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Small Business Acquisition

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I’ve been involved with acquisitions, big and small, on both sides of the table.

With small businesses, especially lifestyle businesses, these are some typical factors and scenarios:

Factors that will shape the deal:

  • Your goals for exit (financial, personal and schedule freedom, ongoing participation, etc.)
  • A specific “magic number” financial goal that will enable the future you desire
  • Your timeline for exit
  • Your market size (be as specific as possible)(industry association press releases, manufacturers’ press releases, market analysts reports and trade press stories are great sources for market sizing information) You’ll need to come up with specific $ sizing amounts for the applicable current and projected market segments. At a minimum, you need an “order of magnitude” number for your current and projected markets size, e.g. $2m, $20m, $200m, $2b.
  • Market growth rate (see previous point on good sources)
  • Your current revenue run rate (current revenue rate projected over 12 months)
  • Your trailing 12 months revenue (if you have annual revenues over $10m it greatly enhances your chances of acquisition by putting you into a large, general pool of viable businesses)
  • EBITDA run rate (current EBITA projected over 12 months)
  • Trailing 12 and 36 month EBITDA
  • Gross margin %
  • Comparable acquisitions in your market or adjacent markets
  • Top five companies most likely to acquire your company
  • The one company you think would be the best fit to acquire your company and why
  • Provisional or issued patents for any of the products
  • Trademark, trade secret or any other form of Intellectual Property (IP) protection on any of the products or designs
  • Barriers to entry that prevent your existing or new competitors from entering your market by duplicating your designs / products or designing around any of your IP protection

Does my startup idea suck?

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Here’s how you answer that question in 10 steps:

  1. The top five things that differentiate your company from your competition (these must be things that make you different, not better)
  2. The specific pain that you solve for your customers
  3. No more than eight words that describe how you solve that specific pain
  4. The six defining characteristics of your ideal customer
  5. Your market size in annual spending on your products/services expressed as ARTS:
    1. Addressable (all customers on the planet who could conceivably buy your products/services)
    2. Relevant (the portion of the addressable market who currently buys your products/services)
    3. Target (your ideal customers)
    4. Serviceable (the customers you could service with your available resources; here assume that you obtained sufficient startup capital to create the minimum business model reflected in your financial projection scenarios)
  6. The four reasons your products/services are need to have purchases for your customers (as opposed to nice to have or want to have)
  7. The most important customer benefits of your products/services (these must be customer benefits, not product/service features)
  8. Your top three barriers to entry (the things that your company has that prevent competitive entry, e.g. intellectual property / patents, technology, sales channels, trade secrets, etc.)
  9. The three things that make this new business a low-risk proposition for potential investors
  10. One sentence that states the reasons why your founding team are people worth investing in

The answers to those 10 questions will tell you if your startup idea sucks.

 

The Business Model

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There are seven stages in the life-cycle of a business:

  1. Assessment (ideas, resources, market)
  2. Seed (nurturing the idea)
  3. Discovery (discovering a sustainably profitable business model)
  4. Proof (proving the business model)
  5. Scale
  6. Execution
  7. Exit

 

Most people starting this journey for the first time think they will go directly from brilliant business idea to execution of a highly lucrative business model. What they miss is all the hard work in between that it takes to nurture their idea, discover a viable, sustainably profitable business model, prove that model and then scale that model into the highly lucrative machine of their initial dreams.

In addition, most of the business startup press, especially the maximum-buzz high technology startup media, concentrates on the Lean Startup methodology as applied to the business model discovery phase. http://theleanstartup.com/ This leads some first time entrepreneurs to believe that as long as they optimize the business model discovery stage of the journey, nothing else really matters. Unfortunately, this is not the case.

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The Best Type of Corporation

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Which type of corporation is best: LLC, S corp, C corp, etc.

First, an important disclaimer: I am not an accountant. I am not a lawyer.

This is a topic that affects your tax liabilities and your legal status so you need to educate yourself on the basics of this topic as well as discuss this in detail with an accountant regarding the tax implications and an attorney regarding the legal ramifications.

* * * * *

There are three main types of corporate entities that you will consider as an entrepreneur, all of which provide liability isolation but each with different tax consequences:

  • C corporation
  • S corporation
  • LLC and its variants

The best type of corporation for your business depends on many factors. In a very broad sense, if you are planning to seek outside equity (stockholder) investors to fund your business, then a C corporation will probably be best. A C corporation will be a requirement for any institutional investor and most angel investors. If you are planning a small-scale, lifestyle business and just need some liability protection, an LLC can be very inexpensive to create and maintain, while retaining simple, low-cost tax preparation and accounting costs.

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Cash Flow

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Cash flow is the top challenge for just about every new business in the world.

Most people who are new to business are fearful, if not overwhelmed, by the financial side of the business. Not many new entrepreneurs have a working understanding of the financial terms, much less the reports, used by business finance professionals. How many new entrepreneurs understand the differences between and the implications of cash versus accrual accounting? Not many.

