the right business and buying it within six months.
- Engage with your advisors and the banks early.
- Rule number one for establishing a purchase price is making sure the business can afford to pay for the business.
- As a buyer of a company with established revenue, infrastructure, and earnings, you are buying cash flow, not non-revenue generating IP.
- Look at ratios like Return on Equity (ROE) or revenue per employee.
- When analysing revenue, the best exercise you can do is a year-over-year comparison. It will show you the revenue trend of the company.
- When you are analysing past performance, it’s important to understand that this performance is what happened under the current owner’s management. If the results are good, what happens when they leave?
- There are three main asset-based valuations: book value (BV), fair market value (FMV), and liquidation value (LV).
- Don’t buy any outdated or unusable inventory. The author doesn’t acquire inventory in excess of what he expects to use in the first ninety days of ownership.
- Only buy the assets of the company necessary to continue operations and the corresponding cash flow. This is precisely the infrastructure you are after. Ultimately, make sure you’re getting the assets you need to continue the operations of the business. If in doubt, include it.
- To stress-test your model, consider the burden of the loan on discretionary earnings and then consider how much revenue would need to decrease in order for you to get into trouble
- Entrepreneurs are notorious for overvaluing their companies.
- Let the future value of the business be the driver of your interest, then price that future value on past performance. This will assure the value you build in the company will be yours to enjoy.
- Identify what’s important to the seller other than price. Is it future employment of key employees? Is it the timing of the close? Is it not to hold a seller’s note? Is it the ability to execute on one of their own growth strategies? Or is it just getting the highest price possible, no matter what?
- Negotiate everything you can, other than price, before you make a formal offer.
- If the seller wants three specific things and it costs you nothing, and you’re willing to do them, do all of them.
- Download the seller’s brain.
- Identify the rabbit holes and smoke screens in the story and the numbers.
- Ask for the entire history of the company, the “genesis” story, and how it got to where it is now.
- Apply the “bus test”: if the owner got hit by a bus, what would happen to the business?
- Never ask the question “Why are you selling? “ upfront.
- Listen to your intuition while working with the seller.
- Ask for a tour in the business
- Culture is probably the single most overlooked aspect of a potential target company by buyers, yet it’s a critical piece of the puzzle and essential to understanding your plan for how to manage the company from day one.
- The best buyers understand that the fair price will reveal itself.
- Define what would need to be true for you to make an offer to acquire this company?
- Time kills all deals, and if you can close quickly, you increase the odds of closing.
- Beware of the eleventh-hour freakout.
Continually make decisions based on an underlying, crystal-clear understanding of the intersection of three areas, and achieve superior economic returns as a result. Those areas are:
- What you are deeply passionate about.
- What you can be the best in the world at.
- What best drives your economic engine.
A shorter business version of Ikigai.
Do your legal, financial, and operational due diligence. Remember that you are not only looking for holes in the story, but also a validation of what you are buying. You need to learn the business, and this is the single best opportunity for you to learn the entire business with no risk other than your escrow deposit and professional fees. Use this time to examine and determine what the actual business drivers are, to determine whether this is a good business that you can make great with your skillset and effort.
There are three primary approaches: all cash, earnout, and purchase with a seller note. Having an all-cash offer puts buyers at a disadvantage since they accept all the risk from the seller on day one. Earnouts keep the risk of the company with the seller even though the buyer is taking over ownership. It is used if there is a material risk or real material reward in the near future. High customer concentration or a large contract coming up for renewal are characteristics that add risk for the buyer and can also be addressed with an earnout. Having the seller carry a note is the absolute best way to approach most acquisitions. A typical structure is that the amount of the note, associated interest, and payment schedule are agreed to, then paid out by the company over, say, two to five years. A typical seller note would be 10 to 20% of the purchase price paid out at a lower interest rate over the following few years.
The types of companies
- Eternally profitable: This is the business that serves a need that is very unlikely to go away. Eternally profitable companies are found in mature industries. These companies are no longer “sexy,” their technology is no longer new, and you won’t find their CEOs on the covers of magazines—but they make up the bulk of the economy.
