Friday, August 23, 2013

Buy vs. Build Model

LBO vs Start-Up = ???

It Depends...

In 2005, I bought out an under-performing telecom company, by buying out their lease. Personal savings, friends and family contributed the necessary capital for me. It was a small retail-centric company. Two years later, I sold the business to a larger regional company. I lost a lot of money. Lesson learned? Equity is expensive.

When considering buying an existing business or launching one from scratch, there are a number of variables that entrepreneurs should consider:

1. High Margin or Low Margin: High margin businesses are more profitable, but require more capital (cash) to fuel that high margin. Low margin businesses are less profitable, but tend to sell themselves. The telecom company I acquired was immensely profitable on a per sale basis. But the volume was terrible. Fixed costs can be considered a sunk cost:  you have to pay certain expenses regardless of your sales cycle. Whereas Low margin businesses have high volume revenue streams which can carry your fixed costs, even if your company is in the red. For instance, large retailers remain in the red until after September.

High margin businesses consume a substantial amount of capital to launch from scratch. Think about most sophisticated technology and biotech companies. They require a large capital base to sustain capex, develop products, move products, hire talent, enter markets, capture market share, defend market share, absorb mistakes, develop new products, evolve business model, acquire horizontal or lateral companies, and the list goes on.

2. Working Capital : Running out of cash happens. Even worse, negative cash flow or ZERO sales can kill you. How do you fund working capital requirements? Unless your business can receive cash upfront per sale, you're better off borrowing money from a bank, vendor or alternative sources, versus using cash. Buying an existing company allows you to use cash flow from operations to sustain or even grow your business. Whereas most start-ups have a quicksand-like burn rate because they don't have tangible assets to leverage against.

There are always ways around working capital requirements. Depending on the product or service, you can revenue-split, re-package or re-sale a competitors product. You can also utilize a work-in-progress system. If you can get around this issue, then perhaps launching a company with a clean slate might make sense.

3. Don't reinvent wheel. Make a better wheel. When considering buying or building a business, I tend to consider my options by developing a "buy vs. build" model. Although similar to a replacement cost valuation, my model considers the cost of trial and error (volatility), the cost of developing a brand, probability of market acceptance, projected churn rate and the cost of technical know-how.

Your competitive advantage (and not passion, unless passion is your competitive advantage) is the most important asset you have as a business person. This could include market knowledge, financial/human/technical resources and timing. If you can afford time (long duration) and other resources, then market knowledge could be acquired.

But then again, that's why companies engage in mergers and acquisitions. Time can be lethal.

Sunday, August 18, 2013

Top Ten Reasons (Excuses) For My Hiatus (Disappearance)

Greetings. The summer is almost over. The New England weather will soon morph into bitterness, although with a spectacular fall landscape. I have been mysteriously away from my blog for many reasons. Some bizarre. Some outrageous. A few random. And definitely exhausting.

1. Deal Flow : - Beginning Christmas Eve, I've experienced an exponential growth in deal flow. I found it exhilarating yet stressful. From an outsiders perspective, acquiring a going concern might appear to be very linear. Step 1, Step 2, then Step 3. Unlike the movies, that is rarely the case. I had been targeting and negotiating with a Texas-based tech company for over a year. The deal fell apart due to a legal technicality (material averse clause). Deal size = $15M+.

2. Deal Flow (post February) - As a fundless sponsor, an efficient way to acquire a company is by advising the principals of the company. By advising a company, you can quickly gauge if it's worth you acquiring the company. It also lets you get acquainted with the seller, and he/she might feel that you have a vested interest in buying and building his/her company. Privately-held companies tend to have quirky and unusual challenges. These companies usually benefit from an outsider, plugged into the wacky world of finance/investment banking. I came across an unusual number of investment/merchant banking and consulting engagements. Usually with companies too small for a series A round and companies lacking scale (i.e. negative cash flow or unpredictable revenue). Some of these engagements affected my ability to pursue acquisitions and also robbed me of a personal life. Deal size = It depends...

3. Burn out : This thing of ours, requires tenacity, drive, discipline and the ability to be scrappy. Finding a potential deal is never easy. If you come across a company being marketed by a banker or broker, chances are that there might be a reason why it hasn't been sold. It becomes tiring coming across complicated deals, working the deals and then having an owner change his/her mind or realizing post-LOI that there isn't any rational way of financing the acquisition. Couple that with going close to three years without a vacation, and that might leave one a tad bit grumpy. And lazy. Deal size = $200 million.

4. Tired : Help?

5. Valuation : I came across a company with $15M in EBITDA; cyclical industry; 30 years in operating history; one feisty 80+ year old owner and one 60+ owner; the elder statesman wanted $110M at closing (unreasonable); the younger owner was open to $70M (fair); the deal collapse after months of haggling, arm twisting, flirting, etc. Rinse and repeat approximately nine times. Deal size : :/

6. Austin : Austin can be addictive in the summer. I've spent 80% of it here and find it to be an amazing place to do business. People are laid back and there's less of an opportunity to be affected by groupthink, which is rampant in Boston. There are also interesting companies within fragment industries, if you exclude technology. The downside can be the awesome weather, which can make you less "focused". Deal size = $5M.

7. Austin : He he he...

8. Bad luck : In a one week span I lost five deals. Five. After working on them on and off for roughly six months. This happens in the shark infested business of buying a business. Deals fall apart. Like New England leaves in the fall. Sometimes the disintegration process is random. Sometimes downright brutal. Coincidentally, I just received an email last night from a CEO stating that a previous potential acquirer promised to buy his company on September 16th at twice the price that he offered me two weeks ago. The company is worth 2x my offer if one were a strategic buyer. I am definitely more a financial buyer, so 2x at closing wouldn't make sense to me. However, at 2am, I sent him a sweetened offer of $1.5M at closing and $1.5M in seller financing over three years (reasonable). I also mentioned that I could close before the end of the month (true - I already secured the financing). Deal size = $3M.

9. Repairing personal life : I have not been on a date for over a year. A year and half to be precise. Why? I wanted to focus more on my business and I was exhausted after my last go-round. What I learned is that being single can be an asset when you're ambitious. It also brings clarity and allows you to focus on short/mid-term, time and capital sensitive initiatives. Unfortunately, it can also make you appear to be creepy when you're at an interesting bar in Austin, at 1:30am, with your laptop open. Deal size = -$1M.

10. Thinking : I spent a good chunk of 2013 thinking about everything. Thinking without asking questions. Thinking more alongside understanding. Understanding comes from assuming an external position when analyzing an abstract object or concept. For instance, if a company is for sale, it is more productive to think about the multiple reasons why an owner would sell their business. Some reasons why are positive, some, if not most, are negative. But either reason could be turned into a positive, and the price would reflect either position. $2M.

Lesson learned : The greatest skill that one can learn is constant motion...Mental and physical.