When you first approach investors, perhaps even before you start your presentation, you may be asked a seemingly simple question that may set you back on your heels. It is “What do you want out of your business?” Your first response might be “to make money” but what does that mean? Make money by selling your company in the short-term or long-term, provide a stable income for you for your entire career, or build a multigenerational family business? Perhaps your goal is not necessarily centered on financial rewards. No matter what your motivation is, you need to think long and hard about your goals before you start your business. Understanding your desired end game will help you make a number of critical decisions early on which could have a major impact in meeting your long-term objectives. As Yogi Berra once said, “If you don’t know where you are going, you’ll end up someplace else”.
Probably the first question you should ask is if you want to create a “lifestyle business” or a business that can be acquired by another company or become a large private or publicly traded company. A lifestyle business, the most common in the US, is described in Wikipedia as “a business that is set up and run by its founders primarily with the aim of sustaining a particular level of income and no more; or to provide a foundation from which to enjoy a particular lifestyle.” One needs only to look at the retail stores in a strip mall or think about franchise operators to find examples of lifestyle businesses. With them comes a significant amount of freedom along with a significant amount of restrictions. These considerations cover the range of being your own boss to not having the flexibility to take extended vacations. Owners of lifestyle businesses generally need to be content with a business that they can personally manage and, perhaps, rely on a few key employees for day-to-day operations.
From a fund-raising perspective, most investors will not be interested in your lifestyle business for one simple reason; there is no clear path for them to recover their investment in one lump sum. Financial investors typically realize their return on investment during a liquidity event such as an acquisition which is rare for a lifestyle business. An exception to this generalization is investors such as high net worth individuals or some wealth management advisors who are interested in receiving annual returns on their investments instead of a one-time cash-out payment. In these rare cases, the investors will more than likely want to invest in a well-established, stable company with a history of positive cash flow that will continue for the foreseeable future. Lifestyle companies are then most likely limited to fundraising through personnel, secured asset loans, or loans from friends and families. Based on the particular business and the owner’s qualifications loans from Federal, state, and local governments may also be available.
For entrepreneurs that envision their businesses being acquired by another company or becoming a public company through an initial public offering, an entirely different perspective is required. That perspective is based on one simple metric: consistent long-term profitable growth. This implies that the business can be expanded and managed by others and not totally reliant on the founders. It must be scalable. Today, some businesses are purchased for large sums of money based upon their concept and initial traction. These cases are rare and are based on the acquirer being confident that by leveraging their existing structure and market presence they can quickly justify their acquisition. To prepare for a merger or acquisition, an entrepreneur should keep in mind a statement made by Rick Burnes, the co-founder of Charles River Ventures, a highly successful venture capital firm, “Companies are bought not sold”. The key to this approach is to have a mindset that you are going to build an ever-growing business that you intend to operate for years. To implement this approach an entrepreneur needs to think through and implement the steps necessary to build a highly scalable business. To raise money from financial investors, the entrepreneur needs to be able to articulate what those plans are, when they should be implemented, and, of course, what is the long-term, defendable value they can offer. In formulating the business and its long-term vision, the entrepreneur should consider the following ten areas that would make it attractive to a potential acquirer. Most of these areas do not need to be addressed initially. Instead, think of these items as longer-term directions that need to be addressed at some point in the future but remember what Yogi Berra said. In the meantime, do not proceed down a path that does not fall in line with these activities when implemented later.
- Invest only in areas that compliment your core, distinctive competence. Outsource all other activities. (For example, do not do your own manufacturing or set up a nationwide sales channel. An acquirer will already have these capabilities.)
- Provide value that is independent of the founders continued involvement in the business as it scales.
- Be continuously profitable and growing (the acquisition must be accretive to avoid low valuations and extended due diligence).
- Have many respected referencable customers that are important to the acquirer.
- Fill a product/service void or help the acquirer increase their market share or expand into adjacent markets.
- Have a business model that the acquirer can embrace that shows that with their additional resources and expertise, they can significantly increase profitable revenue and “move the needle” in terms of their overall revenue.
- Have an objective, plausible story that convinces the potential acquirer that it is better to invest in your company than to attempt to duplicate your capabilities on their own.
- Show how your core business can expand to serve other markets (breadth) and/or can serve other needs for your existing customers (depth).
- Show your “stickiness” and how difficult it would be for existing customers to switch to another supplier.
- Have detailed records and financials that can withstand thorough due diligence.
In the early stages of planning or building your business, the items listed above may seem to be so far into the future that they do not seem to be relevant. Even if the business exit is too distant for you to think about now, the items listed above will help you bridge the gap between your vision, your strategy, and your tactics.