- Turnaround: The turnaround is a tremendous place to create value if you are strong in operations and have a great understanding of financial reports and managing cash flow. A turnaround describes the acquisition of a company that has fallen on hard times, with the goal of improving operations, building efficiencies, and strengthening the value that the company provides to its customers. It’s the company version of the “fixer-upper.”
- High growth: Growth in revenue and earnings is what drives the maximum value of every business at the end of the day. Company coming off, say, three years of significant revenue growth is exciting and attractive for many buyers. The bad news is that because revenue and earnings growth drive value, you will be paying more for that prior performance.
- Platform: In private equity, a platform company refers to the first company, a firm acquires in a specific industry. In acquisition entrepreneurship, a platform company is one where the buyer of the company is typically the one who will be operating within the company themselves as the CEO.
All normal business rules apply
You need to know the sector. You need to analyse your customers and their motives, understand your segment, understand pain or gain, you need to know your direct and indirect competitors, do a SWOT, you need to know your key personnel and the A en B players and get a perspective of the future. You need to define your future buyer too.
After closing the deal
- First, all of the employees understand that they now work for the new owner, you, not the seller. In a way, it’s their first day on the job. There is no transition period in the employee’s eyes, the customer’s eyes, or as you’ll find out, the seller’s eyes—it’s immediate.
- Second, the seller, with the deal closed and money in the bank, is spiritually, physically, and mentally ready to leave as soon as possible.
- Third, what you’ll learn from the seller at this point is the minutia. It’s important. You will learn these in the first two days. Though it may be only 80% at first, you’ll truly be done with the seller other than some quick phone calls throughout the first thirty days. You’ll
- Fourth, you will understand that you really don’t need them around and that you won’t want them around. Following the first couple of days, it’s better to have many short interactions, rather than keep them around. The seller will be critical during the acquisition process and the first month after closing, but usually not much after.
Again all normal rules apply. Define the mission, vision, and values of the organisation. Identify the core competencies. Know your market segments. Outline the path to growth. Write the “how we plan to sell more stuff” plan.
Identify the one metric
What is the one thing that drives revenue? If there was one metric that could measure the overall performance of the company, what would it be? How can you accelerate or multiply what drives revenue? Understanding what would need to be true in order to double the size of the business is typically a derivative of understanding this metric.
Develop the pitch deck
Follow Guy Kawasaki:
- Problem: Clearly identify the pain or opportunity, as well as who it’s for.
- Value proposition; What is the company’s solution to the problem? What is the offering and unique competitive advantage of the company in supplying this offering?
- Underlying magic: What’s the “secret sauce” of the company? What do they have that the competition doesn’t? Is there “a moat”? What is the core competency? Is there an advantage in technology, IP, brand, geography, or any other area?
- Business model: Run through a business model canvas. It’s a separate exercise that will help you map, design, and assess the model of the business.
- Go-to-market: How do you plan to continue running a profitable business? How do you plan to grow the business, and why will it flourish under your leadership?
- Competitive analysis: Provide a complete view of the competitive landscape. How competitive is the industry?
- Management team: Highlight what you (and your partner or partners, if you have them) bring to the table.
- Financial projections and key metrics: When acquiring a company, you’ll want to project out three years into the future. How much will the company grow? Will you maintain gross margin percentage? Will your expenses increase? Is growth slow and steady? What is the key metric?
The 100-day plan
Ultimately (and always) it boils down to hundred-day plans. Read here about the importance of 100-day plans. The first hundred days are a critical time to establish yourself with the employees, customers, and suppliers, get to know the internal systems and process, get a handle on cash flow, and begin to implement change. It’s important to set a goal or list objectives that are specific and achievable. As you establish yourself as the new CEO over the first ninety days, you’ll want to take a general approach of focusing the first month on the people involved, the second month on learning the processes and systems, and the third month implementing your plan of action.
- Keep in mind, the first couple of months will be spent mostly in a time of assessment, so your goals might be more qualitative at first. Confirm the company’s strengths and weaknesses and the most critical people in the organisation, and identify three ways to make internal systems more efficient, for example.
- Initiate an overall clean-up of the facility. Most small companies that have been owned by the same person or people for decades are in need of tidying. Set an example of how you want the rest of the company to present itself. Keep your desk clean, repaint the walls, and sell off old assets. Cleanliness sends a good message to the employees that you care about the place and want it to look nice.
