Buy, Don’t Build

What do companies such as Tesla, WWE, and even Coca-Cola have in common? Besides being behemoths in their respective industries (we can debate Tesla is more hype than it is fundamentals), they all were purchased from their respective founders and taken to the next level by the buyer. Before Elon came along, the Tesla prototype barely worked. WWE was a small rinky-dink company in a fragmented industry and Coca-Cola was still a fledging soda fountain drink.

Have Immediate Cash Flow Day One. Buy Don’t Build.

Sometimes the worst person for a company IS the founder. And once more, as the founder, they are often too close to a company to see what exactly the problem is that is preventing a company from scaling and hitting that next level. Many founders find themselves in a position where the business isn’t a business for them but a job. Instead of working on the business, they work IN the business.

I have firsthand experience in this. I started a cleaning company earlier this year. In the beginning, I was the one answering the phone, fielding customer emails, and sending out quotes in addition to handling all the marketing and strategy. I was working in the business and it was just a job for me (A poor-paying one at that. It’s not uncommon for founders to take reduced or no salary in the beginning). In the startup world, this is called going from 0-1. It’s a lot harder going from 0-1 than it is from 1-2 because at the 0-1 phase it’s not a business yet. You don’t have systems in place. And there is no capital. 1-2 it’s a business. You have capital and maybe even some employees so you can focus on the overall business strategy.

We are especially in a time where it can be more advantageous to buy rather than build. There are approximately 2 million businesses owned by baby boomers. Sure, most of these businesses aren’t suitable for ownership (probably just 1 guy doing gigs under an LLC), however, even then there is lots of opportunity for those who find themselves in a position for an apprenticeship buyout type of situation.

Many boomers don’t have heirs who wish to acquire and continue the business, opting for careers entirely independent from their birthright. This is an opportunity that as of yet, has not been overrun. Namely, because it’s difficult to find these owners. Of course, this can be wrought with landmines such as businesses being dependent on one client, poor or nonexistent financial statements making due diligence nearly impossible, or employees all quitting on day one. Acquisitions can require a finesse that can require professional experts. Explore working with M&A advisors or business brokers to get a beeline into the acquisitions space.

Make things easy for you. Reduce your brain damage. Have Cash Flow Day One. Consider buying a business.

The Owner’s Paycheck

“Cash rules everything around me. C.R.E.A.M. Get the money. Dolla, dolla bill y’all.”

-Wu-Tang Clan

In the world of lower market M&A, SDE is the principal reason a buyer acquires a company rather than build from scratch. It’s arguably easier to buy rather than build. Seller’s Discretionary Earnings (SDE) are the barometer of small businesses. It’s the metric that reveals the true profitability of a business, beyond what traditional financial statements might show. Whether you’re considering buying a small business or preparing to sell one, understanding SDE can mean the difference between a fair price and a great deal. Let’s delve deeper into what SDE actually is and its significance in lower middle market valuations.

At its core, SDE represents the total financial earnings a full-time owner-operator would realize from a business annually. This isn’t just a technical term for accountants to bandy about; it’s essentially the business owner’s annual ‘paycheck’ for operating the business. Seller’s Discretionary Earnings are what gets an owner up in the morning each day.

It’s important to note that SDE can vary significantly across different types of businesses. Tech/Consulting style businesses, for instance, often boast high SDE due to typically higher margins and lower direct costs. Conversely, Brick & Mortar style businesses tend to have lower margins, given the additional expenses such as rent, utilities, and other operating expenses that must be considered.

To calculate SDE, one starts with the net profit from the financial statements and makes adjustments for:

  • Owner’s Salary and Benefits: All personal expenses paid through the business.
  • One-time or Non-recurring Expenses: Such as unique legal expenses.
  • Non-cash Expenses: Including depreciation and amortization.
  • Discretionary Expenses: These may range from travel to entertainment expenses not essential to business operations.

For sellers, an accurate portrayal of SDE can significantly enhance the perceived value of their business. It provides a truer representation of a business’s earnings, reflecting what an owner truly gains from the business. If taking out a loan to acquire a business, SDE can give an owner insight into how much profit they will take home after loan payments.

For prospective buyers, SDE is a crucial measure of a business’s underlying profitability and potential for future growth. If taking out a loan to acquire a business, SDE can give a buyer insight into how much profit they will take home after loan payments.

The New Leverage

In business school, I learned about different types of leverage such as capital and labor. We are now in the 4th industrial revolution and it introduced tech and automation. Naturally, this has created newfound wealth for the individuals who have successfully leveraged it. But I would like to talk about the new leverage: audience.

Yes, audience. Social media created a new way of promoting businesses and getting ideas across. As cliche as it is, you don’t need everyone to like you. Hell, you don’t even need most people to like. Enter people such as the Kardashians, Donald Trump, insert any popular influencer here. They figured out a way to successfully use social media as a tool to get their agenda across. Why can’t you do the same?

Decentralization is a buzzword nowadays but many have only hit the tip of the iceberg. What if I told you this applies to media, too? What if I told you have the same tools they have (Except the social media team(s). Authentic content is better anyhow). In addition, with the functionality of these sites, you don’t have to be on them all day every day. You can schedule posts and go about your business.

Imagine the implications this has with capital raising. Traditionally entrepreneurs would have a Friends and Family round to raise money for business ventures. If you have a sufficient audience, 1 post about your project can be all you need to raise the capital. There are people right now raising $10 million in 1 week from Twitter followers. And these same followers will help you get the word out so you have customers on day 1. This drastically improves the success rate of new ventures as many businesses fail in the first year primarily due to lack of profitability.

Building an audience isn’t easy. Nor fast. Like most good things, it takes consistency and effort. But it will pay dividends going forward.