Lesson #246: Buying a Business is Hard Work!!

As you may know, Red Rocket has been on the hunt for a business to buy.  We are specifically looking for digital technology companies with at least $500,000 of profit, where we can apply our sales and marketing expertise to help grow those businesses.  We have looked at over 50 businesses in the last few months, but have yet to get to the finish line.  I wanted to share some learnings with all of you, in case you are ever on the hunt to buy a company.  As you will read: buying a business is really hard!!

LOTS OF HUNTING REQUIRED

You need to explore multiple channels in terms of knowing where to look.  Leveraging your network, reaching out to investment bankers or business brokers in your space and even searching online, on sites like BizBuySell, BizQuest and BusinessesForSale.com, are all fair game.  And, it is a fluid market, so new stuff comes up all the time, so you need to constantly be working these channels in high frequency, to make sure you don't miss anything important and be able to move quickly.

CUTTING THROUGH THE CLUTTER

Firstly, there is the process of narrowing down the targets that are most interesting to you.  Even if you are narrowly focused, on something like e-commerce businesses, as an example.  There are so many different types of products being sold across a wide range of revenue size, and needing to narrow them down to the ones which are most interesting for your needs.  And, secondly, how a company markets itself for sale, does not always match up to the reality of the situations once you start due diligence.  For example, they said they have $1MM of profit with the way they had been running the business (on a shoestring budget), but fully loading expenses on a going forward basis, maybe it only has $500K of profit, which materially changes the story.

DUE DILIGENCE SHORTFALLINGS

In addition to the financial due diligence shortfalling described above, there is often times operating issues that get uncovered during due diligence, as well.  As an example, you think you may be buying a strong e-commerce business with a lot of direct traffic to their own website, but often times they are simply Amazon dependent sellers that look to Amazon for marketing to customers and fulfilling orders.  That creates problems like, Amazon owning the customer list, not the business, and risks Amazon disintermediating this product seller with similar product or squeezing them on margins long term, putting the future financial health of the business at risk, entirely dependent on Amazon.

LOTS OF COMPETITION

There is a lot of money on the "sidelines", looking to be invested into interesting businesses.  And, the more attractive the business, or more profitable the company, the exponentially more investors looking at the same business.  Which means you need to be prepared to move quickly (with capital lined up) and potentially pay premium prices to outshine the other offers, or risk losing the deal.

INSANE VALUATIONS

Many companies just don't have a reasonable expectation to what their business is really worth, with them proposing very high asking prices.  For example, if they are in the venture world, they drink the Kool Aid of "unicorn-level" valuations multiples (e.g., 10x revenues).  When the reality is, without them venture funded and growing a lot slower, they are typically valued at more reasonable 3-4x cash flow multiples.  So, finding a seller with reasonable valuation expectations is not always easy.

MULTIPLE PARTIES TO PLEASE

There are typically three parties involved in any transaction:  the seller, the buyer and the financing source.  If you can finance the transaction yourself with your own cash or equity, that is preferred, given one less party to make happy.  But, if outside private equity investors are required, it materially complicates things.  Because not only do you need to like the business, but the investors need to like the business too.  If any one of the "three legs to the stool" is wobbly, the whole deal can fall apart.

LOTS OF HOURS INVESTED GOING NOWHERE

Based on all the issues above, you often need to invest many hours of work into any single project before realizing it will never get to the finish line.  This is not a really efficient use of time, but the process is what it is, and you really don't have a choice, unless you outsource the deal searching, due diligence process and fund raising process to others.  So, be prepared to be frustrated and spin your wheels.

Hopefully, this gives you a good expectation of what to expect when starting to hunt for businesses to buy.  But, if you are persistent and patient, all it takes is one deal to get to the finish line!!

Be sure to read these companion articles on Things to Consider for M&A, Setting M&A Goals and Potential Pitfalls with M&A.

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #245: You Cannot Cut Your Way to Growth

I recently wrote about the war between driving growth and profitability, and that you cannot successfully maximize both at the same time.  The key point here was driving growth requires additional investment in your business, in the form of new sales and marketing activities, the expenses of which put negative pressure on your bottom line.  But, what happens when that additional investment takes your business into a short term loss position?

