How To Evaluate A Potential Business Acquisition
As an advisor, I help people buy and sell businesses. I’ve noticed that every potential acquisition entrepreneur eventually asks the question: Is this a good business to buy?
What they want to hear is that the business they’re considering has no risk and unlimited upside, but as you might imagine, that doesn’t exist. Every business comes with risk, but every business also comes with an opportunity. In this article, I’ll be sharing the nine criteria I’ve developed for evaluating a potential business acquisition.
1. Growth Opportunity
This is the top priority no matter what your version of entrepreneurship looks like. I believe every business has a growth opportunity — you just need to decipher what it is and how it would work. When you find that growth opportunity, match it to your skills, abilities, interests and vision of what you want your day-to-day life to look like. Make sure it’s a fit.
2. Product-Based
Built to Sell by John Warrillow is the bible for understanding the benefits of product-based businesses. Service businesses are harder to scale, build value around and sell in the future because the success of the business model is based on the workload of the people, while products build intrinsic value to the company.
3. Industry Tailwinds
The life cycle of an industry goes like this: startup, adolescence, maturity, decline. In an ideal world, you’re looking for businesses in an adolescent industry because they have innate growth. When you have that kind of industry tailwind, it’s easier to grow your company along with it — just keep the same percentage of market share.
4. Real Brand Awareness
Is the business you’re looking at resonant in the market, or just established? Recognize that just because a company has been around for 90 years doesn’t mean it has brand awareness outside its customer base. We assume that because a business has been around for a while, everybody must know about it, but that’s not always the case. It’s true that leadership in the market is a disproportionate competitive advantage, but that attention is earned, not given.
5. Recurring Revenue
Businesses that have a strong amount of recurring revenue offer you a margin of safety, a strategy popularized by Warren Buffett. If you’re looking at acquiring a company, but its sales are largely transactional, that means you have a cost to acquire each of those customers — every time. On the other hand, if the company’s revenue is subscription based, you acquire them once and reap ongoing benefits.
6. Business Risks
Every business comes with risks. Your job as the buyer is to decide whether or not you’re comfortable with those risks. This is a question that nobody can answer for you. Often it’s the entrepreneur and not the business that is the risk in the equation.
Great tools for evaluating business risk include: Porter’s Five Forces, SWOT Analysis and Clayton Christensen’s “The Innovator’s Dilemma.” These tried-and-true models can help you quickly understand the economic structure of a business model, industry trends and technological opportunities and threats.
7. Third-Party Verification
You need a third party to verify every aspect of a company’s financials, starting with tax returns. Look for strong internal reporting so you can be sure of what you’re buying.
8. Transferability
The first part of transferability is ensuring the business has documented standardized operating procedures. The second part is a little trickier: the seller’s knowledge.
Specifically, does the seller have specialized knowledge or more general business knowledge? If you’re acquiring a business where the owner is deep in technical work every day, you need to know that upfront. Most buyers are looking to hand the technical work off to other people while they handle managing and leading.
The last part of transferability is workload. Is the current owner white-knuckling it eighty hours a week, or do they get their work done in twenty hours? If the latter is true, that would leave you more time to work on your business and not in your business.
9. Old Vs. New Economy Business Models
Think about Amazon. This is a company that is not just driven by new economy metrics like click-through rate and conversion rate. It is also powered by a staple of the old economy business model: a fulfillment network. By fusing these models together, Amazon went from selling books to having a market cap north of $1 trillion. And it isn’t the only one. Apple uses software, but it also engineers its own hardware. Tesla, one of the most innovative companies in the world, makes cars.
With baby boomers retiring, you have companies built on old economy principles that need to be transferred to the next generation. If you have new economy knowledge and skills, you should be looking for a business where you can merge these two models together and create something that will be strong now and decades into the future. I believe this is the greatest opportunity of our generation.
Asking The Right Questions
With these nine criteria, you thought you were learning to evaluate what makes a good company. But what I’ve actually been helping you see with greater clarity is this: It’s not about whether a company is a good buy, but whether you’re the right buyer.
To make that determination, consider why you want to be an entrepreneur, what you’re bringing to the table and what kind of day-to-day experience you want. Those answers will point you toward the right types of businesses, and when you find one with a growth potential that fits your version of entrepreneurship, that’s when you can use these criteria to determine whether you’re the right person to buy it.
