Every day new startups launch with 90% failing within a few years time. That can be a very discouraging prospect for many aspiring entrepreneurs.
An alternative path to entrepreneurship has gained a lot of attention in recent years: entrepreneurship through acquisition. It promises a way to own and run a company, free of the cold start problem and risks associated with starting a new business from scratch.
But for whom is this the right model and how can someone go about becoming an acquisition entrepreneur?
This guide answers everything about how to get started in ETA, picking the right acquisition target, attracting the right deal flow and financing a purchase.
Entrepreneurship through acquisition, commonly shortened to ETA, refers to the path of buying and growing a small business as a means of becoming an entrepreneur.
As opposed to building a startup from nothing, acquisition entrepreneurs simply buy an existing business with product-market fit.
The main benefit is one of risk. Established small businesses, while still not the safest asset class, are by far less risky to run compared to starting a new company in search of market validation.
Moreover, buying an existing business commonly means revenue is being generated, alleviating the pressure of getting first customers and iterating the business.
Hence, an acquisition entrepreneur enjoys reduced risk and time to market with a viable product or service.
Of course, there are also downsides to entrepreneurship through acquisition. For one, not everyone simply has the means to buy a business or struggles to finance an acquisition (see “Financing an acquisition”).
With potential investors involved, acquisition entrepreneurs will also not have as high of an equity stake in their business as compared to starting the business themselves.
Acquisition entrepreneurs who raise external capital to buy a business to then run are commonly referred to as searchers, or running a search fund.
It is common practice that search fund entrepreneurs own 25% of the acquisition target, with the capital provided by their investors.
Before jumping straight into buying a small business, aspiring entrepreneurs should first learn the ropes. Fortunately, there are many different resources that can be leveraged to make a decision on if ETA is the right path and how to best prepare.
For those who don’t have the time or means to attend one of these classes, there are plenty of free resources on the internet, as well as knowledgeable communities.
It is always worth reaching out to people who have gone down this path before and learn from their journey.
Lastly, there are many search funds that actively look for helpful employees in different functions. Finding a relevant job can help build up an understanding and experience before taking the plunge yourself.
Before attempting to search for a business to buy, an acquisition entrepreneur needs to understand which is the right type of company to search for. A few factors need to be considered here.
Firstly, the company should preferably be within an industry the acquirer is familiar with. Taking over a business with no overlapping background is possible, but very challenging.
Considering the time horizon, the business should have been around for at least a few years. A proven track record is a great indicator for the future viability of the business and also improves overall brand and perception of the company.
In terms of size, the company should generate enough revenue to sustain the buyer and allow for refinancing of a potential loan that was taken out to buy the business.
Valuations can rise up to $20 million, depending on the financing possibilities and ambitions of the buyer.
Buying a smaller business will obviously be much cheaper, but also puts a lot of pressure onto the founder to grow it quickly.
An exception can be companies with very high margins, for example SaaS companies. Here, cash flow can be so high that a smaller company is still a very attractive target.
Similarly, a good business should have margins of at least 15%. This is not only a sign of a healthy business, but also one that can withstand a downturn.
Buying a venture with slim margins increases risk, especially when acquired with debt.
The best customers are those who keep engaging with the business, for example through a recurring revenue/ subscription model.
This means that once the entrepreneur takes over the business, they don’t have to fear rebuilding a new customer base from scratch.
Lastly, location is important. If the acquisition target is a business with a physical footprint, the buyer will have to personally move there - and be happy to do so.
Buying an internet business is a lot easier in this regard, as they are in most cases transferable and easy to run from around the globe.
Finding the right business can be a difficult and lengthy process. Many searchers spend two years looking for the right acquisition target before finally closing the deal.
Being prepared for these long search times and having the financial stamina to shoulder a full time search without any income is key in becoming a successful acquisition entrepreneur.
The first channel is proprietary deal flow. It refers to a buyer having the first chance to acquire a business before the company is presented to other potential buyers.
In essence, it means there is no competition for the acquisition target and the entrepreneur can buy the company for a fairly cheap price, as there is no bidding war.
Of course, this sounds like an amazing opportunity. Proprietary deal flow is, however, hard to come by.
Searchers relying on proprietary deal flow spend a lot of time on cold outreach to sometimes thousands of businesses to assess if they are in the market.
Moreover, many founders of acquisition targets will actively seek out other potential buyers when seriously considering selling their business
An alternative to proprietary deal flow is engaging with brokers. Brokers help business owners prepare for a sale of their company, engage with potential buyers and handle many of the aspects of the actual transaction.
Brokers take a lot of the search efforts off the acquisition entrepreneur’s plate, but come at a cost. Depending on the size of the acquisition target, commission fees between 5-15% can be charged.
Even if a broker only charges the sell-side (which is rare), the fee will still impact the purchase price. Moreover, brokers always engage with multiple potential buyers and encourage auction-style bidding to increase their take, so acquisition prices can fluctuate.
Instead searchers should leverage acquisition marketplaces. Platforms like BitsForDigits (shameless plug) allow business owners looking for an exit, be it a full or partial acquisition, to list their company and get approached by potential buyers.
The benefit of using a marketplace for identifying an acquisition target is that they are commonly much cheaper to use than a broker and still connect buyers with sellers who are actively looking for an exit opportunity, thus saving a lot of time on outreach.
Finding a good business is one thing, paying for it is another. Here, different models can be employed.
Firstly, acquisition entrepreneurs can simply fund their purchase themselves. This is also referred to as self-funded search.
The entire cost of an acquisition is shouldered by the future CEO, which has the benefit of being the sole owner with no other shareholders to answer to.
Self-funded acquisitions tend to be much smaller, as many ETA entrepreneurs do not have the personal funds to buy a $10 million annual revenue business.
In the United States, Small Business Acquisition (SBA) loans are a common practice in financing a company purchase.
Here, a lending partner (e.g. a bank) will loan the entrepreneur the necessary funds to buy a business to then run.
In a traditional search fund model, the ETA entrepreneur will raise capital from external partners to buy a business.
These investors will then commonly hold around 75% of the company, while the searcher keeps 25% in return for finding, acquiring and running the company.
Usually, investors receive preferred stock to ensure liquidity preference and incentivize the entrepreneur to grow the business aggressively.
From here, an acquisition entrepreneur can negotiate and close a deal to then take over the business as the new CEO. In many cases, the former owner leaves the company.
This is where the real work begins and the company is often repositioned for growth.
Get the weekly newsletter and access the marketplace.
Sign up for free to sell or buy tech startups & internet businesses.