You would be surprised how most entrepreneurs would answer that question, especially in family-run businesses where every business expense is perceived as taking monies away from their personal expense needs.  There seems to be a general aversion to losses and taking on debt to cover those losses.  So, instead of raising the required capital needed to fund the full need, they try to cut expenses in other areas of their business to make room in the budget for the sales and marketing need. Or, they simply lower their growth objectives to a more affordable level within their current budgets. All, reactions of entrepreneurs that typically don’t know what is required for long term success.

Why You Should Fund the Full Amount Needed for the Plan

At the end of the day, your long-term goal, should remain your long-term goal.  If your management has collectively been hired to help you grow a $10MM business into a $100MM business over the coming five years, you are going to ruffle a lot of internal feathers if you suddenly switch directions to building a $20MM business.  Those executives signed on to help be part of an exciting 10x growth story, not a 2x growth story, and you most likely will lose them with that move.  Especially, if they were recruited with an equity stake in the business, and they suddenly realize it is only worth 20% of what they thought it was going to be worth.  So, think through the ripple effects of your actions.

Why it is Perfectly Acceptable to Incur Debt

Where in the Business 101 handbook did it ever say debt was bad and should be avoided at all cost. That certainly could be the situation for companies with no reasonable way of paying the debt back, forcing them into bankruptcy if they miss their payments.  But, for most healthy companies that are producing long term cash flow, debt is a perfectly acceptable vehicle with which to fund your short term needs.  It is certainly a lot more affordable than diluting your equity ownership with a new equity financing.  So, debt is not a bad word, it is a perfectly acceptable way to capitalize your business for up to 50% of its needs, provided you have a credible plan to pay it back.  How do you think private equity firms make all their super-sized returns on their portfolio investments—it is not by investing 100% equity for those companies.  Debt helps them leverage their equity resources, to stretch their equity farther and drive a higher return on their equity investment.

Why it is Perfectly Acceptable to Take on Losses

If you look at the growth curve of any startup, almost all of them start by incurring losses in their formative months or years, as the revenues are simply not there yet to cover their startup expenses.  It is absolutely no different for later stage companies: think of your increase in growth investment as like another startup-like event that is perfectly normal and expected.  It is not a bad thing to incur losses if there is a logical reason for the expenses, like needed investment to help jump start long-term revenue growth.  That $1MM loss today, could be the difference between $50MM and $100MM in revenues five years from now.  So, don’t focus on the short-term impact of the loss, focus on the opportunity cost of what you are leaving on the table by not incurring the loss.

Why You Don’t Cut Monies from Other Departments

And, taking money from other departments is not the answer either.  Let’s say you need $1MM of new investment in sales and marketing.  But, your technology department also needs $1MM for new product development needs.  And, you only have $1MM of free cash flow to work with.  Sure, you could give each $500K, but that only helps the business accomplish half of its desired goals.  But, if you tell the technology department to delay your investment in new products for a year, it is not long before your engineers quit or your customers are not seeing innovation and move to your competitors.  And, then you will have an even bigger financial mess to deal with.

Concluding Thoughts

The only time you should take out the hatchet and start cutting expenses, is when your business is broken and your economic model is flawed.  Or, if there is an economic slump you are trying to navigate through.  But, if you have a healthy business and you are trying to accelerate your growth, you really shouldn’t take the hatchet to any part of your business in order to better afford the additional expenses.  Instead, you should finance the full need of the plan, either with debt or equity, whatever is more appropriate for your specific situation.  And, if you are simply trying to avoid diluting your ownership stake, I ask you one question:  would you rather own 100% of a $20MM company or 80% of $100MM company?

For future posts, please follow me on Twitter at: @georgedeeb.

Lesson #244: Stop Selling the 'What', Start Selling the 'Why'

You gotta love entrepreneurs.  All their passion and excitement around the innovative new products they are building.  And, they love talking about their products with others, detailing every feature and functionality of their offering.  They are laser-focused on getting others to love their products as much as they do.  But, then they realize, sales are not coming in.  They question how can that possibly be, given how great our product is?  It’s about that time I usually need to tell them, their customers don’t really care about the product itself (e.g., the “What”), they care much more about how it can improve their business (e.g., the “Why”).  The sooner you learn to ditch focusing on the “What” and start focusing on the “Why” to get their attention, the sooner your sales will start to accelerate.