- During the first few days, all of the little company-specific details that weren’t mentioned before the closing will start to come out. The good news is that you typically learn all the relevant information very quickly.
- Whenever there are employees, there are communication channels that you are not a part of, and each of those employees has questions and concerns that need to be addressed.
Establishing rapport, respect, and expectations with employees, customers, and suppliers is your first initiative and will be the focus of the first month in your new role. Keep the message simple and stick to the truth. People loathe change, and the team will undoubtedly be concerned about changes. The first thing your employees want to know is whether there are going to be layoffs, and the second thing they’ll want to know is whether there are going to be changed in their salary or benefits. If you have plans to change the benefits plan or salaries, this is the time to communicate that. Just “pull the bandage off.” Be truthful.
The first month
- Your first couple of days will likely be spent hiring all the employees into your newly formed entity
- During the first ten days, try to make sure to have a short, one-on-one meeting with everyone in the company. Start with management and work your way down through the organisation. During these short meetings, simply ask them what they do in the organisation, what their background is, whom they interact with, and what observations if any, they might have for improvement in the organisation as it relates to their job. Ask them what they would focus on if you were in your shoes? What improvements do they think need to be made, and how would they go about making them?” Often during these meetings, you can discover hidden talents or identify skillsets that can be utilised later.
- The only exception to a short sit down is with any salespeople. Ride with your salespeople instead. Understand how they work, what the marketing message is. You’ll get plenty of drive time to chat.
- The most important thing is that every employee feels heard and knows you are accessible to them.
Meeting with these customers is the best way to immediately establish a customer feedback loop. How long have they been using the company? Why do they buy from this company? What are the strengths and weaknesses? Where could they improve? What is one thing they are not doing that would be of the biggest value? Who is critical to them in their interactions with the company? What would cause them to leave? Explain you’d like to have a short check-in meeting with them once a quarter to review your performance and explore opportunities to do more.
When meeting with suppliers, you typically want to make very clear what you need from them and how you will be evaluating their performance. It’s amazing to me how many existing suppliers will try to sell you new things immediately. It’s fine to understand what they offer, but never sign any new, long-term contracts.
The second month
- The second month should be focused on deeper learning of all the systems and processes. Learn the accounting system and order entry. This will initiate your path of improvement by being able to have documented processes rather than depending on specific people.
- Consider the “bus test.” If this person got hit by a bus and died, could the company function? If the answer is no, that’s where you’ll want to focus first.
- Put together a thirteen-week cash flow projection so you can understand your cash demands for the next quarter and get an intimate understanding of how cash cycles through the company.
- The second month is a good time to consider best practices in the industry and establishing ongoing meetings with the supervisors. This is getting into the flow of operations for the first time—what your day to day will look like. Make sure you can effectively perform all of your adopted responsibilities, look for areas you need to learn and begin looking for small, early wins.
- Defined your goals and objectives
- Identify what you want to accomplish and what success looks like.
- Define metrics for success: what is the best way to measure your results?
- Schedule milestones.
- Break your goal down into steps, then build a timeline that outlines when you plan to accomplish each step.
- Allocate your resources: Is your plan reflected in your forecast? Do you have adequate resources to commit? This could be time, money, or personnel.
- Create a dashboard or a Balanced Scorecard to keep track of progress and make sure you’re moving the metrics that matter. It’s commonly recommended that you don’t change a single thing until you have a chance to live in the business for a while and understand all the moving parts.
The third month
Then is when you contact us to help you double the turnover.
Acquisition in the entrepreneurship economy
Becoming an entrepreneur is like becoming a knowledge worker in 1900. Entrepreneurship is the next limiter to be conquered. As the economy shifts, entrepreneurial skills will, like never before, define the forefront of economic development. Simultaneously, there is an enormous transition, never before seen in history, occurring right now. Baby boomers, who own more companies than any other generation in history, are retiring in droves—$10 trillion in business value will need to change hands, with the highest volume of opportunity in businesses below $5 million in revenue. Entrepreneurship isn’t just popular anymore, it’s necessary. Acquisition entrepreneurship provides a career accelerator for people going out on their own. It provides infrastructure beyond just one person and de-risks your investment in time, effort and money.