Buying your way into entrepreneurship

Many aspiring leaders take conventional routes to the top in business: They get on a C-suite track at a large company, climb the ladder to partnership at a consulting or investment firm, or launch their own start-up. But there is another career path that has become increasingly popular in recent years: buying and running an existing operation—or what we call acquisition entrepreneurship. A record number of such transactions occurred in the United States during the first three quarters of 2016, according to BizBuySell, an online small-business marketplace.

Whether acquisition entrepreneurship is right for you depends on your preferences and temperament. But most of the individuals we’ve taught, advised, and tracked have found it to be personally, professionally, and financially rewarding.

Another plus is having a more flexible lifestyle than might be possible at a fledgling start-up or a large firm. When you’re running a stable operation, you rarely need to work nights and weekends, and as the boss, you set the rules: If you want to leave early for a family or community commitment, you can.

But small-business acquisition and management is not without its challenges. That’s why you need to make sure you’re suited to it and then approach your search, deal negotiation, and transition to leadership in a systematic way. Through our research on multiple companies and their buyers, we’ve developed a road map for tackling all of these steps.

Reflection

To succeed at acquisition entrepreneurship, you of course need basic management skills: an understanding of finance, a knack for leading and managing others, and an aptitude for decision making. But you need other attributes, too.

Confidence and persuasive ability are key; the job requires you to reach out and project optimism to people you don’t know—business brokers, investors, sellers, and the employees and customers you inherit. Acquisition entrepreneurship means instant impact. You’re immediately in charge.

Persistence is crucial, too. When seeking a business to buy, you might find a great prospect, reach agreement with the owner on price and terms, and work for months to close the deal—only to have it fall apart at the last minute. You need the fortitude to bounce back. And once you’re an owner, it will be up to you to drive the company forward and ensure that it recovers from setbacks.

Additionally, and perhaps most importantly, you should be an enthusiastic learner. Throughout your search, you’ll have to quickly get up to speed on unfamiliar industries, sectors, and companies. When you find an interesting target, you’ll need to become knowledgeable about the business. And as an owner and CEO, you must be able to develop expertise across functional areas, stay curious, and recognize that you can and should grow into the job. “Nothing can prepare you for owning a company other than owning a company,” Bautista comments. “No day is boring.”

It’s also important to reflect on the trade-offs that all entrepreneurs make in choosing to go out on their own: Do you value what you’ll gain more than what you’ll lose? For example, you’ll have professional independence and the ability to make unilateral decisions, but that comes with a great deal more pressure. You’ll be giving up the comfort of working in a larger, more structured organization where you have greater access to capital, a better-known brand in which to take pride, and the support of peers, bosses, and functional groups such as HR and R&D. Yes, your pay will be directly linked to your performance, with every positive move you and your employees make benefiting you and your investors. But there is a negative flip side: Inevitable mistakes and down cycles will hit you harder than they would if you were a cog in a corporate machine.

So carefully consider what you’re in for. If, after all this thinking, you determine that you have the skills and the appetite to become a small-business owner, you’re ready to begin your search.

The search

Although would-be entrepreneurs often worry about making mistakes once they take over a business, it’s actually much earlier that many falter. According to research by a team at Stanford University, about a quarter of acquisition searches end without a successful purchase. In other cases, people let emotion or a desire for expediency lead them into buying bad businesses (or the wrong ones for them) or overpaying. We’ve focused on avoiding these outcomes in our work advising former students and in making investments ourselves. Here’s what we suggest.

Whether you’re working alone or with a partner, you need to commit to searching full-time for six months to two years. This may sound extreme, but an extended period is necessary to raise funds from investors, identify potential acquisition prospects, thoroughly vet the best of them, negotiate with sellers, and, eventually, find one that agrees to sell at a reasonable price. Then it will take at least three more months to perform due diligence and complete the transaction.

Establishing a search fund is the most popular way to raise enough capital for out-of-pocket expenses and your cost of living during this time. The process involves approaching potential backers (wealthy individuals in your network or those in the small-business-acquisition community) and offering them a first look at investing in an eventual acquisition at favourable terms.

In a typical search you’ll encounter acquisition prospects every day—through referrals from your network or brokers or through your own direct outreach to business owners. These prospects might total in the thousands over a year or two, so you will need to dismiss most of them very quickly. We recommend that you evaluate each using five criteria:

Is it profitable? Is it an established business? Are its revenues and cash flows in the desired range? Do you have the skills to manage it?

Does it suit your lifestyle (location, hours, need for travel, and so on)? If you can answer yes to all of the above, ask two additional questions that take a bit more time to investigate: How enduringly profitable is the business? Is the owner serious about selling it?

Markers of enduring profitability include a steady, loyal customer base; a strong reputation; deep integration with customers’ systems; large switching costs; and few or no competitors. Examine the financials carefully and look for strong margins and low customer churn.

Negotiating a deal

You may have spent only a day or so on the prospect thus far, but if it’s still of interest, you should now devote substantially more time to preliminary due diligence: a focused period of rapid learning in preparation for making an offer.

This is when you’ll test the seller’s initial claims and verify the information that has made the business appealing to you. You believe the company has many devoted customers because it reported a low churn rate—but are those customer businesses themselves healthy? You think cash flows are steady—but what did the books look like during the last recession?

And how sound are the company’s current business practices (regarding quality control, billing, refunds, pay, and benefits)? You’re looking for any reason that you might not want to acquire this business.

Use the company’s historical financial data to project future earnings and your return on investment. These calculations will allow you to value the firm as accurately as possible—and thus to arrive at an offer price, typically between three and five times the current EBITDA.

If your offer is accepted—or accepted after negotiations—you’ll enter a period of confirmatory due diligence in which the company’s records will be fully open to you. You will typically have around 90 days to work with your accountant and attorney to check for any inconsistencies and red flags. (It’s a good idea to wait until this stage before bringing in these outside professionals so that you don’t have to pay them should the deal fail, as is more likely earlier in the process.) This can be an extremely nerve-racking time for both the buyer and the seller, so it’s important to be patient and calm.

Source: hbr.orgax