If you’re a business owner, the most efficient way to grow your business and generate a higher return on investment, is to acquire the assets of another business that is already generating good cash flow.
Today, many entrepreneurs and investors look for the investment opportunity that will quickly turn their asset base into a very high multiple of what they already have, but assets that appreciate so rapidly may also decrease in value equally as fast. That’s true regardless of how well the business is managed.
A business that is earning consistent and growing cash flow, on the other hand, will continue to earn more as long as it continues to be soundly managed, and if you are already managing a similar type of business, the prospect for continuing or improving those earnings in the future is extraordinary. Instead of investing in a unicorn, you are now investing in an olive tree that will bear fruit and continue to have greater value, size and productivity for as long as you will tend, prune and harvest from the tree. In fact, it may further continue the same growth for many generations after you’re no longer managing its growth.
Think about the options people consider when they want to grow their business:
- Organic Growth – By investing more into marketing and sales.
- Startup Endeavors – Looking at what you have and bolting on a completely new business enterprise with a different model, services or products.
- New Products and Services – Keeping the same business in place, but simply adding to your product or service mix.
- Passive Investment in Other Companies – taking earned resources from the company you have and investing them into a company wholly managed by an unrelated third party.
All of these options have advantages and disadvantages. They can be combined and used strategically at different times and in different ways. In the end, however, it is difficult to beat the level of certainty of success you are likely to have by purchasing an existing profitable business versus an of the other options. Growth by acquisition is regularly the most effective way to continue to increase both gross revenue and return on investment at the same time.
Let’s consider each of the other options described above and how growth by acquisition can be superior to what each of them offers.
Every small business owners’ impulse and daily drive is to continue growing what they have through increasing sales. They work long hours networking, building marketing platforms, hiring new people and doing anything else that might help them succeed in their effort to continue increasing revenues. They do it because they believe – hard work pays off! And it does. The problem is payoffs are not all the same. The payoff for one person putting in an extra 30 hours a week may actually be far less than it is for another who puts in an extra 10 hours a week. And the deeper you dive into a market, the harder it is to predict coming success. Even as your sales and net profit increase, your actual percentage of return on each dollar or man hour invested may decrease.
Marketing is a little different, but the bottom line is the same. There are generally diminishing returns on each additional dollar you invest in marketing, at least once you hit stride with the product offerings you have generally available. I have seen many small companies struggle immensely due to an unwillingness to invest enough in marketing to move their sales ahead, but I have also seen plenty who have plateaued, declined or even found they cannot attract more of the same type of business they previously had, except in higher risk areas, if they were going to try to continue to increase sales in the markets they serve.
Growth by acquisition works very differently. You are looking for a company that has figured the formula needed for its marketing and sales success, without investing your own time or additional expense, at a given level of earnings. You are buying a stream of earnings and the confidence those earnings can be sustained or continue to grow with stable and/or consistent management.
The great advantage of a true startup is that you get to pick the product, services and business model that you desire. You are the builder – the general contractor if you will. It is all up to you from the start. The problem is, of course, that everything mentioned above regarding organic growth, is not only true here but instead, you are working from the very first sale and going forward from there. I have often advised an entrepreneur that perhaps their own first startup activity should be an acquisition of another profitable business, so they understand what becoming that kind of business consists of. I wish I had taken my own advice years ago. Buying a business, as a startup yourself, is truly much easier than starting it from scratch. It’s also a whole lot more likely to succeed.
Startups are fun. They are also a ton of work, and they come with no warranties. Creating a unicorn is possible, but very unlikely. Even if you can or do, you would still be well advised to have the experience of buying another business first, even if only to know what the process of ultimately exiting that business looks like.
New Products and Services
If you think about it a minute, creating new products and services ultimately involves a bit of organic growth along with a modified startup mindset. Here’s what I mean. You can’t sell the new product or service without some marketing and sales. You have to get them to market. And they are new. As new offerings to your customers, you have the advantage of goodwill that does not exist, in general, with a startup. But in many other respects, you have a startup of its own. A startup product or service, for sure, but that is what every startup is about, isn’t it? In the end, you still bear the risk it won’t take off. With the existing business acquisition, it already has. What more do you need to know?
Passive investment is often thought of as a separate category of investment altogether, as in the other options we are considering, you are or become the majority or sole owner of the business. But the people I work with are often people who would typically be angel investors if not for their disposition to own their own business. But if you choose to consider a diluted, minority interest, you are entitled to do that.
In a passive investment, you are typically concerned solely with your return on investment. The percentage share you own in the business is not important at all. If you want a high return, you want to know the return is both liquid and accessible. While you can know these things in a business you own outright, your own business presents considerations around the consistency and growth of earnings, while in the passive investment, you are happy to receive all of your return in the appreciation of equity. By default then, return on equity becomes more important as you own less of a controlling share of the total enterprise and growth of earnings is more important when you are a majority or sole owner of the company. Neither of these is necessarily good or bad in and of itself, but it does call into question risk/reward analysis (RRA).
In other posts, we will dissect the mathematics supporting the RRA, but for our purposes here, I think it is reasonable to assert that where the reward/return on a Growth By Acquisition move might be 15-18% and the beta risk on that return is very small, i.e. there is a 95% likelihood you will earn between 10 and 25% on the investment in the 12 months following closing.
Meanwhile, on the passive investment, no doubt your goals are a bit higher, say to earn 25% or more on the investment, but the probability curve tells us that the 95% probability is that you will do anything from losing 100% of your investment to earning 200% on the investment. Huge risk, huge reward. If that is what you’re seeking, great. And though, you can never lose more than 100%, as the time horizon extends out further, the risk that it is NOT a unicorn investment increases in and of itself.
If you’re truly looking for stable returns with a positive upside, however, acquisition is probably your best friend. Simply stated.
There are many, many ways and many options for trying to grow your business. Often, the most efficient and effective way to get there, however, is to buy the success of another business and continue operating as if it as your own in the future.
As always, if we can help, please give us a call! With your latest Landmark recap, I’m Drew Thompson wishing you the best of success in your business today!