This is a problem because people tend to avoid, downplay and fear that which they don’t understand. Accounting and finance are no exception. Entrepreneurs who have little to no understanding of finance and even less available time to go up the learning curve on it are naturally vulnerable to financial challenges, if not disaster, in their businesses.

The key to overcoming this is to focus on cash flow, because that is what will kill your business.

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Crowdfunding

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A relatively recent form of raising money to start or grow a business is crowdfunding. Crowdfunding is crowdsourcing for money. With crowdfunding, you take in money from a large number of people, each of whom contributes a relatively small amount. Lots of people each invest small amounts of money, thereby spreading the risk of any one business failure among a large number of people and providing anyone who wants to be in the game the opportunity to share in the upside of a big startup win.

While this sounds logical enough, taking money from others in exchange for a piece of your business is a highly regulated activity in the U.S. So many scam artists have fleeced so many widows, children and inexperienced investors out of their life savings to fund non-existent or otherwise fraudulent businesses that the Securities and Exchange Commission (SEC) has made it very, very challenging to accept money in exchange for equity in your business.

The SEC restricts private investments for equity to people who are “accredited investors.” Accredited investors are high-net-worth individuals and people who can prove they are sophisticated, informed investors. The pool of accredited investors is not tiny, but it’s not the millions to billions of people who are available via internet crowdfunding.

The SEC is currently reviewing their restrictions and may authorize an officially sanctioned form of crowdfunding. In the meantime, it is caveat emptor, meaning it is incumbent upon you to ensure that any money you take from anyone in exchange for equity is in compliance with any and all applicable regulations.

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The Initial VC Pitch

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What should my initial VC pitch be?

When you set out to raise capital, one of your biggest challenges is to craft and deliver an effective pitch.

If you’ve got a business model that is suitable for Venture Capital (VC) funding, you will be participating in a very competitive environment for only a relative handful of capital allocations.

Far fewer than 1 in 1,000 VC pitches receive VC investment, so it is very important to make the most of your opportunity.

The first and most important factor is to research the VC firm before you pitch them.

First, research the VC firm itself. Start with the basics. Do they invest in your market? Do they invest at your stage of growth?

Next, ensure that they have an active fund that they are investing. If the fund is closed out or the remaining balance is being held back to sustain their portfolio companies through tough times, then the VC firm is not a candidate.

Last, check their reputation. Are they people who are assets to their portfolio companies? Do they add value beyond the cash? Talk to CEOs in their active portfolio and, especially, seek out CEOs from companies that the VC funded but later abandoned, shut-down or otherwise shared a negative outcome. It is very important to discover how the VC responds to adversity since every startup is a long string of adverse events overcome, one-by-one.

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Funding via MicroLoans

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Funding my business; all I need is a small amount to get started

By far the most popular challenge here at the Idea to Exit answer desk is funding a business, especially in the initial stages.

The first step in funding a business is to understand the basics of funding.

Those who are pursuing a small-scale, lifestyle business or bootstrapping their startup may only need a few thousand dollars to get their business started.

One path to small amounts of startup capital is a microloan.

Microloans are best known for helping people in developing economies build small businesses via loans of very small amounts, from a few dollars to a few hundred dollars, through programs from Non-Government Organizations (NGOs) such as Kiva http://www.kiva.org/ .

However, there are also microloan programs in developed countries, including the U.S., whose purpose is to fund small business startups by making loans in amounts of a few thousand to tens of thousands of dollars.

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Patents

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I have been granted a patent by the United States Patent Office. I am seeking funds to help with the manufacturing in China.

Congratulations on your patent.

By obtaining a patent, you have obtained Intellectual Property (IP) protection for your product. In order for a competitor to directly compete with your device, they must either pay you a licensing fee for the use of your patented design or create an alternative design that accomplishes the same purpose.

In a broad sense, you have erected a barrier to entry for competitors. Barriers to entry can be created by a dominant brand position, capital resources, unique product capabilities, proprietary sales channels, vendor and customer relationships, etc. All of those barriers to entry are market based.

A patent is a legal barrier to entry in a specific market. In your case, you have a U.S. patent, so your design is protected in the U.S. market. A country specific patent protects products in that country. An International Patent protects a design in all countries who are party to the international patent agreement.

The burden of any legal barrier to entry such as a patent or copyright is that it is incumbent on you, the patent holder, to enforce your rights. That means you must police the marketplace to discover infringing products and file (and pay for) legal action to stop the infringing product’s sales.

The upside of a patent is that it provides legal and enforceable IP protection. The downside is that you need the required capital and legal resources to enforce your patent.

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Requirements for business in my state

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Knowing the requirements to run a business

Starting your own business is a very daunting challenge, but there are many resources available to help you learn the basics of business.

If you are new to business, I recommend beginning with your local Service Corp of Retired Executives (SCORE) chapter: http://www.score.org/

SCORE’s services are entirely free.

SCORE can provide the basic information around the nuts-and-bolts of starting a business.

Beyond SCORE, your local public library has book, magazines, videos and audio recordings that address business topics.

There are a wide variety of online resources related to business, including:

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