Defining “Why”

For most customers, the things they truly care about are: (i) how will this help me drive more revenues; (ii) how will this help me lower my costs; or (iii) how will this improve my user experience (e.g., where users can either be their customers or their employees).  Sure, there are other things, but these are the big ones.  And, the bigger you can economically illustrate the impact of your product or service to helping them achieve one of the above three goals, the more attention they will give it (e.g., a 10% boost will resonate a lot better than a 1% boost).

Calculating “Why”

If you are pitching a revenue lift to their business, first you need to research what their current revenues are, and ideate ways on how your business can help them grow their revenues (where a minimum lift of 5-10% should get their attention).  If you are pitching a cost savings rationale, you need to estimate how big their current costs are, and how your product can help them lower those costs by at least 5-10%, where costs savings on their biggest expense line items will get more attention (e.g., help them maximize their overall margins and cash flow).  In both scenarios, you don’t want to price your product or service any higher than 10-20% of the overall revenue lift, or the overall cost savings estimated (e.g., a gross gain of 10%, may only net them 8-9% after they pay your fees).  Again, the bigger the lift, and the more of the lift they keep for themselves (vs. paying it to you), the better it will be for them.

A Case Study on “Why?”

When I was at iExplore, building my adventure travel business, I was trying to close a strategic relationship with National Geographic, and was pitching their CEO and CFO on the idea.  I tried to put on their hats?  What would get their attention?  With the traditional magazine industry hurting, I knew they were on the hunt for material new revenue streams with which to pivot their business (e.g., cable channel).  I also knew that the demographics of their readers, were frequent adventure travelers, buying active and experiential vacations like the ones iExplore offered.

I told them the collective reach of National Geographic was around 100MM households across their magazines, websites, cable channels, etc.  If we could get 1% of them to buy a vacation from National Geographic at iExplore’s average price of $10,000 per transaction, that would result in a $10BN revenue opportunity, or around 20x the $500MM in revenues they were generating at the time.  Needless to say, I had their attention, and we closed the deal.

I didn’t lead with the cutting edge features of our website, or the 5,000 trips we offered in our database or our snazzy marketing plan.  I focused on the economic impact of what it would mean to their business and the estimated financial return they could make from their investment in iExplore.  And, I gently let them know other media companies, like their direct competitors at Discovery Channel, were also interested in working with us.  That was simply the icing on the cake, creating the fear of missing out on a big opportunity to one of their rivals.

Summary

At the end of the day, you are selling compelling stories, not products. Hopefully, from this post, you have learned that the key to successful sales is putting on the hat of your customers.  How are you going to materially improve THEIR business (as they don’t care on how it is going to help your business)?  And, how are you going to make them look smart to their boss, so they can get the personal win?  Stop focusing on the “What” (as they don’t really care how it works, as long as it works) and start focusing on the “Why”, and good things will surely follow. 

Once you hook them on the “Why”, then you can backfill on the “What”, after you already have their attention.  Because, the “What” alone, may simply put them to sleep and your revenues on life support.  

For future posts, please follow me on Twitter at: @georgedeeb 

Need a Salesperson? Recruit Three!

A startup cannot survive without revenues, and more importantly, revenue growth that will impress investors.  And, oftentimes, this success rests squarely on the shoulders of your sales team.  Therefore, your sales team will make or break your success.  Hiring your sales team is arguably the single most important hires you are going to make.  You have to get it right!!

Read the rest of this post in Forbes, which I guest authored this week.

For future posts, please follow me on Twitter:  @georgedeeb

Personality Tests: Useful Tool or Lazy Shortcut?

For decades, personality tests have been used by big corporations to evaluate candidates during their hiring process. But, more and more, I am seeing early-stage companies using these tests to help them in their hiring process. I am not sure who is pointing them in this direction, most likely the increased access to free online personality tests. But, just because they are there, doesn’t mean you should use them. They are often used as a crutch to help make decisions, instead of using true leadership by hiring managers. And, often times, the practice does not result in actionable changes within an organization. Let’s dig deeper here.

Read the rest of this post in Entrepreneur, which I guest authored this week.

For future posts, please follow me on Twitter at: @georgedeeb